Why do banks give loans?

[erac22]

"Why would they want to risk their $$$ in the volatile markets when they got a sure thing?"

Lol, I think we're learning that it's not such a sure thing when dumb bankers make dumb loans. "Oh Bernanke, please bail us out!!!"

[DesertCat]

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+10%, +10%, +10%, -20% does not average out to 10%

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Seriously, when a bank loans money it is not lending savings it has on its books, it is literally conjured out of thin air.
How can you not know this? This is how Fiat money works.

Edit to add, though the amount of money the bank can create is related to the currency it holds on its books.

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Exactly. Fractional reserve banking. They are loaning out 10 times or more of what they have in reserves. Why would they want to risk their $$$ in the volatile markets when they got a sure thing?

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What are you guys talking about? Wells Fargo has $374B in loans but a net $380B in deposits and debt (subtracting out cash & securities owned).

[The once and future king]

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What are you guys talking about? Wells Fargo has $374B in loans but a net $380B in deposits and debt (subtracting out cash & securities owned).

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Just one bank. Banks are a closed loop backed up by the central bank, when you look at a system as a whole loans far out strip deposits. This is not conjecture. Watch the video I linked it explains it very well. (though the normative judgments it makes I am ambivalent about)

For example for each 1000K deposited (from the central bank) the banking system as whole can create 100,000K of loans.

[DcifrThs]

banks give loans to:

1) make best use of their capital (persuant to their role)

2) diversify revenue (banks make different duration loans now rather than all on one spot on the curve)

3) make good use of their ability to borrow cheap and lend expensive (credit spread)

those are the balance sheet type reasons that a bank loans.

the purpose of a bank, hwoever, can be debated as we now know many banks branch out from branch banking to commercial & investment banking after repeal of glass steagal (sp?)

the main issue with banking internationally is to avoid catastrpohe and thus Basel II and institution of VAR in determining reserve requirements (risker bank loans mean bank must hold relatively more on deposit than with lower risk loans).

it is always fun to read about banks makind mistakes that we now know are a bad idea (i.e. not maching assets & liabilities). most banks have learned from that and when the yield curve is very steep, they dont' put all their eggs in the borrow short/lend long bucket (though that is typically the bank's MO due to its structure)

anways, way off track, as usual. point is, banks make loans because it is profitable to do so and good for the economy.

the fed has a (not too often quoted) measure of of what a small unit increase in money supply does to growth. it is called the velocity of money. reserve banking is part of that velocity as a dollar flies aroundthe banking system it can end up with many multiples of itself available to add to domestic consumption/investment.

Barron

[Phone Booth]

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What are you guys talking about? Wells Fargo has $374B in loans but a net $380B in deposits and debt (subtracting out cash & securities owned).

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Just one bank. Banks are a closed loop backed up by the central bank, when you look at a system as a whole loans far out strip deposits. This is not conjecture. Watch the video I linked it explains it very well. (though the normative judgments it makes I am ambivalent about)

For example for each 1000K deposited (from the central bank) the banking system as whole can create 100,000K of loans.

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Fractional-reserve banking works by each bank lending x% (less than 100) of their deposits, and this creating a maximum money supply of (initial deposit) * 100 / (100 - x). This is greater than x, but in this scenario, the total amount of deposits is still always greater than the total amount of loans outstanding. Otherwise, the money supply growth would be unbounded.

[gonebroke2]

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"Why would they want to risk their $$$ in the volatile markets when they got a sure thing?"

Lol, I think we're learning that it's not such a sure thing when dumb bankers make dumb loans. "Oh Bernanke, please bail us out!!!"

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Excellent point. Should not have said sure thing. My point was that through the use of fractional reserve banking, they are loaning out several multiples of what they actually have in physical deposits. Hence their potential profits are a lot more than what the stock market can offer them.

[hawk59]

Banks are leveraged, their return on equity is much higher than their return on assets. Most banks are earning a mid teen return on their capital.

[Nomad84]

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point is that because of compounding, huge drawdowns carry enormous risk. 5% for 4 yeras is better than losing 30 the first year and making 20 the next 3 (and that even averages out to 10)

second, whats the profit percentage if you take someone elses money at 5% and then lend it out at 7%?

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Wrong again (by quite a bit), but I agree with your point that pure expected return numbers mean very little without also knowing the associated risk.

[MatthewRyan]

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Banks are leveraged, their return on equity is much higher than their return on assets. Most banks are earning a mid teen return on their capital.

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do you have a source for the mid ten return number?

[The once and future king]

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What are you guys talking about? Wells Fargo has $374B in loans but a net $380B in deposits and debt (subtracting out cash & securities owned).

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Just one bank. Banks are a closed loop backed up by the central bank, when you look at a system as a whole loans far out strip deposits. This is not conjecture. Watch the video I linked it explains it very well. (though the normative judgments it makes I am ambivalent about)

For example for each 1000K deposited (from the central bank) the banking system as whole can create 100,000K of loans.

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Fractional-reserve banking works by each bank lending x% (less than 100) of their deposits, and this creating a maximum money supply of (initial deposit) * 100 / (100 - x). This is greater than x, but in this scenario, the total amount of deposits is still always greater than the total amount of loans outstanding. Otherwise, the money supply growth would be unbounded.

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Yea, but most people dont conceptualize/understand how this works in practice. You end up with debt backed by debt backed by debt backed by debt. Let me give an example.

Say someone takes a car loan of 10K, they buy a car and someone deposits that 10K at a bank.

Bank A 10000 Lends 9000 Then someone spends that 9K and it is deposited at bank B

Bank A 10000, Lends 9000
Bank B 9000 Lends 8100

Now let us see what would happen if that process is repeated 10 times.

10000> 9000
9000 > 8100
8100 > 7290
7290 > 6561
6561 > 5904
5904 > 5314
5314 > 4782
4682 > 4304
4304 > 3874
3874 > 3486

As you can see each bank can show that its assets outweigh its liabilities, but we can see that from an initial debt of 10K another 58,616 worth of debt has been created in just 10 transactions.

This is also just from standard consumer deposits. Banks can lend at much greater ratios from deposits secured against the central bank.