by: Jenny
Barclay A
bank or mortgage company is nothing more than a box in which to keep money. The
owner of the box has to do a few calculations. Firstly, how much is he going to
offer those people who deposit cash in his box, in return for such a deposit?
Secondly, how much of that money should he keep as cash in case the owners of
that cash want it back? Maybe 5%, maybe 10%, what are the regulations in his jurisdiction?
Thirdly, how much is he going to charge those people who wish to borrow the money
of others, previously deposited in his box? The
person who owns the box then sets out to find lots of other people to put their
spare cash in the box, in return for which he promises to give them their money
back plus interest. In the eyes of some economists, these people are lenders and
not investors. This terminology is based on the fact that the capital investment
of lenders does not change, whereas the capital value of investors, in stocks
or property for example, can go up or down. The owner of the box then has to find
other people who do not have spare cash, but in fact wish to borrow it.
Fixed or variable?
Both the
lenders and the borrowers can sometimes be bewildered by the variety of terms
offered by such institutions. The easiest terms to understand are those that are
based on a current rate that will vary according to the market for interest rates,
which alters daily, although the companies will try to even out such daily fluctuations
with only periodic changes in the rate. Fixed rates, for a given period, are more
difficult for the average lender or borrower to understand, a fact that has given
rise in the past to greedy companies being able to reap huge benefits from such
lack of knowledge. The reason for an institution wanting to attract deposits at
a fixed rate could be based on the fact that their advisors calculate that interest
rates are going to rise. Should they find it possible to attract deposits at e.g.
3% over 3 years, and then find that current rates are 5%, they will be somewhat
pleased. In the case of a borrower finding that they are in this situation they
should be congratulated for being better at guessing than the company’s advisors.
On the other hand, a borrower tied in to a contract at say 10% for several years
who then finds that rates have dropped to 5%, will not exactly be celebrating.
In my short experience since I started at university fourteen years ago, I have
seen deposit rates vary from 14.5% down to 1.5%. Is
a bank safe? There
is also a common belief among lenders that their capital is safe. In the absence
of a government or similar state authority providing such a guarantee, this can
be far from the case. At university one of the cases we studied, was that of a
particular savings bank. A rumour went around the city that the bank was in trouble.
A great number of people went to the bank to withdraw their savings. Those that
represented the first few % of the total deposit had no problem. When the percentage
rose to 6%, which in this case was the amount decided by “the owner of the box”,
the rumour became fact in that there was no cash to pay out to depositors. As
this was in a country in which the owners of all the boxes were members of a club,
the aim of which was to protect the undeserved, but perceived, reputation of said
members, the members sent round security vans with sufficient cash to pay out
all those who people who “had taken notice of an unfounded rumour.” Things quietened
down after a while, and the government decided to introduce legislation to create
a minimum liquidity level. Another
case we studied was that of one of the world’s largest banks, the board of which
was mainly composed of greedy souls. They had decided that the stock market was
a good place to keep the liquidity margin, so that in the event of a bear market,
they could create more profit for the shareholders. A sudden bear market wiped
out the liquidity margin, and the bank came within a hair’s breadth of going belly
up. Once the
bank has reached a substantial size, the liquidity should be sufficiently large
to cater for all such panic withdrawals, unless of course the panic is as great
as 1929. For
the borrower it provides a necessary service, and apart from penal conditions
imposed on borrowers, is a vital service to our society. From the investor’s point
of view, it depends firstly on the mentality of the treasury function within the
bank, and secondly the legislation that governs their actions and accountancy
practices. From the investor’s point of view, considering investing in the stock
of such an organisation, it depends entirely on an analysis of the bank’s net
worth and profitability. Both the examples mentioned above have since gone from
strength to strength, and have since been bought for more billions that most of
us can count. ©
Jenny Barclay |
