Banking is Broken (And We May Not Be Able to Fix It) - How Money Works 

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Just a sidenote: Germany has a system of so called Sparkassen: Banks owned by cities or counties with the sole purpose to serve their local businesses and provide basic banking and payment services for every citizen living in their region. Normally, they are much more stable, have a lesser risk to default and keep a connection to local business

One thing I’ll say about having a relationship with your manger for a loan is that as much as people hate to admit it, it allowed “personal biases” to influence their decision to hand out a loan

7:53 "These loans used to be called sub-prime loans but for some reason that terminology has fallen out of style." Yeah I can't possibly imagine why... *glares in 2008*

This is generally correct, but it's important to realize that there are 5,000 banks in the US (more than the rest of the world combined). The 50 biggest banks act as you describe, the smaller 4,950 do not and will make decisions based on actually talking to customers. To simplify, if you've got a 9-5 job and a steady paycheck, the technology offerings of the megabanks (Citi, Chase, Wells Fargo and BankAmerica) will solve your issues; their employees aren't authorized to help much. If you've got anything unusual in your financial life (unusual income, foreign wires, small business, etc.), go with a community bank.

This explains a lot. And it's not only an American problem. I live in a small country and I've observed the same trend re: lending to small businesses etc.

When my dad bought his first house back in the 70’s , he literally used my grandpa’s word that he was going to pay as collateral. Apparently that was more than enough for the bank manager

This is the only video, where I did not learn anything, simply because my business partners and I have gone through this in person. That being said, it is accurate to the last word. Thank you for the content! We ended up bolstering the company's credit rating with our own private money, something generally unadvisable, since you should spread your risks in your wealth portfolio as much as anyone else. Putting almost all your eggs in one basket has never been smart.

Banks do not lend deposits. They create a deposit in the name of the person who receives a loan which is the borrowers asset, paired with a liability to pay it back. Similarly that account is the bank's liability and the obligation to pay it back as their asset. All of this is created ex nihilo. And it all adds up to zero. At least at first. The assets held by banks are not there to be lent out, they are to cover the instances where one of their assets goes bad via loan default but they maintain liabilities in the form of money in people's accounts.

Yup, so much easier getting a loan as a full time employee, I've been building a biz on the side for the past 4 years. Tried getting loans here and there. Realized banks don't give loans for startups, so started looking at investors, they don't want to give out much. So I been using my house as a loan source as well as credit cards. Just a couple of weeks ago, I talked with a startup investor and he didn't want to invest because I'm already making way to much for what he looks for. The bank on the other hand still wont lend to me, so I leveraged my house again. It's ridiculous.

Can confirm from personal experience; especially when you start with an incorporated, limited liability company. The bank would not even look at my application unless I asked a number north of 100k, not even when I backed the amount I applied for with equal security.

I've heard of an example that was equally funny and sad: an actress had her first major role and the movie was such a success that she became a millionaire. At that point, she wanted to rectify something she wanted to do years ago: get the citizenship rather than having to extend her permit all the time. Thus, she went to the office and there she was asked if she had a regular income, which she had to deny. She was then told that she'd need a regular income and if she's a part-time cleaning maid, that would be good enough...

Thanks for the video, I remember when I had a small business... Bank gave one of my employees a mortgage, declined me because: reasons. Go figure how his salary was more secure, even if I was the one paying it... Smh...

the introduction is how it used to work. Fractional banking, QE and fiat money changed all that.

Overtime is in that supplemental category. Half my pay is overtime, and my base schedule includes a ton of “overtime” before I work any extra days. The upshot being I barely qualified for a mortgage with a monthly payment that is slightly less than the gross pay that I’m getting for a single day of overtime. But I’ve also been approved to pay rent equal to four times my mortgage payment.

wow i’m early! thanks for the video, it’s interesting learning how we balance the trade between safety and practicality in all aspects of society

On the same line as the comment about Sparkassen, in Brazil we have cooperative banks that offer lower rates and more personal service to small business.

Never, ever work with a big bank. Work with your local credit union. They actually depend on local customer satisfaction to survive, unlike a bank who couldn't care less how happy you are with their "services".

That bit about business loans is a super powerful insight out of view of most people.

Getting a mortgage for a rental property with Chase was horrible. Delay after delay after delay. Headache upon headache. I went to a local bank and told them I'd like to mortgage a house that I plan to rent. I think in total I sent maybe 10 emails and spoke on the phone twice. Local bank has my business forever now.

