Dumb question on banking: why do they have to charge interest in they lend money they don't have?

Interest makes sense if they were only lending money equal to their deposits--otherwise they wouldn't make a profit.

But if they are lending me money they didn't have in the first place, they are making 100% profit even without interest.

I can see why they like interest though: even if the rate is pretty low, the longer you take to pay, the more it compounds (my student loans doubled in a few years just with interest).

But it seems like banks should be limited to doing ONE of those--either only loaning money equal to deposits and charging interest OR loaning money they just have and collecting interest.

Although even the second sounds logically and morally wrong (and of course what we actually allow them to do is worse).

Hypothetically you lend out "free money" at 10%.

If 10% of people default on the loan you break even.
If more default then you lose money despite it being "free money".
If less default then you gain money.

It is actually more complex on that because earlier defaults are more expensive then late defaults (more interest collected, less principle unpaid) but I think you see the picture.

Of course fractional reserve is not quite free money. They can't lend unlimited amounts it is based on deposit amounts and they pay on deposits (very little but not 0%).

Lastly when lending money inflation is your enemy.

If I make 1% after defaults but inflation is 3% I am actually down/behind 2% in "real dollars". It would have been better to not lend anything and simply put the money in something that goes up with inflation (like gold).

Generally speaking interest has 4 components:
inflation risk/cost
default risk/cost
depositor cost (price of money)
profit

Even if profit was 0 the bank must still cover inflation, depositor, and default costs. Credit Unions are non profits and they don't lend money at 0.00% for that exact reason.

It is not the bank's money, they are not lending their property.

If they keep lending money at < cost eventually they do go bankrupt.
Many people seem to think there is no cost to fractional reserve and a bank can "make as much money out of nothing they want".

If that were the case NO BANK WOULD EVER FAIL!
98 banks failed this year alone.

The fractional reserve system allows them to magnify the effects of deposits however there are still costs involved (deposit cost, default costs, inflation costs).

If revenue < expenses the bank will fail.

Even NON-PROFITS like a credit union must collect enough that REVENUE = EXPENSES or they too will fail.

business model.

There is cost for the bank, however. If the loan is not repaid, the bank loses nothing but the future income from the interest charged and a diminished capacity to make future loans, which can and has been adjusted dozens of times to expand lending capacity when default go up.

The banks have a few fixed costs, but bear no risk. The currency controls that the banks exercise are the essential functions, all the rest is simply legal theft.

Really? Once again if it worked that was then banks would never become insolvent. That isn't fractional reserve system it is more like imaginary money system.

It doesn't work that way. Banks have demand liabilities. If they lose depositor money the demand liability doesn't go away. Banks can't "erase" fractional reserve liabilities.

If bank loses too much assets they fail to meet reverse obligations and the FDIC seizes control of the bank. Even before the FDIC a bank in that situation would be insolvent because they wouldn't have sufficient assets to pay depositors if they attempts to redeem funds and fail.

steps in. The Fed can, and has, adjusted the reserve rate to take banks out of insolvency, IOW, it is practically impossible for banks to fail. When they do it is due to gross negligence, malfeasance on a scale we pretend doesn't exist in an institution entrusted with control of our currency.

Loans are new money, except for the interest and fees charged. Since that money never before existed it belongs to the citizens, the bank has no ownership of it since it created it through license from the government (the citizens) Banks use deposits in their own investments the profits of which "belong" to the bank while losses are pushed off to the investors and then the public.

This is the kind of thing Henry Ford was talking about when he said,"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.".

Profits must exist in the process substantial enough to create incentives for the banks to exist and propagate--this is due to the nation's ideological belief that the best method to make credit and capital available for the most people is via private industry.

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

"out of thin air".

you repay the loan, that "created" portion of the money effectively disappears. it was just an open accounting position in the first place. repayment closes the position.

however, the interest you paid was "real" money from the "real" money supply. this is the bank's profit & cost, & if you think about this being done repeatedly, you see how banks & financial institutions come to control larger chunks of national wealth v. the population as a whole.

This sets up a system that MUST expand or die. It also sets up the wild business cycle.

But what happens with fractional reserve banking is that they tell the depositors that they can be paid back at any time, whereas the people the banks lend to are told they only have to pay it back after the agreed amount of time (which may be years away, with a mortage, for example).

The 'fractional reserve' is the amount of deposits the banks don't tie up in long-term loans, so that they can satisfy what they hope is going to be a small demand for depositors to get their money back at any one time. If they get that wrong, the bank can go belly up.

The 'lending money they don't have' aspect comes when the money is recirculated; the loaned money makes its way back, during commerce, into banks (not necessarily the same bank, of course), where it can then get loaned out again, up to the fractional reserve amount.

If the reserve amount is 10%, for example:
1 bank takes a deposit of $1000, and loans out $900 of it
That $900 is deposited in another bank, which loans out $810 of it
Another bank gets that deposited, and loans out another $729
and so on.

The end result is that $1000 becomes $900+$810+$729+... in several accounts; but at no point is any one bank "lending money they didn't have in the first place"; they're just lending it and hoping the depositor doesn't ask for it back, even though the depositor has a right to. You could fix it by saying that you have to match up the terms of loan and deposit, so that to get interest from a bank deposit you'd have to tie the money up for years or whatever; and say that any instant access account money can only go to loans repayable on demand (the overnight loans between banks, perhaps).

then they lend to you at higher rates. The difference is known as the spread.

Banks, like any other company, fund themselves in a variety of different ways deposits, interbank loans, the fed window, long term bonds, not so much by securitization anymore (unfortunately for me).