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  • Writer's pictureDavid A. Schneider

How Do Banks Work

Updated: Nov 8, 2020

Nowadays it has become common to be in debt.

Sometimes even deeply in debt.

Hey, don’t point with your finger at others, financing your car is equal to being in debt!

And so is a mortgage or a lease.

Shockingly, 90% of all cars that get sold nowadays in the Western world are based on a lease or other form of financing. This means that today hardly anyone owns his or her car but instead the bank owns almost all vehicles that you see cruising around all day.

But it of course doesn’t stop there, average household mortgages in 2016 in the United States were at 196.014$, with its number rising continuously.

This should not come as a surprise as today you hardly can pay any average home in an urban area below 500.000$, which is multiple the number it would have cost you if you bought just some years ago.

Interestingly, the wages have stayed the same for a long time while your economy slowly starts to get back on its tracks again.

What causes a headache to everyone who looks closely at the numbers, is that the recent economic growth comes mostly from new debt that gets into the market.

But who cares, today we have an upcoming generation where it is considered normal to finance even your furniture.

In this article we want to show you some common traps and pitfalls concerned with credits and financing that you should carefully consider even before you walk into any bank.

To look through it all, you have to understand how banks do work in the first place.

Actually there is an entire system behind all these offers that is designed against you, and most people will lose it and stay possibly in debt for the rest of their lives.

Lets begin with the most important thing to understand:

how do banks work
"I know this guy well since many years, sure I trust him!"

The banker is not your friend

As I have worked for years in the financial industry I can tell you firsthand that banks and insurance companies work entirely differently than any normal company, but try their best to look normal to any outsider.

It starts right at the core with their basic business model and what they earn their money with.

Any usual business in the world has to produce a product, and usually the product does make something better, faster, or convenient.

If the product is good enough, people will pay money for it, which keeps the company alive. The value a customer receives from the product has to be higher than the price asked for it.

Only then is it a fair deal where both parties end up better than they were before.

It is a win-win for both, and this is what drives economic growth

But banks and insurances work a little differently.

They don’t produce any goods.

There is no real value being created.

Instead they play a sort of game where they try really hard to let money create more money, based on fundamental calculations.

For example, the bank borrows its money at the central bank.

The bank pays 0,1% p.a. interest rate to the central bank for lending them the money, and if you go there to qualify for a loan these days you will pay around 1,4% annually.

And then they will even dare to congratulate you for getting such a “good interest rate”, while they are pocketing almost all of it.

That is the essential business model of any bank and explains how banks do work.

Their business model is based on dealing with money - buy it cheap and sell it high, just like any ordinary trade organization.

That is what they do for a living.

It is very similar with an insurance company:

One insurance I worked for had annual revenue of 800 million, meaning this is the amount all of their clients pay to them combined throughout the year in all their contracts.

The insurance company has lots of data and exact calculations that lets them assume the annual payout they will have to face is around 600 million.

Sometimes more, sometimes less, but it always is around 600 million per year.

Any school child could now tell you that they make a simple and clean 200 million profit every year.

Not bad, right?

Have you ever heard of an insurance company that went broke because they had no money?

Me neither. Now you know why.

So many of the fundamental duties and responsibilities in such a business are different because the value adding does take place in a different form, or does not take place at all.

Without going into too many details about how exactly banks and insurances work, let me just give you the main information that will be viable for you as a customer.

As there is hardly any way around insurances or banks today, chances are very high that you will need them sooner or later.

To be sure they will not take advantage of you, it helps to know a thing or two about them in the first place.

First of all, the banker or the insurance representatives are never your friend.

Even if you know each other from high school or he or she might be a very nice person, he in this case is a sales person.

And guess what salespersons are supposed to do.

Sell stuff.

Everyone working in the financial industry has certain goals that he or she has to fulfill on a monthly basis.

Every new month even if you performed great the last month, you are at zero again.

This translates into constant pressure on the workplace these people are in.

They have to sell x amount of contracts or they will get fired (which is why I got fired several times at such jobs - favoring the customer is not tolerated).

They are expected to make the sale no matter what.

It doesn't matter if they sell you something that will eventually ruin your finances instead of helping you. As long as the bank earns a lot of commission, they will do anything they can to sell it to you.

So even if the personal relationship with the banker has been a good one so far, it is always a good idea to be suspicious of their intentions.

how do banks work
"Sell 10 products a day or you are fired!"

That alone would already be bad, but there is an even bigger system operating behind them in every bank and insurance:

The sales rep’s bosses in middle-management get their paychecks and commissions based on what their inferior team is selling.

The directors above them get their payments and commissions based on what the middle-managers and their inferior teams sell.

And the steering committee on top of them all gets its paychecks and commissions based on what the directors and their inferiors sell.

This insane structure makes sure that there is no one within any bank or insurance who is not under constant pressure to sell the company’s products and to perform, day in and day out.

Some wonder why the financial industry has such an extreme turnover, for me this is the main reason. It is also probably the root of why there are so many bad practices in their businesses - people are put under pressure against people.

Bosses against their teams.

Individual employees against the customer.

If you start to sabotage the system by being more open-minded, looking for creative solutions, focusing on the long-term gains of business or a benefit for the customer - you will be fired because your boss´s paycheck will be smaller if not everyone is selling on a shortsighted basis.

They might be a good person in private - but in their role as an employee of such a business they are forced to sell as much as they.

Essentially this is how banks do their work. And if you can, you are best advised to avoid them alltogether.


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