In this article, we cover:

  • How people think banks work
  • Why this isn’t the whole truth and how banks really make their money
  • Why this is great for banks, but not good news for you and me
  • What you can do to beat the banks and make substantial returns on your hard-earned cash.

So, You Think You Know How Banks Work?

What is your opinion on banks?

Most people are fairly indifferent.

You can deposit your money and they will look after it until you pop in to withdraw it. They might even pay you a little bit of interest so you can see your money grow while you sit back and relax.

When you need a little extra cash, you can even go to a bank and they might give you a credit card, a loan or a mortgage which you can pay off over time…although you do have to pay them a lot more interest on the money they loan you than they pay you on the money you give them.

On the other hand, perhaps you aren’t a huge fan because of the role they played in the financial crisis of 2008. But that is all in the past.

All in all, banks are ok. Right?

But what if you found out that banks don’t really work like that at all? Or at least it isn’t really how they literally make load of cash by leveraging the money you give them.

Banks are Legal Money Trees

So how do they do it? Let me introduce you to fractional reserve banking.

Fractional reserve banking is the real way that banks make money and they are using your cash to do it. Here is how…

You’ve been working your socks off all month and finally pay day has come! You take your well-deserved cheque for £1000 and pay it directly into the bank. But contrary to what you may believe, the bank doesn’t just pop that cash into their vault and leave it there until you come back to collect it.

In fact, your money probably sits in the bank for a very short period of time.

This is because one of their other customers (let’s call him Pablo) wants to borrow that cash on his credit card. Banks are legally allowed to lend your cash to others as long as they hold at least 10% of it back in reserve. You know, so they can at least give you some of your cash back if you come knocking at their door.

Pablo is a happy man, because the bank has just given him a shiny new credit with £900 on (your £1000 minus the 10% reserve).

What you need to know about Pablo is that he loves sweets, like REALLY loves them. So, he goes to John’s sweet shop and spends his £900 on a wholesale load of jelly babies. John is delighted that he now has £900, so he goes and puts that £900 in the bank for safe keeping.

And then the process starts again…

…the bank takes John’s £900, keeps 10% (£90) and lends the other £810 out to someone else. As you can see, at this point your £900 has now allowed the banks to lend out £1710 in total, even though it hasn’t actually increased in value.

This process can be repeated over and over and over again.

You can calculate how much money can be created through fractional reserve banking by multiplying the original deposit by 1 divided by the percentage of required reserve. Using our example above:

£1000 x (1/10%) = £10,000

So, not only are banks lending your cash out to others and charging them high rates of interest, but they are also doing this over and over again, creating vast sums of money in the process.

Admittedly this is pretty smart of the banks. But it is also pretty bad for us.

Naughty Banks

Fractional reserve banking has been used by banks to ‘generate’ cash for a long time. So, is it really that bad for you?

Well, yes…

If you have opened a savings account recently, you will be well aware of how pathetic interest rates are. When you consider the fact that banks are lending out your money to other people with interest rates upwards of 50%, the 0.01% interest they are paying you hardly seems fair.

But wait, it gets worse.

Not only are banks paying you a rubbish interest rate on your savings, but they are also

using your savings to make your cash worth less!

By using fractional reserve banking, your bank is generating more and more cash. As the amount of cash in the market place goes up, the value of that cash goes down.

Let’s use an analogy to explain…

Imagine you own a chicken that lays golden eggs.

It is the only chicken in the world that lays golden eggs and people give you £1million to take a magical, shiny golden egg off your hands – woohoo.

But suddenly those eggs start hatching and the chickens that come out of them also lay golden eggs. Now there are hundreds of chickens that lay golden eggs. Now you would be lucky to get £10,000 per egg. As more eggs are sold and more golden egg laying chickens are hatched – your golden eggs become worthless.

Similarly, as banks create more money, your money is suddenly worth less. This devaluation of cash is what is known asinflation.

The combination of rubbish interest rates and the fact that banks are lending your money to drive inflation means that the money you save in the bank is worth less today than it was last month.

