banking is an incredibly important industry which is based off a very simple concept people with
more money than they know what to do with can keep it in a safe and secure institution which
can then lend that money out to people who have big ideas but not enough money to make them happen
they give a small incentive to the depositors and charge a higher premium to the borrowers
making a profit for the service that they provide as a financial intermediary this system has become
more complex over time with things like fractional reserve banking and alternative capital sources
but if we strip all of that away we will find that the heart of banking is this simple mechanism for
all of the hate that banks get they can do a lot of good in an economy to people who want a safe
place to keep their money they offer an almost 100 guarantee that the money left with them will
still be there a day a month a century from when it was deposited they also make that money readily
accessible online over a phone from a collection of atms or simply through a plastic debit card to
people that want to borrow money they are also the go-to institution for a fair loan based on lending
parameters developed over time we may hate things like credit scores and employment checks but it's
part of the reason why so many people are paying below three percent on their mortgages right now
banks have become masters at mitigating risk by making everything as uniform as possible
so uniform in fact that even home loans one of the most personalized financial products imaginable
can be bought and sold like commodities in financial markets but even securitization
which was the catalyst for the global financial crisis is still not the reason modern banking
is broken banking is running into a problem today where it has become so consolidated that it can no
longer effectively perform its role as a financial go-between so it's time to learn how money works
to find out how the last financial crisis set us down a path that fundamentally broke banking to a
point where we may no longer be able to fix it this video was made possible by this channel's
members and patrons on patreon for a bunch of cool perks please consider supporting the channel on
either of these two platforms the current issue with banking really started in the mid-1990s
back then computers were just starting to take over the decision-making process
of most junior level bankers before this time if you wanted to get a loan to buy a house or
start a business it was all about having a relationship with the local bank manager
manager would sit down with a potential applicant in their office and look over the basic stuff
do you have a job do you have savings do you have other assets all of the stuff that banks still
look at today but there is also a more personal aspect to this whole process a bank manager might
actually ask someone's parents to vouch for them this vouch would carry no legal ramifications but
it might mean if those same parents wanted to loan themselves to buy a beach house or an rv
they could get declined if their children were in arrears this was all very colloquial and
it did work well all things considered but it caused problems for the banks the first problem
was that bank managers were expensive given the responsibilities that they would personally take
with their decisions to lend or not lend money they were very well respected professionals today
a bank manager is a glorified credit card salesman before the 1990s a bank manager was as respected
as a judge or doctor and paid as well as one too the other problem that this caused the banks was
scalability if a bank wanted to move into a new city they would be without basic information
needed to run the business someone with terrible financial conduct could walk into a new branch
and possibly walk out with a loan and when they inevitably default on their new loan the new bank
loses money that the existing local bank would not have made because the established bank knew better
than to not loan money to dodgy doug down the street fortunately for banks these problems were
resolved as computers and crucially credit scores became widely adopted credit scores as we know
them today did not exist before 1989. today your credit score has basically entirely replaced the
role of building a relationship with a bank today a bank manager doesn't even need to know your name
they can learn everything they need to know about you by reading a number off your nationally
available credit file credit files have their own problems but for now i am going to ignore them
because like it or not they are here to stay it is simply too easy and too profitable for the
banks to be able to utilize this pool of data to make finance decisions this has been made
even easier still by computers and worldwide communications today when you apply for a home
loan you will normally do so in one of three ways online at a branch or through a mortgage broker
if you apply online you will be asked to fill out a whole lot of details and then those details will
be turned into data points and then that data will be sent off to an assessor if you go through a
bank branch or a mortgage broker the same thing happens only this time it's a bank employee or
a broker that fills your details out for you inevitably it all ends up in the same place an
assessment office normally an assessment office in a low-wage country like india or the philippines
modern banks have been able to move their offices here because approving financial applications has
become a very simple process the workers in these offices simply need to verify that the
data provided to them is correct by cross-checking it with official documents and then they plug that
data into an algorithm that gives the application an approval or decline it's an elegant solution
which allows for far more applications to be processed at a far lower cost as i said at the
beginning of this video some of that cost saving has been passed along to consumers
which is a good thing but it's about where the good news ends in the early 90s there were around
20 large banks vying for market dominance here in the states today there are four through a series
of mergers acquisitions and bankruptcies over the years major full-service banks have become
increasingly concentrated big banks want to make sure that their operations are relatively uniform
so leaving the decision-making process up to one piece of software rather than thousands of bank
managers just makes good business sense even before considering the operating cost benefits
but as with a lot of things something that makes good business sense doesn't always make good sense
for the society at large again i am going to ignore the issues that come along with credit
