Ask most and they would likely respond that banks make a signficant amount of money. As proof, the U.S. banking industry’s profits reached a record $62 billion during the third quarter of 2018, fueled in large part by the corporate tax cut. Without the tax cut passed by Congress last year, the industry’s profits would have been $54.6 billion, according to the Federal Deposit Insurance Corp., a banking regulator…still a pretty hefty figure.
The 29 percent increase in quarterly profits is just the latest indication that a decade after a global financial crisis that wiped out trillions in wealth, the country’s 5,400 banks have not just recovered but are even stronger. Banks are issuing more loans and profiting from more service fees, according to the FDIC data.
So how do they do it?
First, they understand the importance of CASH FLOW, and they manage it better than other businesses. Your money flows through them before you get to use it. Because of direct deposits, your money sits with them and is available for their use until you need access to it. Other financial institutions and the U.S. Government have figured this out as well. Before banks recieve our money, dollars are withheld for taxes and are directed to 401k plans automatically.
Second, banks understand the power of LEVERAGE. Financial leverage is the act of using other people’s money to gain a higher return or to control a larger asset you couldn’t do with your own money. When we deposit money into banks, we are essentially loaning money to them while they get to loan our money out to others.
Let’s say you deposit $100 into the bank and they pay you 1% for the use of your money totaling a liability of $101. In order for the bank to profit, they have to loan your money for more…say 4%. Therefore, they get back $104, pay off their liability to you of $101 earning a profit of $3. It doesn’t look like much, but the banks spent $1 to earn $4, equating to a 300% return. Do that often, and big profits can be made.
One last key to banks profitability is the use of COLLATERAL. Collateral is any asset that a borrower offers as security for a loan. If the loan is not paid back, the bank can take the asset. A house serves as collateral for a mortgage, just like a car serves as collateral for a car loan. Banks don’t like to lose money, and having adequate collateral in place protects their interest in the money they loan out.
Putting these key principles into place in your own personal economy can help you build significant wealth and keep you in control of your money while reducing risk.
