This is the 2nd source of inflation and the devaluation of the dollar. Who pays for this inflation? We all pay for this inflation to the banks because everyone increases their prices to pay for this interest. Of course if the bank does not have the hard currency on hand, it must borrow it from the fed at the current Fed Fund Rate which is by the way ZERO… Would you please recalculate the ROA or ROE based on these facts.
Let’s see, I can use someone else’s $10M in deposits and receive $4.7M revenue. Pay for my overhead (employees and facilites) about $1M. Pay myself $2.7M and contribute $1M to every Congressmen in my state and to both the Democrat and Republican parties. That should cover all my bases… I think I will start a bank…
At 20% reserve, the bank should be able to make a nice profit. Buying a house and putting 20% down would be the almost the same risk as lending from deposit at 20% if the housing market is stable. But if you don’t fix the deposit reserves to the same 20%, the bank will take the down and put it out on loan causing higher risk.
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Basically you’re pointing out that fractional reserve banking is inherently inflationary due to the multiplier effect. Agreed. That’s covered on the first day of Banking 101.
Your spread and profitability assumptions, however, are completely incorrect. I’m assuming this is the case because you’ve never operated, worked at, analyzed, or invested in a bank. This is not surprising as there are many folks on the internet who feel the need to pontificate on issues about which they know very little. So, you are not alone.
The current spread (yield on avg. earning assets less rate on avg. liabilities) for a typical bank is about 300 bps. (There is no bank in the country with a spread above 400 bps right now.) So, the typical net interest margin is around 340 bps. Operating expenses and the loan loss provision eat up another 250 bps, leaving us with a pre-tax profit of 90 bps. Subtract taxes and were down to an ROA of about 60 bps. Multiply that by typical leverage of 12.5 and we get to an ROE of 7.5%. Now, that’s where things stand currently. In good times, the average bank earns about 1% ROA and 12.5% ROE. But we’re not in good times. The best banks in the country in good times might earn 1.75% ROA and 25%+ ROE. But these are a very select few banks and only in the best of times. (Basically, you’ve got the margin and operating expense structures wrong, and have neglected to take into account the provision for loan losses.)
The average CEO’s salary and bonus for a bank with less than $1 billion in assets (which comprises 90% of the banks in the country) is around $550K. This is a nice chunk of change – don’t get me wrong. But it’s not out of line with what CEOs of companies of similar size (based on revenue and employees) outside of the banking industry earn. The absurd pay packages are almost all concentrated at the largest banks.
My points are that (1) most bankers in this country don’t make fortunes like those we read about in the news; (2) the banking business is extremely competitive and none have profitability models approaching anything close to what you suggest; and (3) based on your “I think I will start a bank” example, it’s clear that you have little idea as to what you’re talking about.
But at least you understand the money multiplier. So that’s a start.