Coming to this a year after it was posted... As someone whose Washington Mutual account was gobbled up by Chase, I felt that consolidation first hand. It was NOT a better experience to go to Chase - where they want to charge you a fee for everything that might involve a human in any way. After a few years, I got smart and moved my accounts over to a credit union - where they might still use computers to make hard decisions, but at least they aren't ALSO out there to nickle and dime you to death.

Historically banks have not been safe. Throughout US history financial crises and bank failures have been common. Banks are not necessarily a safe place to put money. FDIC insurance helps but it doesn’t absolve banks of their shoddy risk practices

I love the educational financial vitamins provided here.

Your series should be required viewing for any school, business, or pretty much anybody

Oooo really interesting video, great work!

Great video As always.

The whole economy will need a maior change. Those concepts were based upon pre industrial ideas, and with the speed of light, everything is a bursting bubble, or huge monopolies, crushing everything in between

I worked as a data scientist in a russian bank for a while, we used your job field as a category for a model. This way the information that waiters are better clients due to tips is incorporated in the model. I mean, it's a basic easy to implement trick. Either the video is incorrect or US banks don't use even basic application fields, which is 146% incompetence

Where I work we have clients that can finance their purchases. For some reaason, someone who just begun working at a retail store is more trust worthy than a person that has been self employed for less than 2 years. When explained, it makes sense, but when you sit down to think about it it really doesn't. The person is working in retail has not even gotten over the 3 to 6 months test period they usually have where they can fire you for whatever reason.

I normally really like your videos but this one has some problems. For one, you admit that it is more difficult to verify supplementary income. The reason that the banks that will accept this income charge higher rates is because it takes longer and requires critical thinking which together mean that it costs more money to originate those loans. Now, does someone deserve an 18% car interest rate just because they have an annuity? No. But if the increase in APR is 3%, I don't think that's something to say is the end of the world. This is also something that isn't broken and isn't fixable. If it costs more to manufacture a product (in this case a loan), it is generally going to be sold at a higher price than a comparable product that cost less to manufacture. The next problem is that you put focus on small business lending as opposed to big business lending, stating that banks are fine lending to bigger businesses. However, lending to big businesses vs small businesses can't be compared the way you are trying to. First, smaller businesses just don't have the ability to sell bonds on the open market. Historically, banks used to hold lots of corporate bonds and provided liquidity in the corporate bond market by allowing essentially any investor to sell bonds to the banks the same day. Now, banks hold almost nothing compared to what they used to, and instead serve as a finder service, linking corporate bond buyers and sellers. So outside of the arms of banks that are holding corporate bonds for investor portfolios, banks simply hold a lot less business debt in general, it's not just that they aren't allowing small businesses to lend to them. Finally, non-prime and subprime are not the same thing at all. The ranges will depend heavily on the specific source and type of loan in question, but generally 680+ is prime, below 600 is sub-prime, and everything in-between is non-prime. Non-prime isn't bad, it just isn't great. It often means the person has generally decent financial responsibility, they just aren't always on time with their payments. Non-prime consumers will have significantly better rates, sometimes single digit interest rates, as opposed to the 15%+ that a sub-prime might see for the same loan if we are talking about auto loans. Additionally, many sub-prime customers can't even finance a car at all unless at a buy-here-pay-here dealership, yet non-prime customers can almost always get normal financing just at higher rates. Comparing someone who wants to claim supplementary income to a sub-prime consumer by saying they are currently called non-prime which is a new euphemism is just flat out wrong. This isn't a case where you simplified something to avoid going into unnecessary detail and dragging the video out. This is just incorrect and misleading. If someone watches this video and then hears someone refer to non-prime and thinks sub-prime in their head with all the connotations that term has, they will not have the right idea at all.

Insightful!

This could be easily dealt with without breaking up the big 4 and making it a pain for everyone, Simply make it illegal for the big 4 banks to acquire any further companies regardless of whether the smaller company's asked to be acquired or not and then place a limit on how large you can grow and still acquire companies once you hit that limit you too will be subject to the laws that prevent you from acquiring any other companies.

Nice job!

The worlds economy is broken not just banking. the world is fueled by debt and money printing these are scary times when we living in an unpressidented era of QE and global debt. .

Your content is always top tier

The net worth and home ownership statistics is a natural correlation, but not causation. Those with higher net worth can own. Those without, rent.

