Imagine you’re giving one of your most prized possessions to someone for safekeeping. But, you have no idea what happens to it once you’ve handed it over. Would you be ok with that?
But, isn’t that what happens with banks? Has your bank ever explained to you what happens to your deposits? We’re guessing not.
The bank collects all our deposits and uses them to fund various forms of loans – mortgages, credit, overdrafts. The borrowers pay the bank an interest for these loans. This is the bank’s income. From which it pays for its costs, pays its shareholders and pays you an interest.
Now for years we have accepted low interest rates as the norm. But, why are interest rates so low?
One reason is, since the financial crisis interest rates for borrowers were slashed so more people can buy houses or cars. This keeps money flowing into the economy and helps it recover. But, in spite of that banks still earn 2-5% on mortgages, 5-10% on personal loans and 10-20% on credit cards, by lending out your deposits.
So, why do our savings still get less than 1%?
This is probably the reason why your bank doesn’t explain its inner workings to you. The truth is, your bank is like any other business so its aim is to maximise profit for its shareholders. So, how do they do that? They can’t easily cut its running costs (those 300 year leases on central London properties can’t just go away). It can’t charge more interest to borrowers because the rates have to be competitive. So, the only thing they can squeeze is – the interest paid to you. Hmm.