You and the Bank
Michael Bronstine, Managing Partner GBK Strategic Financial Partners (March 2020)
The banks, financial institutions, and Wall Street enter transactions with you when you pay a loan, buy stock, or put money into a fund.
Every transaction has two income statements – yours and the banks. Your loan payment is your expense and their income. Putting money into an investment or account is your outflow and their inflow.
You Can Either Be the Bank or Be a Customer of the Bank
If you follow the path of money, you’ll notice that most often, it flows back to banking and the wealthy. Have you considered that the truly successful who don’t worry about money think differently than the rest?
It’s because there are two opposite rulebooks: one for the bank, and one for the customers of the bank.
Here’s the short list of what the bank wants:
- Get as much money as possible
- Get money as often as possible
- Keep it as long as possible
- Give you as little back as possible
- Take as little risk as possible
But if you consider what you’ve been told to do, it’s quite radically the complete opposite:
- Put away as much money as possible
- Put it away as often as possible
- Keep it there as long as possible
- Take back as little as possible
- Take as much risk as possible
This night and day difference in the way banks think about money is what puts the banks on top when it comes to earning cash flow, stewarding it well, and profiting.
The rules we’re taught have us being forever a customer of the bank. We end up building the house of the bank and not our own.
Instead, if you apply the rules of the bank in your own personal economy, you’ll prosper.
Your mindset is like a door that opens into limitless financial possibilities. With the right mindset, you’ll be surprised by the creative strategies you’ll find to reduce your expenses and increase your income to widen that cash flow gap.
If you want to take control of your life and destiny and build financial freedom, here’s the roadmap to do just that:
Banking 101: The Seven Rules of the Bank
#1) Banks Want Cash Flow
Typical financial advice teaches that you need decades to create wealth. But it never takes the bank decades to create wealth, because banks don’t focus on accumulating money. Instead, they accelerate money by increasing their cash flow.
It’s favorable to the bank to have loans paid back more quickly, through shorter loans, bi-weekly payments, or extra payments to the principle. The more quickly their borrowers repay loans, or the more money investors put into their funds, the more cash flows into their control.
While paying off loans more quickly increases the cash flow to the bank, it decreases yours.
Because paying off debt faster will reduce the interest paid to the lender, many borrowers mistakenly believe that paying extra will reduce the cost of the loan. When you factor in opportunity cost, that is not always the case.
Besides, paying off debt faster can result in a liquidity crunch when you need the money, but can’t get to it.
Instead of paying off loans for the sake of paying off loans, prioritize financial moves that increase cash flow. Using the cash flow index will allow you to determine the efficiency of your loans and decide which ones to pay off and which ones to keep. In this way, you can pay off loans in a way that allows you to increase your cash flow and maximize access and control of your money.
#2) Banks Earn Interest
Banks use arbitrage, the spread between what they pay and what they can earn with the same money. They earn more than they pay by buying low and selling high in another market. They may pay 0.07%* on deposits but charge 18% to loan out the same money.
The bank earns the spread between the interest rates.
If the bank takes $1 in deposits and pays 1% (a penny), the deposit is the bank’s liability, and the interest rate is their expense. They can then loan out that dollar at 5% (a nickel). The loan is their asset, and the interest earned is their income. In this case, they would earn the difference of $0.04. You calculate the spread like this:
Earnings / Investment = Rate of Return
In this case, $0.04 / $0.01 = 400% Rate of Return
Let’s look at a more realistic example. The bank pays 2.00% on $10,000 in a 5-year GIC, and they loan out the $10,000 for a 5-year car loan at 3.88%. They pay $200/year and earn $388/year on the same money. This generates a 94% Rate of Return for the bank.
If you’re able to borrow at 5% and use that capital to earn 15% in a business opportunity, you make the 10% spread, which is a 200% Rate of Return.
Make That Compound Interest
Banks are wise to the power of compound interest.
Those who understand compound interest are destined to collect it. Those who don’t are doomed to pay it. – attributable to Albert Einstein, Benjamin Franklin, or John Maynard Keynes
In every transaction, the bank seeks to earn more interest than they pay and consistently earn compound interest.
How can you apply this in your own economy? Looking at your own inflows and outflows, total up the payments you’ve made to financial institutions over your lifetime and the ones you’ve made to yourself. Who is earning the compound interest? Are you paying more interest on loans or earning more on your money?
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Additionally, to model the bank, earn more compound interest than you pay by retaining control of your capital.
#3) Banks Use Leverage
When you have savings with the bank, that deposit is a liability on their balance sheet. The bank now has an expense to pay you interest each month. They go into debt to you. They also earn interest on that money by loaning it out. The bank takes your money and makes more with it, multiplying everything in their control. They use debt as leverage.
