Interest

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Interest

Postby Tailsteak » Mon Apr 28, 2014 12:05 pm

My wife has a bank account here in Canada that we don't really use - we need to have it, but money generally neither goes into nor comes out of it.

We only keep about $20 in this account at any given time, and, every so often, we have to top it up, because various fees cause that $20 to erode and disappear... and if we let it get to $0, we'd be charged even more. On one such visit, we began talking - tongue in cheek, of course - saying things like "Man, remember back when we were kids, and banks paid you to leave your money with them? There was interest? Whatever happened to that?"

And then, of course, I started thinking, and, unlike most people who bemoan the banking fees that are now standard issue... I've decided I'm okay with it. A typical checking or savings account with a typical bank should not provide interest.

To my understanding, money in any sort of fund should only really grow if its owner is also assuming some sort of risk. There are ways of mitigating that risk - diversification and hedging and so forth - but if a fund is 100% guaranteed free of risk (as a bank account is), and the money always remains accessible to be removed from that fund, then there's no real reason that that fund should also increase in value. In the case of the bank, they're providing me with a service - keeping my money with them is safer and more convenient than keeping cash under my mattress - so why shouldn't I pay for that service?

So, without referring to "back in my day" or "banks are big businesses and are therefore greedy", convince me - should my wife's bank account be increasing, rather than slowly decreasing, in value?
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Re: Interest

Postby Merle » Mon Apr 28, 2014 2:34 pm

Yes; because your bank isn't just "keeping that money safe", it's gambling with it, to an extent. The bank uses the money people give them to invest - basically, they're putting your money to work to support the bank. It'd be just as "safe" in a locked safe in your house as it is at the bank, so the interest that they pay on an account is an incentive to customers to let the bank use their money.

Think of a savings account as the lowest-possible-risk form of investing. Rather than trying to find companies to invest in yourself, you're lending your money to the bank, which then invests that money itself; the bank is taking on most of the risk, and the interest they pay you is your share of the rewards of that risk.

Or, to look at it another way, you're essentially the creditor in a loan, in which the bank is a debtor; withdrawing your money from the bank is equivalent to calling in the debt. Hence, interest on that loan.
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Re: Interest

Postby snowyowl » Mon Apr 28, 2014 5:27 pm

Merle wrote:Yes; because your bank isn't just "keeping that money safe", it's gambling with it, to an extent. The bank uses the money people give them to invest - basically, they're putting your money to work to support the bank. It'd be just as "safe" in a locked safe in your house as it is at the bank, so the interest that they pay on an account is an incentive to customers to let the bank use their money.

That's the theory - the banks pay interest to offset the risk. So, presumably, if they're not paying interest it's because there's no risk.

And it's not necessarily true that money is just as secure in a safe in your house as it would be at the bank. If your house gets robbed, you lose the money. If the bank gets robbed or even goes bankrupt, they still owe you money. So if you're paying to own the bank account, that might still make sense if the risk of losing access to your bank account is less than the risk of having your home broken into.
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Re: Interest

Postby kais » Mon Apr 28, 2014 7:10 pm

The real reason banks pay interest is to try to keep up with inflation. You already are paying by keeping your money in a bank, the money you are keeping there is constantly losing buying power.

In general though, I agree with you. I was shocked when as a kid I learned that banks would just open an account for you for free. Paying 3 dollars a month to keep 20 dollars in a bank though is just silly though. banks manipulating you into paying more fees than you are used to is annoying, it's only natural people would complain about it
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Re: Interest

Postby MysticWav » Tue Apr 29, 2014 7:46 am

My bank doesn't charge me any fees for my account and still offers interest. :)
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Re: Interest

Postby Tailsteak » Tue Apr 29, 2014 1:53 pm

To my understanding, a bank account has no risk whatsoever - even if my financial institution of choice burns to the ground tomorrow, my balance is till protected, and I have access to it at any time.

