Many articles were written on this topic. Financial experts have analyzed the subject at length. Is there a moral problem behind bank loans? How about an economic one? Financial crises emerged due to unsustainable loans.
So, is it profitable to lend money from banks? How about depositing money there? According to many, it isn’t. Why? The only winning parties are the banks themselves and a few wealthy people.
Banks don’t enjoy quite a good reputation among consumers. However, they do have some merits. Many people couldn’t afford a house or car without loans. Yet, there are many downsides to getting one. Paying more than you borrow is just one.
Economists explored the pyramid scheme behind bank loans. In short, loans are only beneficial for a few. And the privileged are already rich. The system behind bank loans doesn’t benefit regular lenders. It pretty much looks like a pyramid scheme.
One that profits from the lower tiers to feed those at the top.
What Is a Pyramid Scheme and How Does it Work?
Some pyramid schemes are legitimate, while others are mere scams. The legitimate ones are usually related to retail and marketing. In such a system, protagonists must recruit. The more people a recruiter gathers, the better.
For example, door-to-door sellers need to find colleagues. Bringing more people aboard involves benefits. They get products for free. Alternatively, they can also get a promotion. As a result, they’d climb another level in the pyramid.
And they would stop selling products directly. Instead, they could focus on training other sellers.
This is just an example. Pyramid schemes can take myriad forms. However, the bottom line is similar. Those at the base of the pyramid feed the system. They do it by working for free or products (in legit retail schemes).
In investment schemes, they support the system with cash contributions. These schemes often translate into scams.
The most famous one was Charles Ponzi’s scheme. In modern history, Bernie Madoff is the most notorious pyramid scheme author. Pyramid investment scams are based on getting money from investors. Recent contributions are used to pay off older investors.
However, scammers keep most cash to themselves. They only pay some older investors to make the scheme look legit. Those at the base of the pyramid (early investors) get nothing.
So, what does all this have to do with banks? Well, some agree that bank loans work similarly. They support a pyramid structure.
Why Are Bank Loans a Pyramid Scheme?
Some consider the banking system a legal pyramid scheme. Here is why.
Many people deposit their money in banks. Some might assume that it actually stays there. Yet, this is not true.
Banks use the money from their customers’ deposits. This money is not meant to stand still. It has to circulate to produce more money. And how does this happen? For instance, through bank loans.
Each time a lender makes a loan, they promise to create new money. When paying off their debt, they accomplish their promise.
But where does the loan money come from? This is where the pyramid scheme resemblance kicks in. Banks use other clients’ money to provide loans. Just like in a Ponzi scheme. Investors’ money is used to repay other people supporting the pyramid.
So, who wins in the end? This is a tricky question. Only a few people benefit from the system in an illegal pyramid scheme. Namely, those at the top of the pyramid. Whereas those at the bottom support the rest.
Imagine depositing $10,000 in the bank. On the one hand, you do it to secure the money. On the other, you also want interest. Hopefully, the accrued interest will amount to a significant sum in time. But more than often, it doesn’t.
Banks worldwide offer meager interest. This is just a tiny percentage of the deposit amount. Mathematically speaking, you need a lot of money to be worth it. Let’s come back to our $10,000 deposit example.
Imagine you earn %1 per year as interest. This means $100 per year. So, how many years would it take to double the amount?
Closing Thoughts
The bottom line with loans and deposits is that they only benefit the rich. This goes both ways. First, the more money you deposit, the bigger the interest. If you deposit $1 million, 1% per year as interest is considerable.
Secondly, when you have lots of money, other loan terms and conditions apply. For example, you get a lower interest. You also get other repayment terms compared to regular borrowers. In other words, the system only benefits the rich.
And obviously, banks also win in all scenarios. They make money constantly from the poor and the rich through interest rates and fees. Therefore, we can compare them to a modern, legit pyramid scheme.
Educational guest post by Stratford Management Scam Education Department.