scores there are so many videos talking about just how terrible they are so i don't want to
repeat too much of what you probably already know but i do want to focus on something else
there are people out there today that have perfect credit good savings a stable income and yet still
can't get a loan why well because they have a financial situation outside the rigid parameters
of the bank's automated framework someone working a normal full-time job is absolutely perfect for
a bank application because an applicant can just put one simple point of data in their income field
their salary but what about people that rely on tips for their income or royalties investment
returns rents business profits or even government allowances as in the case with a lot of retired
police and military personnel what about them well in banking speak this is what is called
supplementary income and unfortunately it is not particularly popular amongst big banks why because
it requires some critical thinking beyond the scope of what this automated process will allow
the irony is that a lot of these income types can be more secure and more consistent than a salary
but because a computer doesn't understand that these types of incomes don't produce
one neat little number every year it has to do one of two things optimistically the
people entering the data into the computer will be told to be ultra conservative if you made 50k in
2019 and then 500k in 2020 off your business then the bank is going to use the 50k figure
often the major banks just won't accept these income types at all forcing people to go with
lenders with less restrictive standards but much higher interest rates interestingly enough this
will often be the exact same bank or perhaps just a subsidiary of the bank the only difference being
that they charge a premium because reasons these loan products used to be called subprime products
but for some reason that naming convention fell out of style so now bankers call those
loans non-prime or non-conforming non-conforming is really the right word for these types of loans
because as i said earlier you will often find that the people that are forced to take out these
loans in order to buy a house are in far better financial positions than your regular salary man
the issue this creates is that it can force people into just getting a regular job over building out
their business or pursuing some other profitable endeavor starting a business is risky at the best
of times and the best way to mitigate that risk is to make sure that your own personal finances
outside of the business are rock solid it really is hard to put yourself in a rock solid financial
position without owning a home and yes it is possible to be financially secure while renting
of course it's just a lot harder the median net worth of an american household who owns the home
that they live in is 255 000 the median net worth of a household who rents is just 6 300 according
to a 2020 survey many promising individuals find themselves pushed back into the regular workforce
simply because they don't want to miss out on the opportunity to own their own home
unfortunately for those who do end up sticking it out and start their own business
the bad news keeps coming dr richard werner is one of the foremost academics covering
the role of banks in the modern world he has raised concerns about most of the issues i
have covered in this video but the biggest warning he has given out over the past 20
years has been that large consolidated banks are increasingly unwilling to lend a business
business lending is inherently more difficult than consumer or residential lending if a mortgage goes
into default then the bank will still have a house to sell to recoup some or all of their losses
if a business does not do well it's likely that a bank will never see that money again
businesses are also much more complicated a bank trying to mitigate their risk would
need to assess the health of a business which is extremely difficult certainly it is well
beyond the scope of the standardized process used for mortgage applications
a non-standardized process equals expensive in the eyes of a big bank someone looking for a 100 000
loan to open a second store in a new city might cost the bank more an assessment cost than they
could ever hope to get back in interest this means that some banks just won't even consider giving
loans to smaller businesses and the ones that do end up charging much higher rates to make up for
the costs involved in assessing these loans small businesses are incredibly important to the overall
health of the economy back when banks were small and approval processes were much more personalized
businesses could get the funding they needed so long as the business idea made sense to the
bank manager today big banks only have the appetite to lend to big businesses
this graph shows the breakdown of mortgage versus non-mortgage lending compared to the american gdp
note that the spike in mortgage lending in the 90s coincides with the plateau in non-mortgage lending
around the same time this stall is even more severe than it might initially look because
in that time things like credit cards car loans and personal loans have become a lot more popular
meaning that good old-fashioned business lending is making up a smaller slice of this stagnating
pie big businesses naturally favor products that are generic uniform and easy to replicate
this is normally fine because it lets smaller businesses carve out a niche for themselves to
be offering more unique products unfortunately retail banking is next to impossible to get into
and even if a small bank is successful it will probably end up getting acquired anyway
breaking up banks is also extremely difficult for the majority of average consumers big banks
offer better products better accessibility and better services than smaller banks could
average consumers also don't want to wake up one day and realize that their
city checking account is now with some new institution because citigroup got broken up
it would be a pain and it would undermine the confidence people have in the financial system
so unfortunately it looks like the role of banks as financial intermediaries will continue to be
focused on projects that are worth the attention of some of the biggest companies in the world
this video was actually an unofficial part two of another video i made last month
detailing why companies do not care about staff loyalty anymore so if you found this video
interesting and you want to find out what career planning has to do with the banking industry
go and check out that video too as always a big thanks to my channel members and
patrons on patreon for continuing to make it possible for everybody to learn how money works
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