Thanks, I also noted that since 2008 we have waaay to little competition as the small business don´t work anymore. Seems the only way to get a business going is with Venture Capital now... Sad

I remember hearing that Congress was contemplating banning credit scores in the loan decision process. That was several months back. It went away just as quickly as it appeared.

My supplemental income couldn't be recognized at all, even though there was a guaranteed allowance. Results is mortgage paid off in about quarter of loan life

Thank you so much

This channel is so much better than Economics Explained!

Nice video. Do you think credit unions can help in such cases where usual banks don't help small businesses? Please make a video about credit unions!

On a bit of a binge of these financial videos at the moment, and it’s hard to miss that Dr. Richard Werner is becoming a bit of a celebrity in these circles.

Great video, but a point you missed is that most loans in the US today are made by non-bank lenders (business development companies, securitization firms, mortgage REITs, private loan funds, etc.). Additionally, banks, especially community banks, have lost access to cheap retail deposits because of money market funds and competition from other cash alternatives. Low-interest rates and a flatter yield curve also contribute to the problem. These non-bank lenders and money market funds do not have the same stringent entity-based regulations and capital requirements that banks do so it's a complicated picture. Where is the level of risk higher? In a regulated, but concentrated, banking system, with flawed a consumer protection regime, or the shadow banking system?

Always look forward to your new videos! Keep it up ☺️

Insurance companies, especially in the niche area of surety do a LOT of business health analysis for large and small businesses and it is often for a relatively small premium amount in proportion to what risk they assume. They rely on indemnity and quantity of contracts to maintain profitability. Because quantity is a factor and they have to be very risk averse due to small profit margins, it is possible that lenders could piggyback off of the efficient business analysis that surety underwriters perform when determining if a business meets their risk tolerance for lending.

You always make me sad with reality. Love the channel. Hope one day we can fix all the damn money problems the world has

Oh yeah, the one neat number... I was much more financially stable when I was a contractor, between full time jobs, but was never able to get a loan... I've learned, During the times when I have a full time job, approved and take out as many loans types that I didn't qualify for the last time I had a full time job... Because you can keep an account open and in good standing, but yes, unfortunately, many banks won't even let you show them your income is stable and just deny outright no questions asked.

You're pretty much dead on with all of this. Way back in 2013, I was getting a loan so I could purchase a warehouse and get out of leasing. The bank did approve it after a lot of analyzing on the company financials but had a pretty low number as my limit. It ultimately didn't matter because I found one heck of a deal. But it could have hindered me from getting a place as big as I did or even needed. The cap they gave me actually almost got me to buy something that wouldn't have worked out long-term. And the actual payment on the loan was almost nothing compared to the income that I had but they were very cautious about it even when the warehouse existed as collateral. I'd imagine anyone seeking a loan to START a business is going to get shut down pretty hard if there aren't definitive assets which can be acquired should the business fail. So yeah, getting a business loan is more expensive and difficult for sure.

One of the issues is that the methods of measuring money have become more important than measuring real value. There is to much disconnect from money and value.

the local banks were usually ran by people who also lived in the same community they served, so they knew all the details of the customer lives. you knew who was a trickster and who was an honest guy.

0:26 Thanks for showing me my bedroom window

I agree and disagree. Banks don't simply provide capital. Banks make borrowers. 40 years of falling interest rates while wages are falling away from inflation. Increased debts loads as a percentage of income. It's a house of cards as banks eat away at real productivity crushing standard of living and pumps the cantilion effect into the veins of a status anxiety driven consumer culture. Financialization of the economy makes speculation in the markets far more rewarding than participating in the markets. This sickness is why banks are inefficient for the economy.

I always did wonder how my salary is somehow more stable than, I don't know, investment returns, since I can be fired at a whim

You claim the problems started in the 90's. I say it was late 70's early 80's, a lot of them started with Thatcherism/Reaganomics when a lot of the "checks and balances" were removed, leading directly to the GFC.

Very nice content thank you for informing anyone thats interested in this type of stuff.

Thanks god we still got cooperative banks in my county...at least that is progress.

Currently having this problem. Can’t get a loan cause haven’t been at my job for two years. And can’t use my side hustle income because I tactically wrote it off to avoid taxes. But to the bank I made a net loss. When in reality I’m making more money than I ever have. I’m pretty much as low risk as it gets. Lol

Is a possible way to look at this be that conforming loans have discounted rates because they're cheaper to process, and non-conforming loans are charged at prevailing rates? Also, what about credit unions?

