How Are Banks Allowed To Lend?
Welcome to the Real Estate Espresso podcast, your morning shot of what is new in the world of real estate investing. I’m your host, Victor Menasce. On today’s show, we are going to examine banking and how banks make decisions on whether to lend or not. Access to capital is one of the key pillars in real estate. I want to clarify that I’m not a banker or a mortgage broker in any jurisdiction, nor am I here to provide advice of any kind. I’m merely sharing what I’ve observed, which may be incomplete or even incorrect.
So let’s take a look at how banks make money to better understand why they might approve or decline a loan request. First, we need to understand the number and types of banking institutions. As of 2024, there are approximately 4,200 charter banks in the U.S., along with about 4,700 credit unions. These charter banks are further divided by their charter, based on whether they are national or state level. National banks are members of the Federal Reserve System, while state level banks may or may not be.
Banks in the U.S. earn income from a diverse set of sources, which can be categorized into two main groups: interest income and non-interest income. But before we delve into loans, we need to discuss bank leverage. Fractional reserve lending allows banks to create money out of thin air. There’s significantly more money generated by banks than by the government. In the U.S., the leverage of charter banks isn’t merely a basic ratio between loans and deposits. There are different leverage ratios that compare a bank’s capital to its total assets. These ratios are designed to ensure that banks have sufficient buffer to absorb losses without failing and jeopardizing the financial system. The specific ratio requirements vary depending on the bank’s size and systemic importance.
The rest of the podcast discusses in detail various aspects of banking such as Tier 1 leverage ratio, Supplementary Leverage Ratio, types of loans, and the criteria for evaluating loans. The podcast ends on reflective note about the risk factors banks consider before giving loans and the various sources they might utilize to earn income.
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