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Pragmatic Capitalism

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How do banks make profits?

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I was reading this article about HSBC’s profits declining by 62%. https://m.ca.investing.com/news/stock-market-news/global-markets-hsbc-slump-eclipses-punchy-euro-zone-growth-signals-114662

If this was a normal business that profit drop could have collapsed its share prices by 50% in a day and file for bankrupcy or be acquired by another firm in a month.

But for banks it seems the same scenario does not apply i.e. Deutsch Bank is another example whose profits have collapsed but still endures.

So how exactly do banks make profits and how do they go bankrupt? Am I to assume that a lack of demand for loans is the cause for the profit drop? Or is it something else?

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Posted by Incognito 7
Posted on 02/21/2017 6:26 AM
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Private answer

Modern “banks” do a lot more than banking. In general, banks earn a profit by having assets that earn more than their liabilities. So, in a traditional banking model you make a loan at 6% and your liabilities cost you 3% so you earn a 3% net interest margin. But today’s banks have their arms in a lot more pots than traditional banking. I don’t know what HSBC took write-downs on, but it was probably a bad loan or trade. So, if a bank makes a bad loan then they eat the write-down against their assets.

But the basic gist of banking is to have assets that earn higher returns than your liabilities.

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Cullen Roche Posted by Cullen Roche
Answered on 02/21/2017 3:52 PM
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    Hi Cullen,

    I’m still finding it hard to wrap my head around the part where savers’ deposits are “low cost” liabilities for the bank. How does that work?

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    Posted by Incognito 7
    Answered on 02/21/2017 5:22 PM
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      Well, take a loan from start to finish. When you go into a bank to get a loan let’s say they approve you for $100. So, they create $100 in loans which creates $100 in deposits for you. This loan is an asset for the bank and a liability for you. The deposit is an asset for you and a liability for the bank. If it costs you 5% per year to have that loan then perhaps the bank will pay you 1% in interest on the deposit so you keep that deposit with them. The bank is earning a 4% spread on their net interest (the cost of the deposit vs the revenue from the loan).

      Likewise, the loan is a 4% net cost to you because you earn your 1% on the deposit, but you are charged 5% on the loan each year….

      Make sense?

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      Cullen Roche Posted by Cullen Roche
      Answered on 02/21/2017 5:30 PM
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