I can understand banks competing to lure customers away from each other, but absent that motivation, there really seems to be no reason for them to offer interest.
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Re: Interest

Postby snowyowl » Wed Apr 30, 2014 3:56 am

Tailsteak wrote:To my understanding, a bank account has no risk whatsoever - even if my financial institution of choice burns to the ground tomorrow, my balance is till protected, and I have access to it at any time.
My parents lost some of their money in the 2007 financial crash. They eventually got some of it back, but not all. Money in bank accounts is safer than any other money I can think of, but I wouldn't say it has "no risk whatsoever".

Tailsteak wrote:I can understand banks competing to lure customers away from each other, but absent that motivation, there really seems to be no reason for them to offer interest.
Lending the money out to other customers at a higher interest rate, and pocketing the difference?
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Re: Interest

Postby Merle » Wed Apr 30, 2014 7:51 am

Tailsteak wrote:To my understanding, a bank account has no risk whatsoever - even if my financial institution of choice burns to the ground tomorrow, my balance is till protected, and I have access to it at any time.

I can understand banks competing to lure customers away from each other, but absent that motivation, there really seems to be no reason for them to offer interest.


As snowyowl said, there's no such thing as "no risk".

Think of it this way: the most conservative strategy with your money is keeping it in a safe hidden in your basement.
The riskiest strategy with your money is starting a company with it. Other activities like directly investing in a company, or playing the stock market, fall at various points on a spectrum of risk/reward.

Storing your money with a bank is not as conservative as the hidden basement safe; it's safer than investing it yourself, but not 100% safe. Therefore, if the bank doesn't give you some return on your (indirect) investment, they have no reason to expect you to choose them over the safe.
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Re: Interest

Postby Packbat » Wed Apr 30, 2014 9:38 am

An even closer parallel would be the difference between storing your money in a safe-deposit box and storing your money in a bank account - in both cases, you are trusting the bank with your money, but in the latter, you are allowing the bank to take risks with said money.

(Actually, bank accounts with less than $250,000 in them are much safer in the US than safe-deposit boxes, because the FDIC guarantees them.)

(Edit: Speaking of which, one of my favorite This American Life episodes - "Scenes From a Recession" - includes a story about an FDIC-managed takeover of an insolvent bank.)
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Re: Interest

Postby Deepbluediver » Wed Apr 30, 2014 9:45 am

Tailsteak wrote:To my understanding, a bank account has no risk whatsoever - even if my financial institution of choice burns to the ground tomorrow, my balance is till protected, and I have access to it at any time.

I can understand banks competing to lure customers away from each other, but absent that motivation, there really seems to be no reason for them to offer interest.

As other people have said, though, in most cases the bank doesn't just sit on your money- they lend it out to other people in the form of loans. If enough people default on those loans, the bank might fail, and your money would be lost. That's where the risk comes from. The interest is the bank paying you for the temporary use of the your money, essentially.
At any given time, most banks have only a fraction of their customer's money actually available for withdrawal, because the assumption is that not everyone will want all their money back all at once. This is called a "run" on the bank, and it used to be more common at points in the past when banks where smaller (more local); I think it's what happens at the end of the Christmas movie "It's a Wonderful Life" and the protagonist is trying to convince the towns people to NOT take out all the money they want, and instead just the money they need, so the bank doesn't run out.

AFAIK, in the U.S. the federal government guarantees bank accounts up to the amount of $600,000. That means if I have 50 grand in the bank, and the bank goes under, the government will replace all of it. However, if I have 1 million in the account, I'll only get 60% of it back. I also believe that there is no limit on the number of bank accounts you can have, though.


I'm not sure if there exists a truly 100% risk-free form of money-storage. I have a small investment account that, AFAIK, doesn't pay interest, because the company that controls it derives their income from other sources (mainly fees based on stock-trades) but I don't know what the laws are if they go bankrupt or shutdown. More research would have to be done.


Edit: Packbat apparently said some similar things, but with the amount the government ensures much less. I could be wrong; I'll need to do a search and see if I can find out what the current laws are.

Edit2: According to this website (http://www.fdic.gov/deposit/deposits/in ... asics.html), the $250,000 value is the correct one. I'm not sure where I heard 600k, now.
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