Because of the fractional reserve banking system, the bank must hold 10% in reserves. This means that they can loan out up to 10X the amount of money in deposits. When you deposit $1.00, they now have permission to create and loan out $9.00 more.
This leverage increases the spread they earn. Here’s how the bank increases their returns by using leverage: If the bank pays 2.00% on $10,000 in a 5-year GIC, they can now loan out $90,000 at 3.88%. They pay $200/year and earn $3,492/year, a whopping 1,552% Rate of Return.
One way you can take your money and make more with it is to use the leverage of debt. If you can borrow capital and use it to make money, you’re a steward of that money. This is different than borrowing money to use for your own consumption.
For instance, purchasing a $100,000 rental property with $20,000 down, and a $200 net monthly cash flow after all expenses will yield you a 12% cash on cash return. If you had not used leverage and instead paid for the property in cash, you wouldn’t have to pay the loan and may net $800/month in cash flow. In this case, but your cash on cash return would be much lower at 9.6%.
To model this principle, use debt for production, not for consumption. Instead of fearing or avoiding debt, use it to make more money.
#4) Banks Use OPM (Other People’s Money)
Banks don’t wait to stockpile their own capital. Instead, they incentivize other people to deposit their capital into the bank, and then use those “other people’s money” (OPM) as the seed capital to make more. When you put money in, it’s now in their house, and they steward it to bring in cash flow.
How can you apply this rule in your own economy? Provide enough value that other people want to invest in your endeavors. Instead of using your own money for an investment, keep your own money compounding, and use OPM for the purchase.
#5) Banks Want Money Back Faster
Determine what they value by evaluating interest rates – from their perspective.
Deposits with higher interest rates attract you as a depositor because you’ll earn more on your money. For the bank, the higher interest rate they’re willing to pay you (their expense) means the money is more valuable to them. The entity holding your money will pay higher rates of return for longer period deposits because they have control of the money longer.
Loans with lower interest rates attract you as a borrower because you’ll pay less for the loan. However, the bank will earn lower interest rates on shorter loans because they get the money back quicker.
High rates on deposits and low rates on loans both put more cash in the control of the bank.
When you use interest rates to make decisions about loans, you often end up making the decision that’s best for the bank.
When you deposit more money with the bank, you increase money in their control, shrinking the cash you could have used to create cash flow. Likewise, when you pay higher payments to loans, you decrease the cash in your control and end up with less money to use to generate cash flow.
Instead, make financial decisions that put more of your cash in your control, not the control of the banks.
#6) Banks Take the Guarantees
When you invest your money through a fund, the financial institution’s income on your investments is the guaranteed management fees. Your income on the same investment may be subject to market risk. Whether your account performs well or loses money, the bank gets the guarantees, and you take all the risk.
In your personal economy, pursue guarantees, not risk.
#7) Banks Want Low Risk and Guaranteed Returns
When you seek a loan, the bank is most likely to give you money if you don’t need it. If you need money, you are the highest risk to the bank, and most likely to be turned down.
When assessing your debt-to-income ratio, a higher ratio means higher risk, because more of your cash flow is already earmarked to pay fixed loan payments. A lower debt-to-income ratio means you are financially more stable and solvent and more of your monthly cash flow is available to make payments to the newest loan.
The bank’s determination of your creditworthiness is all about your cash flow, and their ability to gain cash flow.
If you have no money, no income, and are seeking an unsecured loan, you are the highest risk to the bank, because they have little guarantee of being paid back, and no collateral to collect if you default.
If you have income and cash reserves and obtain a secured loan, you’re a lower risk to the bank, because they know they’ll be repaid. In the unlikely case that something goes wrong, they’ll still be able to collect.
To apply this rule in your own economy, invest in opportunities that are low risk that give you the highest chance of getting paid.
Model the Bank
You have a choice to make.
If you follow typical advice and focus on paying off debt and accumulating money, you’ll continue being a customer of the bank and giving up control of your capital. Banks and financial institutions, Wall Street, and the government will gladly be the recipient of your cash and your cash flow when you prioritize paying off loans, accumulate net worth in risky securities, and pay too much in taxes. These actions have money flowing out of your control.
Instead, of paying so much to financial institutions through investments and loans, you can choose to do what the bank does. If you model the bank, you’ll prioritize cash flow, earn compound interest, use leverage and OPM, get money back faster, secure guarantees, and invest in what is most likely to pay you back.
In this way, you’ll get as much money as often as possible, keep it as long as possible, give up as little as possible, and take as little risk as possible.
One of the Most Effective Ways to Be the Bank is to use your own Privatized Banking System.
Interested to find out how, please contact me to set a convenient time to discuss.
Michael Bronstine –
Managing Partner, GBK Strategic Financial Partners
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