General question here…
For each $1.00 of deposits…generally speaking…how much can banks lend out?
I’ve read the figure before and can’t remember if it’s 100x or 1000x what they have deposited.
In other words, if they hold $1000 in deposits from a customer…can they then lend out $100,000, ($1000 x 100)?
I know there’s some type of Federal ruling on this that controls expansion of lending.
Can anyone clarify?
Thanks,
-Mike
Banking is a pretty straight forward business. You take deposits and make loans, in its simplest form. You can’t lend out more than you take in. Perhaps you are referring to the money multiplier effect. If a bank loans out $100 that money in turn transfers hands multiple times; borrower buys a house, seller buys another house from a developer, developer pays his employees and suppliers all with the same $100.
Actually, I don’t think it’s a 1:1 ratio as you say…
Dug up this from the book Who Took My Money:
“When you put your money in a bank, the law allows the banking system to lend out that money many times (it’s called leverage of your deposit; the bank is required to keep reserves that are only a fraction of their total deposits).”
What I don’t know is if it’s 1/10 or 1/100…
Was hoping to get some clarification here.
Thanks,
-Mike
You are correct the ratio is not 1:1, it is actually less than 1. If a bank takes in $100 of deposits and is required to maintain a certain level of reserves and capital then by definition they cannot lend out $100, they can only lend what is leftover.
Banks are highly leveraged operations with required capital ratios of about 3-6%, meaning for every $100 of deposits they must have $3-$6 in capital reserves or equity. The remaining $97 is loaned out or used to purchase securities.
Consider the quote; “the law allows the banking system to lend out that money many times over”. The key word is system, not just a single bank but the entire system can lend out your $100 in deposits many times over. Bank A lends you money, you then spend some of that money and maybe deposit the rest in Bank B. Now Bank B has funds to make more loans which follow a similar path.
So…more or less…5% is what an individual bank has to keep on hold after taking in a deposited amount into something like a CD.
The remaining +_95% they can use to achieve ROR that create a spread well over and above their averate rate they payout in interest on deposits.
This helps…thanks.
-Mike
That’s it in a nutshell, but capital/reserves can come from other sources as well. Such as paid in capital from sale of stock, or retained earnings etc.
Lending and earning a profit are the challenge. The difference between rates charged on loans and rates paid on deposits is called spread and this is the bread and butter of banking. The spread along with other fees earned by the bank must cover their operating expenses and credit losses in order to earn a profit. Banking is a pretty stable business until we hit a recession or other economic downturn, then borrowers default on their loans and banks have to write-off a bunch of that money. The old saying ‘your collateral is worth the least when you need it the most’ holds true for RE investors as well as for banks.