How do they do it?

[sweeps]

Re: How do they do it?

It's nowhere near 10 times because of the so-called drain ratio. Link (See the section titled "A more realistic model of money creation".)

Also, the multiplier effect is a macroeconomic phenomenon. There's no guarantee that a bank will get the money they lent out deposited back in their bank. In reference to irsmun's comment, sure, a bank can lend out most of that initial deposit, but if and when someone deposits that newly available money, the bank still has to pay 5% on that too.

[jmjj215]

Re: How do they do it?

I always thought the multiplier effect was just sort of a given -- could be relied upon. I guess it really can't if you're considering large scale economic events or disturbances.

[greedy4chips]

Re: How do they do it?

Awhile back I read an article discussing how banks do it, so forgive me if the numbers are a little off.

Assuming a single local bank has $30,000,000 in assets. They must maintain $3,000,000 in cash while the other $27,000,000 can be loaned out to individuals. Consider that a majority of that is loaned out in the form of mortgages, high interest personal loans, or invested through many stable means such as loans to other banks, treasuries, etc.

Interest earned minus default/uncollectable loans minus interest paid out minus overhead = profit. When you consider $27,000,000 at a minimum profit of 3-4% per dollar you can expect to make $1,000,000 per year. That is if all loans were simple interest, but when you factor in mortgages which typically have a huge interest to principal ratio for a large portion of their loan you can create a wave of profits to offset costs.

My interpretation of the article follows:

Take a 15 yr $150,000 mortgage at 5.75% would have $700/ per month average of interest the first yr or $8,400 of interest. $150,000 in CDs at 3.8% my local banks 1 yr CD rate is $5800 in interest. Netting the bank $2600 in profits. That same $150,000 lent out in car loans at 9.5% for 5 years earns the banks $13,200 the first year or $7,400 profit. $27,000,000 / $150,000 * ( ($7400 + $2600) / 2) = $900,000 profit.

Personal loans, motorcycle loans, and car loans to less financially sound borrowers can easily add another 2% to the loan but also the risk factor of not being paid back.