If you are a continuous visitor of Forbes.com, you will not be surprised to see that its ranking page on world’s top ten companies is occupied as much of more than half by bank and financial institutions. More surprisingly, the page hardly sees the first position taken by the company other than banking sector.
Why do banks remain on the top positions? The answer is pretty simple. While Forbes determines the rank based on several criteria, let’s look at the criteria from stand point of profit only. To make things simple, we assume that there is a bank engaged only in collecting deposits and making loans and also doing other traditional banking activities such as money transfer, investment in government securities, etc.. Let’s say the bank has $10 billion deposits which it collected at the interest rates, on average, of 3 percent. Out of this $10 billion dollar deposits, $1 billion will go to central bank if 10 percent is cash reserve requirement (CRR), leaving $9 billion available for making loans. Customarily, this bank will make loans at higher rates than deposit rates, say average of 13 percent. Here the spread between savings and lending rates is 10 percent, which is believed to be a major contributing factor for the banks to generate profit. If operating costs are covered by bank’s traditional transactions other than ‘spread income’, this 10 percent, which is equivalent to $900 million turns out to be a net profits of this bank. This simple math can help us figure out how banks earn a lot of profits.
Would banks remain on the top positions forever? Most probably. Even during the period of economic crisis, they were able to secure this position; normal situation is as such a boon for them.
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Petrica Molnar,
ReplyDeleteBanks will always be among the top companies in the U.S. and in the world. Let's look simply at how and what they do to explain this. They are the main financial intermediaries for most economies in the world. Normal every day people need a place to get the money they need to do the things they want, and they turn to banks. Even bigger companies turn to banks to take loans to do business. Even banks turn to banks to make up for loses or meat reserve requirements. Now that being said lets look at how they run their companies and how they make money and explain it. They do a great job of dealing with adverse selection and moral hazard, because they are so large and deal with so many people and companies that economies of scale, and diversification help them greatly. So most of their assets in loans are being paid back with interest helping them cover many of the costs and giving them profits to reinvest. Now because the economy relies so heavily on banks, the government will also bail out failing banks to insure that people keep and have their money safe that they deposit. So even if they fail or make mistakes they are given many more chances to reinvest and learn how to fix their mistakes. All this together is why banks will continue to be one of the leading companies in the U.S. and the world.
Under the assumption that banks engage in only S&L acquisitions and investing in government securities, then answer is quite simple. The interest rate spread is enormous. Simply put, banks must generate more interest income than they have to pay out on deposits. Banks are paying approximately a 1 percent interest rate on savings deposits and lending it out at 6 to 14 percent, not including credit cards, which could yield up 30 percent interest. That is an extremely profitable spread. Also, banks charge many different fees for the services they provide, such as, e-banking, application fees, and penalty charges, which are all a substantial portion of a bank’s earnings. On the other hand, while banks suffered huge losses during the banking crisis and were forced to write down billions of dollars in mortgage securities. All was not lost. Even though banks were forced to write down these mortgage assets from their balance sheet, there is still the potential to receive market value from foreclosures and short sales to recoup additional capital to lend and reduce load loss reserves.
ReplyDeleteWill banks remain at the top of Forbes list forever? I believe they will just based on lending activities and a personal saving’s rate trending in a positive direction once again. However, there is some risk that there will be regulations imposed on capital and liquidity requirements that will have a negative effect on profits. Therefore, opening the door for other blue chip companies to take over the top spots.
Brian Frisch
No one can debate the profitability of financial intermediaries and I do not expect their top ranking to change in the future. Our financial system is the backbone of our economy and financial intermediaries, such as banks, are an integral part of that system. When businesses do well, banks do even better, and when the economy is down, banks can still do well; individuals and companies will always need loans to operate. Their extreme profitability is not all that surprising when you consider their operations. Fixed costs are miniscule when compared to other large corporations, everything they touch is profitable, and they have very advanced strategies to mitigate risk. The recent financial crisis has proven that they are not completely invulnerable, but the speed at which they have recovered says it all. Modern financial institutions are absolute behemoths, and even as new regulations hinder their operations, financial innovations will ensure that they evolve and find new ways to make high profits. The only threat to their stance as the world’s top companies comes from energy companies, an equally important and profitable industry.
ReplyDelete-Matthew Moore
An interesting paper regarding banks profitability and the Volcker Paradox (the fact that increases in competition have not decreased profitability as you would expect to see in other industries):
ReplyDeletehttp://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_101-150/WP134.pdf
-Matthew Moore
Banks have always been among some of the most successful and profitable business enterprises. One of the reasons is that money in never outdated, never goes out of style, and is always in high demand. In most other forms of business, when a new product or service in introduced, quite often the firm’s machinery needs to be updated, and personnel retrained. There’s very little of that in banking. New financial concepts are quickly realized into new services with minimum adjustment costs. Since money is universally accepted everywhere, banks can easily borrow and lend among themselves and other financial institutions, as their money is their capital. No other form of business has such a liquid capital. Banks really give the meaning to the old adage “it takes money to make money.” And unlike virtually all other businesses, banks have almost unlimited growth potential, since they are able to continue expanding exponentially. It seems that the only roadblocks to banks’ growth are government regulations from the outside, and poorly thought out and risky financial operations from within.
