I see a lot of ppl criticising banks regarding their lending policies. Banks gets 1000s of ppl everyday requesting for loans, they need to put in a system in place that strikes the right balance between risk and return.
Banks are in the business of lending money and making a return. But do you know what sort of return the banks make? Don't be fooled by the billions of profits they report each year. Look at the amount of assets they used to generate that profit.
Lets take a hypothetical scenario.
Bank has lend 100 loans each of $1million at 10% interest.
Bank has to pay 7% interest for using depositors funds and borrowing funds from money markets, thereby giving it a spread of 3% (10%-7%).
Interest Income received: $10 million (100 x $1m x 10%)
Interest Income payed: $7 million
Gross Profit: $3 million
General, Sales, Admin costs: $1 million
(Bank has operating expenses: salary, rent etc.)
Income before tax: $2 million
Tax @ 30%: $600K
Income after tax: $1.4 million
So the bank made a profit of $1.4m on asset of $100 million. The return is a whopping 1.4% ($1.4m x 100/ $100m)
As you can see there is not much room for banks if the default rate increases and asset value decreases simultaneously. The $1.4m profit will be gone fairly quickly.
Banks need to be conservative because the aggressive ones have long since gone bankrupt.
Cheers,
Oracle.