A Better Way

With this knowledge in hand, it can seem like trying to save or grow your money is a waste of time…which it is. Or at least it is if you only save your money with a bank. But before we move on to some other, better, options let me explain one thing.

You NEED a bank account and a savings account.

Wait…what?

Haven’t you just been telling me exactly why keeping my cash in the bank is a bad idea?

Well, yes. But there are two circumstances that you need the structure that a bank offers:

  1. For your day to day spending needs (rent, food etc)
  2. An emergency fund

Banks are a (relatively) safe bet when it comes to holding the money you need to access immediately. Pouring all your cash into other investments isn’t a good idea. After all, heating engineers don’t accept McDonalds shares when your boiler breaks down.

How much you keep in your emergency fund will depend on your circumstances and your lifestyle. Most people will need £2000 as a minimum and you should ultimately look to hold 3-12 months’ worth of expenses, depending on how risk adverse you are.

Just remember that your emergency fund is likely to go down in real value as inflation increase, so may need topping up from time to time.

Once your day to day needs and emergency fund is covered, that is when we get to the exciting and profitable stuff.

When it comes to beating the bank, there are plenty of options out there. Which one works best for you depends on your appetite for risk, desired lifestyle and area of interest. Here are a few ideas that you may choose to explore:

  • Investing in property – g. buy to let, flipping properties, investing in real estate funds
  • Investing in stocks and shares – g. buying shares in McDonalds, Tesla and Apple
  • Investing in tracker funds – g. buying shares of funds that track FTSE 500 companies
  • Investing in managed funds – g. buying shares of a specialist funds run by fund managers
  • Buying, holding and selling cryptocurrencies – g. buying and selling Bitcoin or Litecoin
  • Buying, holding and selling on the foreign exchange market – g. buying and selling foreign currencies
  • Buying, holding and selling resources – g. buying and selling gold

There are countless options out there. Each with their own level of risk and reward.

For example, investing in tracker funds is a relatively safe bet and may help you beat inflation over a long period of time, but is unlikely to help you significantly improve your lifestyle in the short or medium term. On the other hand, trading in cryptocurrencies is perceived as riskier, but with market volatility also comes the opportunity to make significant returns.

How We Can Help

Here at Platinum we help our clients beat the banks by offering them the training, knowledge and insight they need to successfully trade in cryptocurrencies and forex. Our team of expert trainers have years of experience and can give you the tools you need to remove a significant amount of risk whilst increasing potential returns.

If you want to start your trading journey today get in touch to book a free 30-minute consultation.

The Platinum Formula:

Perfect Fundamentals + Perfect Technical Analysis + Perfect Logic + Perfect Risk Management = Perfect Trade

 


 

The Platinum Way

At Platinum Trading Academy, United Kingdom, we teach all individuals from different walks of life to become a full-time trader or create a secondary revenue stream by trading part-time. We trade in an Institutional Way by letting the market come to us and being patient. Using Platinum’s Trading system you can take many Pips out of the market. We can ensure using this style of trading your trading will make a turnaround as you will become much more consistent.

If you want to trade like the professionals do, making consistently profitable returns from your trading, get in touch with us and we will demonstrate live exactly how we approach the markets.

Download our free ebook to read about the various Trading Patterns that work in the Financial Market. Watch Trades of the Week Videos in our video gallery. Subscribe to Platinum’s Forex Newsletter.

Hopefully, you have enjoyed today’s article. Thanks for reading! Have a fantastic day!

Nisha Patel
Live from the Platinum Trading Floor.

Nisha Patel

Nisha Patel is a Forex Trader and Content Writer at the Platinum Trading Academy, she has been trading in the markets for over 15 years and covers three major aspects: Forex, Indices, and Fundamental Analysis.

“I understand the pain of day traders; by writing dynamic and exciting content which my readers can enjoy, I hope to enhance your trading skills and bring both profitability and consistency”

Having worked for three major corporate banks such as ICAP, Credit Suisse and JP Morgan, Nisha finally found a home with the Platinum Trading Academy.

Working together, we hope to bring you amazing content while trading the financial markets.

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