ReplyDeleteMichael Kinsley
Avadella White
ReplyDeleteI believe, as long as money is available for lending, and it is, banks are in a position to make great profits; especially since, as was mentioned in the Blog, interest rates on deposits are so low. It has been reported by The Wall Street Journal that the Federal Reserves, during this time of economic down turn, has purchased $1.75 trillion of housing related assets proving its willingness to help fiscally strengthen financial institutions. Also, financial institutions tend to benefit greatly from stimulus dollars earmarked towards them as well as towards consumers. They benefit greatly when stimulus dollars and corporate incentives increase housing and vehicle purchases because both purchase types require loans from financial institutions. Additionally, the revenue the institutions receive from the service fees charged are huge. Even though Congress has recently stepped in with regulations regarding some of the fees financial institutions charge, I do not see these regulations negatively impacting the profits received from these fees. Financial institutions are always one step ahead of government regulations. One of the regulatory changes is, financial institutions can no longer charge over the limit fees on credit cards. I have been made aware of credit card companies encouraging customers to go over the limit because they will not be charged a fee and/or increasing the credit card limit knowing that all additional spending will incur interest fees, which increases their bottom line. They will however, be charged interest on the additional spending which will increase the company’s revenues. It appears that whether the economy grows rapidly or slowly, financial institutions will still make a profit.
I am not surprised at all to see that most of the top ten companies are banks. Through the fruition of the Federal Reserve Act of 1913, it unified many of the banks in operation today to help regulate the money supply in lieu of inflation. This power diffused along to many banks builds a unified front for both the banks and the trust of the people to allow the bank to loan or borrow their money. The bank takes this money and loans it back out to businesses and individuals for a profit most likely in the form of interest payments from the loan.
ReplyDeleteFor example; you have 25,000.00 dollars in a savings account that earns 4% interest. At the end of the year you have made 1000.00 dollars just from having your money in the bank. Nice deal, right? Your bank however is loaning out your money for various investment loans such as a Credit card, a Student loan a Mortgage or a small business loan, all of which are accruing interest at higher rates than that are received from the bank to the individual originally lending the money. Although you have earned 1,000.00 dollars from the bank; the bank has made much more from the loan of your money. Now; if you take the savings of that individual that the bank was able to utilize for gain and multiply that by the many people that use the banking system it is clear to see how banking can be so profitable.
To think about it in simpler terms; everyone I know or you may know places most if not all of their money in banks. The federal reserve and their regulation on the diffused power of the banks system has helped the bank to build a reputation of trust among most that it is a safe place to store/loan their money. With that being said the bank is usually the first entity to touch most money in circulation. By Federal regulation they are required to keep a small percentage on reserve and for daily operations and withdrawals (Typically 10 percent). The rest is used to invest and make profits.
Without restating the obvious or repeating what Bamadev and my classmates have said it is quite clear that banks were designed to do exactly what they are doing, maximize profits. The real beauty is how simple the model is. Depositors put money in, banks loan the majority of the deposits, and make a killing while the most significant risk exposure the bank has is making sure deposits are covered in the even there is a run on the bank.
ReplyDeleteIn addition to this the elimination of many customary free services has helped to increase bank profits also, like these charges for example:
1) Account transaction activity fees if a certain high dollar balance is not maintained
2) Loan shark type rates on charge account that have only recently been outlawed by the government
3) Loan origination, commissions, penalty charges and more.
Banks will continue to profit in similar ways because demand will always exist for the service that they provide. As far as deposits go the larger percentage of individuals that make regular transactions with others will maintain a need to put their money in deposit accounts to make transaction processing between party’s’ convenient.
Renell Anderson
How are banks still remaining on top when they should be the hardest hit during an economic crisis? With this economic downturn, more people are defaulting on their loans from the mortgages than before. Since you have more people defaulting,the money earned from the interest rates on the loans go as well. More peole have taken their money from banks, but less people have what it would take in order to get a loan now due to their deteriorating financial situation. More houses have gone into foreclosure and more jobs have been lost which should be resulting in less accounts being opened and more money being taken away from banks. The fact that banks are still realizing a profit even when people are at their toughest is a problem. If the people are hurting then so should the banks, after all without people and their money how can financial institutions still stand? But I guess at this point where the banks lost money in interest rates the gained in late fees on loans and early distribution fees (for those who had to crack open their cd's to survive). At this point if a bank is rendering a profit it should be given back to the people in order to assist the economy in recovering. With many people needing loans now more than ever before, the Federal Reserve should be giving back more money to the banks so that the banks can essentially loan out more money but with a lower interest rate over time as a way to help in this economic faux pas that was started by the banks. Since they make a profit when people are at their highst and lowest, taking a loss as a way to say "sorry" couldn't hurt.
ReplyDelete-AJ Sturges
To provide end to end solutions to individuals and corporations, banks have grown into huge organizations, beyond traditional banking. They not only deal with deposits and loans but also offer financial advisory services, provide investment services and also indulge in securities trading.
