What stops a bank owner from depositing his money and giving himself a million percent interest on his account?
Where is the bank going to get the money to pay a million percent interest on the deposit?
The regulatory bodies that oversee banks?
And the bank’s shareholders, I should think. Who owns a bank themselves, nowadays?
Hey, as long as he doesn’t withdraw a big chunk of it, it’s just a number in a ledger.
What kind of oversight is there for banks? Does the FDIC check to see who’s doing what in the banks balance sheets?
A bank’s owner would have an interest in the bank making profit, so I assume you mean bank manager or partial owner.
Bank fraud may be increasingly common given the the country is now run with a goal of emasculating most government regulation. However IIUC the usual way to steal from shareholders and FDIC is to make sweetheart loans to one’s friends.
And any time you put numbers in one column you have to have the opposite number in a different column.
When the bank adds interest to your account they don’t just multiply your balance by 1.005. The interest is taken from other funds.
Banks have to keep their books in order just like any other business.
I guess the historical perspective should be mentioned.
Yes, at various points in history, banks have been more susceptible to being run by fraudsters keeping phony books (and sometimes not initially dishonest people keeping phony books out of desperation for their failed banks).
And there was also a general distrust of many banks, bank runs and ensuing financial panics, wild swings in inflation/deflation, etc.
This was one point to setting up the Federal Reserve system and the FDIC in the US (and equivalents in other countries), which do have requirements and regulations for banks.
And it’s generally worked. There are fewer bank runs and there are better incentives (or worse disincentives anyway) for keeping honest books. That’s not to say fraud and/or problems don’t happen as we’ve seen in the last few decades, but we’ve had fewer massive disruptions to our system and relatively few people have their entire savings wiped out by fraudulent banking practices.
That’s not to say you can’t set up a bank that operates outside the aegis of this system entirely. The flip side is it’s harder to convince people to deposit their money in such an institution, and even if the books are crooked there are few if any ways to actually extract the money created fraudulently - other banks, the Fed, etc being wary of lending or sending money to this bank, especially in large quantities.
A ledger isn’t just a piece of funny-looking paper. There are rules. You can’t credit one account without debiting another. Otherwise money would just appear out of thin air. That’s called fraud.
That is exactly what the FDIC and Federal Reserve do constantly. It’s a necessity if the FDIC is to fulfill the part of their mission concerned with seizing control of failing banks.
So the FDIC and Fed are the answer to my question. But as to the matter of interest and created wealth, when I get $5 of interest in my account, does that not increase the amount of wealth in the bank? Doesn’t the bank now contain $5 more invisible/intangible wealth?
No. Where do you think your $5 in interest comes from? It comes from the bank - they have to pay you that money from somewhere else.
The interest paid to you from the bank comes out of the interest that other bank customers are paying to the bank in service of loans they have taken out to buy cars, houses, and other expensive items. The difference between the interest paid to the bank from loan customers and the interest paid from the bank to you as a deposit customer is kept by the bank and used to pay for operating expenses (labor, infrastructure, etc.) and profit to shareholders/owners.
That explains it, then.
More generally, you could ask your question of any business owner – why doesn’t she pay herself a million dollars? There has to be money somewhere else in the business to pay the owner’s compensation, whether the owner calls it salary, bonus, or interest.
The questions seems more relevant to banking because the concept of fractional reserve banking often leads people to say somewhat loosely that banks are “creating money.” That is a misnomer as to any individual institution; a bank never lends (or pays as interest) money that it does not already have.
Don’t know about the US, but in Canada, no one person or corporation can have more than a 15% share in a bank, for just this reason: diverse ownership means no one person controls the bank, and that in turn is a check on fraudulent practices.
Assets - Liabilities = Net Worth
The money in your account is a liability of the bank, not an asset. When they pay you interest, they’re increasing the number in your account: their liabilities. Did that increase the “wealth” of the bank? Quite the opposite. Their assets are the same. What happened when they paid your interest is that the net worth of the bank (“equity”) went down, precisely because the interest in your account is yet another liability that they owe.
Assets - Liabilities↑= Net Worth↓
When banks are paid interest on their own loans, they are either increasing their assets (or quite possibly decreasing their liabilities). When the bank’s assets go up (or their liabilities go down), then that increases the net worth of the bank. It increases the cushion of equity. And the bank can use those positive payments of interest from their own loans to finance the payments of interest that they make to you on your own account. Anything that’s leftover can be paid as dividends to the bank owners, or even to help finance more loans to bring in even more interest in the future.
Your confusion probably comes from being primed with the “Banks create money out of thin air” … truth? scare?
But that is predicated on the same nature of book keeping that you ignored in thinking interest on an account creates money. When the bank gives you a loan, they have the same dollar value of assets. They used to have cash/account balance, and they’ve replaced that with your loan, which is also an asset.
The “out of thin air” comes when you, or someone else, deposits the money you just loaned in the bank and they loan it out again. But whenever the bank “creates money” this way, there is also a creation of “anti-money”*, the debt owed.
*make sure to spell that correct
You open a savings account with $10,000.00.
If you close the account, the bank owes you 10 grand, plus 2% interest.
I get a mortgage for $10,000.00.
To pay it off, I owe the bank 10 grand, plus 5% interest.
As long as I owe the bank more than the bank owes you, the bank stays in business, and can keep paying you interest.
Trying to remember the name of the guy Jimmy Carter picked to be his Secretary of Finance(?). The fellow owned or managed a small bank near Plains, and when the press started digging into his antics, they found a number of “how to milk the bank” shenanigans. Chief among these was making large loans to friends and family, and then writing them off as bad debts. (And to answer the OP, bad debts are covered by the interest paid by the people with good debts. )
Didn’t some of the kids of GHWBush also have these sorts of bad debt issues during the S&L problems in the late 80’s?
Neil Bush was on the board of a failed S&L, but I think he was too stupid to be a crook. It was one of those sweetheart things for the dunce of a powerful family.
Reposted from a closed thread:
Double-entry book-keeping should be a required curriculum for all high-school students. It really clarifies the movement of money. Here’s a really basic example.
Let’s start a bank with zero assets and zero debts, for a net worth of $0 = $0 - $0.
Alice deposits $1000 with the bank. That increases the banks assets by $1000 (that’s the cash on hand) and increases the debts by $1000 (what it owes Alice). The bank’s net worth is $0 = $1000 - $1000.
Betty takes $800 loan from the bank. That decreases the bank’s cash by $800 (cash given to Betty) but creates an asset worth $800 (what Betty owes the bank). The bank’s net worth is $0 = $200 + $800 - $1000.
The bank pays 1% interest to Alice. That increases the bank’s debts by $10, so the net worth is decreased to -$10 = $200 + $800 - $1010.
The bank is paid 2.5% interest by Betty. That increases the bank’s cash by $20, so the net worth is increased to $10 = $220 + $800 - $1010.
And so on. The important points are that every transaction changes two numbers and the equality is preserved.