I always have used my small town local banks granted they do a lot of the same stuff larger ones do they do appear to treat me better.

yes, this problem is persisting throughout the western world now. if you want to start something, you're better off doing it in a developing country. in norway, they attempt to mitigate these issues with what is essentially prizes.

This was educational, entertaining, depressing, and slightly panic inducing.

in France we dont have such systems and therefore no such problems as talked in the video. When you ask for a loan you go talk to your bank manager and then they check (and you need to give) few months back or even years for big Mortgages of data about your finances as well as how much you have right now. My mom have her own buisness and had no problem getting her mortgage or any loan overall. So yeah, you can fix it, just getting rid of Credit Score and bring back proper bank managers in the local banks is all you need.

isn't credit score a US only specificity? In France we don't have that notion, loans are based on analysis of assets and cash flows

Banks are not intermediaries, they don't lend from reserves (= money deposited into savings accounts). Instead, bank lending creates new money and it is destroyed once you pay it back.

Hi can you make a video about the circular economy please

maybe a state owned alternative super bank may help with this somewhat? with express purpose to pick up where normal banks fail? tho there are plenty of state owned banks in Russia and they, while successful, are privy to the same pitfalls

How was the statistic about the connection between net worth and home ownership normalised? I would say the people who can have more money are more likely able to buy a house and not that home ownership leads to wealth

Wow, that's the exact boat I'm in trying to get a home loan. I'm not the standard borrower. I have over a half million net worth, built my own hotel from the ground up and have successfully managed it for over 3 years. But now that I'm trying to sell my hotel the bank won't consider that income. And since I'm starting another new business they won't count that expected income until I have at least 2 years of income records. So as far as the bank is concerned I'm not worthy of a loan. I understand their desire to be able to see a reliable monthly income. But it's frustrating at the same time that a financially competent individual with Zero debt, a solid business track record, and such a high net worth doesn't fit the "norm" so I must rent for now.

This is so true. I am business owner for 2 years now and I can't even get approved for a credit card from my bank even though I have been consistently increasing my savings with them and submitted the required papers. What they offer instead is just a personal loan with really low amount and high interest rates. Perhaps it's time for me to move my money elsewhere. I'm a subscriber from the Philippines. Your channel really helped me a lot. Thanks

Please do video on the rising trend of decentralised finance treasuries like Olympus DAO and wonderland time! I think it might replace traditional banking.

I ran into this problem last year. I wanted a mortgage that would have been less than 10% of the value of all my assets. I wanted to borrow simply because it didn't make sense to sell any of my investments as they make a better return that the interest on a mortgage. Because I don't have a 'salary' all the banks refused to lend me money. None of the people I spoke to could really appreciate that I have a low income simply because I choose to not withdraw much money from my investments. I would rather let the value of the investments compound. Literally none of the banking staff I spoke to seemed able to take this into consideration and almost all of the banks weren't even willing to talk about it.

same happens in China, small to medium size businesses are next to impossible of getting a loan (not even an option of paying a premium rate, just no), and majority of the cash goes to 1) huge conglomerates 2) state enterprises 3) residential mortgage result? big corporations eat up most of the profits, state businesses have unfair advantage and a housing bubble. Small business owners make so little that they stop contributing to the real economy and instead put their money into real-estate, further fuelling the housing bubble

Ty sir

Freelancer here, was not able to find a bank that wanted to give me a mortgage, I had to be creative no work with a bank, and I just moved this week into the house, 100% paid off.

If we can come up with a modification to the formula of the credit scores, to take into account the administrative capabilities of an individual, based on his past work experiences and employer records (companies can share a rating of the employee on their overall capacity and productivity just like they share the salary figure)... this way credit score can be retuned to favor entrepreneurial ambitions. Banks can be more assured that the higher a person's credit score, either he has a good financial track record or has exceptional administrative talent hence has greater chances of succeeding in business. All that the Govt has to do is to legislate a standard process based on the Individual's track record, for estimating his or her administrative capabilities.

There are financial services called defi like AAVE who already does decentralized loaning. And since it's open-source and done through digital contracts, there is no need for the trust of anyone essential removing the middle man from loaners and lenders. All you need is collateral and then you are all set

This is a interesting video. My personal point of view is that businesses nowadays are so complex and it is not easy to assess the viability of a business. I think bank shouldn't take up the business risk. However, I do think that bank should do more to support the businesses by bridging up the investor, who is willing to take up the business risk, and the business owner, who has financial need for the business. By doing this, banks can play their role more effectively in supporting the businesses getting financing, especially the small businesses.