ReplyDeleteThese financial institutions make exponential returns through leverage (higher debt to equity ratio). Leverage helped financial institutions make lot of money before the financial crisis and also lose money (leading to bankruptcy) during the sub-prime crisis.
During the financial crisis banks with bigger net worth had better chance survival.So banking and financial institutions will always be in the top ten companies because of their assets and profitability and market value.
ANTARA MAJUMDER
It is no surprise that banks and financial institutions are the most wealthy and profitable companies in the world based on the simplest and most obvious of facts that money is their main and only business. When your entire existence revolves solely around the handling, investment, and maximization of customers' liquid money, it is only fair to assume these such institutions will be able to maximize their own profits through the money that they constantly hold and consequently lend out. When the concept of creating and selling a product is removed from a firm's operations and its only transactions involve the flow of liquid money, the possibility for maximizing your own profit greatly increases, hence financial institutions and banks will always hold the top spots for profit earning companies, especially as they increase in size and scope.
ReplyDelete-Javier Janbieh
I believe banks will always be near the top,if not the top on the Forbes list. My reason for thinking this is because they are near the top during tough economic times and the economy is getting better. That means that banks will most likely make more money when the economy gets better and grows.
ReplyDelete- Ajdin Alic
Banks in general get the opportunity to take the risk into their investments. Specifically speaking, banks are the targets of money. Whoever would save his money it would be a desposit in the bank. All of the options appear in a doable zone.
ReplyDeleteTake any kind of other investment for the firms and companies other than the banks. The first issue to be addressed in the capital and total assets, and from where to get the money aid. And plan how to repay. This issue would never be a problem to the banks. However, it is risky since banks would manipulate money that are not their also they have sort of obligations paying them back.
Abdullah Alessa
I believe that banks will remain on top for some time because that is where they have always been and continue to be. even in this economic crisis that we are facing because even in tough economic times they are on top and as the economic times are becoming better they will stay on top.
ReplyDeleteErika Brown
I believe that banks will indeed stay on top. People will always be depositing money in banks and they will also in turn be making loans. Furthermore, banks will issue loans at higher interest rates than the deposit rates; which highlights banks' primary motive -- making profit. In the above example the spread between savings and lending rates is 10 percent. As a major contributing factor for the banks to generate profit, they will continue to keep this spread income high. All in all, unless consumers find "another place" to make a loan or deposit their money, I believe banks will continue to stay on top of Forbes list.
ReplyDeleteWhat ells is there to say, I agree banks will stay at top of profitable businesses in the U.S. for generations to come. Like they say in order to make money you have to spend money and for those of us who don’t have the money right away have to borrow. Not only that but having money or not one has to eat and have some sort of shelter and will often take, you guessed it, loans out until they can’t anymore and even if they have paid back the initial amount the interest can stay for a long time. What can I say you can’t live with them and we can’t live without them.
ReplyDeleteAri Jacobovitz
Brittni Crawford
ReplyDeleteBanks are very important to have they are #1 for alot of reasons. Banks takes risk for alot of people everyday by loaning money out and allowing the use of credit. i agree with the article "banks can bring together the lenders and borrowers and offer suitable products to each party." when you ask for a loan the banks take time to figure out if you are liable person or not and how much they will actually loan out to you, they always try to work with you if they can. anyway it goes banks makes money through high interest rates, so they really never have nothing to lose and puts them on top of alot of businesses.
Brittni Crawford
Banks are on top and will stay on top because people will continue to go to them and deposit money and also borrow money form them with loans. and even during economic crisis banks sill remain on top so that's a clue that they are very important and that it will be very difficult for them to move from the top spot.
ReplyDeleteKim Brooks
I understand HOW the banks manage to continually make money, even in difficult times. However, I do not agree that this should be the case. If the country is suffering economically, why should a bank be able to make money? It almost seems that banks are exploiting the people who deposit money and also the people they give loans to. Since banks use the people's money in order to give loans, I believe there should be much higher rewards/incentive to deposit in any given bank.
ReplyDelete-Jacob Losen
I do not think banks are going to loose their first place in near future. Though the way they are earning profit does not look like justice to me, but people do not have any option at this moment. People deposit money in bank not only for interest but also for security. It is not secured to keep the earnings of one's life in home. Moreover, when someone wants to start a business and needs money he do not have any option other than lending money from bank at high interest rate.
ReplyDeleteShamsad Zaman
I dont think banks will ever have hard times. They will always remain at top position even during hard times. People will always have to go to the bank and companys also. They charge people high interest rates from all types of loans which are ridiculous and they also have other charges such as overdraft fees and other crazy fees which adds up for alot of people. There will always be somebody who needs to make deposits or need loans and a bank is the place that will do that for people to go to.
ReplyDeleteMike Truman
Nour Hijazi; Econ 2020 tues/thurs 10:40
ReplyDeleteBanks are a place most people deposit their money. No matter what the economic status of the country banks will always be in use. People are always going to need loans and want to make deposits. When the economy is in crisis I believe that banks will make more money off loans because people will demand them more.
Nour Hijazi