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by discardedrefuse
1147 days ago
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Someone correct me if I'm wrong, but the reason banks like Ally are able to offer high-yeild savings account is because they are using your money to invest in (something like) a government money market fund. Take SPAXX, it currently has a 4.5% yield. Ally is only giving you 3.75% and keeping the rest. |
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The trick is in modelling and mitigating risk, of which there are many:
1. Duration risk. With demand deposits, banks borrow short and lend long. Demand deposits come and go daily, but the banks use them to make mortgages and other loans. Some stay on the books, others sell and either make more loans or hold other assets. The risk is that depositors may all ask for their money back, but you cant recall the loans you made.
2. Interest rate risk. Interlinked with duration, rate risk is the risk that the rates you loan at now are less favorable than rates later. A loan earning 1 percent is less valuable than one earning 2 percent. The strength of this relationship is tied to duration; losing out on 1 percent for 1 year is less bad than losing out for the next 30 years. The rule of thumb is that for every 1 percent rate hike your asset loses 1 percent of its value times the years until it matures -- so that 1 percent underperformer with a 30 year duration loses 30 percent of its value!
3. Default risk. Loans may go into default, and then instead of getting your money back in 10 years you get less, maybe even nothing. You try to price that into your underwriting, but the error term here might be called "underwriting risk" -- the risk that your risk estimate is wrong.
Theres more ive likely forgotten as a layman, but I'm sure you get the idea.