Have never heard outsourcing to places with starvation wages called "an elegant solution" before. lol.

Very thought provoking video. In the stock market, a company with revenue (especially growing revenue) often gets a “pass” for quite some time if they don’t make a profit on it. Maybe the problem is ultimately verification of income and expenses, hidden subsidiaries etc. Blockchain could have a legit use here unlike cryptocurrency which is functionally infinite because anyone can make a crypto that uses some different hash result scheme

"Would undermine people confidence in the financial system" Bold of you to assume many people have much confidence in it to start with, given the years of malfeasance, greed and scandals that the industry has been known for. The financial sector has worked hard to GET that bad reputation.

Can you also make a video on DeFi? Would love to know your thoughts on it.

I used to have ING. Then Capital One acquire them. I wasn't happy about that.

Fractional reserve banking is how it used to work. Research loans create deposits.

People need money. Bank has/not haz money. Half needed money means half goods not exchanged. Total purchase power equals necessity for more amenites.

My dad is a SBA credit officer. This is basically his job lol figuring out what businesses to lend to

I think that you made a wrong conclusion (or just made the title to be a clickbait) here. You said yourself that the system is optimised so that the cost is as low as possible. Thus, it's not true that people with alternative sources of income are given bad interest rates, they're just given the usual ones, while others get better interest rates because of the optimalisation.

noted

I'd love a service where I could loan people money. A thousand or so at a go on short to medium term loans. More expensive than a bank, but cheaper than a payday loan with backing. I'm happy to loan my money to help and benefit as well. :)

Perhaps there should be a higher global firewall between commercial (retail) and investment banks.

What about credit unions ? Isn't it a good replacement for banks in terms of small business

Loved the video as always, but the statistic about home owners and net worth in the context of the point you were trying to make was misleading imo. Ofc home owners are more wealthy but just because they own the home does not lead to wealth like it is portrayed. Home ownership is mostly something that wealthy people can do better than less wealthy people

The source of the issue is lending. Mainly, there are no enforceable laws to hinder extreme lending and borrowing.

as i watch till the end I must disagree. Banking was never great for the poor, average, or minority American in the first place. The personalized banking system of previous years allowed rasicm to flourish and classism to full take hold. Although there are banking and computing errors, it has allowed more people to access loans than ever before. The idea of supplemental income being a bad thing is kind of funny because if you show 2 years of supp. income then they treat it as a normal income. You are right though, the banking system is changing, I believe for the better. There are more government backed loans available for small businesses, we have record low interest rates even if we raised them 10-15% and soon computers will accurately judge our risk better than we can. We will get the loans but just like credit cards some will be 5% and others will be much higher to match your riskiness of your loan.

There might be an economical turmoil but there is no doubt that this is still the best time to invest.

For starters have our states offer (bank) accounts to us which can be used for pretty much the same things as usual bank accounts with the differance of no fees and no intrest rates. (which of course excludes all intrest based services). By that the hold banks have over us is reduced drasticly already. Have this integraded or controlled by a Department which also controls that our data is not missused by companies and here they check that no government employee without permission in certain cases can have a look at your account. Usually the state is not the enemy, only when it gets too big and therefor has huge overhead and strucutres it becomes more easily corrupted by people who have the means.

If you want to see what's broken about the banking business, look at a banks saving account rates (near non-existent). Brick and mortar banking (big or small) has become a bank with two doors. Front door banking is what they have to do to keep their FDIC charter; side door banking is where they operate as brokers/agents for other people's money and make their most profits with near no risk. This shift happened in 1993 when the Treasury allowed banks to carry their mortgage paper (that they just wrote that day) to the Treasury overnight window. This allowed for infinite cash flow and ended the need for customers/savers to the banks (why mortgage rates are so low compared to market lending rates for non-mortgage products. This means the Treasury has provided capital for the home mortgage market (as the Treasury is uniquely able to do) and gets paid back in post-GDP dollars. Of course, this has disenfranchised every American from the plus side of the American banking system

7:55 - they stoped using "subprime" because the word evokes associations with 2008 crisis. They're selling the same sheit in a different wrapper.

Sounds like tech disruption could occupy the space left by the salary-driven-low-cost big banks

They can use bank managers in this particular case