The savings and loans business

I would like to voice out my views on the savings and loans sector. Its also known as the credit business. If you do not know what is savings and loan, it basically means businesses try to get money from depositors like fixed term deposit or some sort of funding from the reserve bank or related parties, they organise the monies and lend it out to other people, typically with a higher interest rate. That way they are able to make money from the spread, which is the difference between the interest rate they borrowed at and they lent at.

Typically such businesses require between a quarter of a percentage to a half to cover their operating costs. Hence, if they got their funds at a rate of 9%, they would have to lend out at 9.25 or 9.5% just to break even. This margin tends to change based on the particular circumstances at that time. If the money market(typically where bonds, bills and notes are traded) is fairly liquid, then the margin may be lesser and vice versa.

There are some businesses in the past who lent at a rate below what they borrowed at, hence locking themselves in at a loss. These kind of businesses do so in order to undercut their rivals or just for the sake of maintaining market share. Such moves render the bank to the brink of collapse and does not last for long. This condition was typically apparent in the 1980s long decade, where it was boom boom boom for the market till tuesday 20th October 1987 when the market suffered a 25% drop in one trading's session.

Typically, depositors want their money in the bank only for a short period of time, however, the borrowers of the bank's money want long term loans in order to rid themselves of liquidity problems. Hence, the bank has a funding risk. Good banks manage this risk effectively. There are also other kinds of risks such as counter-party risk, the risk of a borrower defaulting, and liquidity risk, the risk where the bank is unable to meet the depositor's call for money back from the bank.

A savings and loan institution are also divided into two types, mainly those who can receive money from the public and those who can't. Those who can have to be regulated by the Reserve Bank of Australia, and those who can't do not need such regulation. Those who can and those who can't get their funding mostly from the money market and then make loans at a higher rate to individuals or corporate clients.

In the past, banks have made silly loans to all kinds of clients. Those clients do not repay their loan, and most go bancrupt. Banks gives out loans in secured or unsecured basis. Those who are secured usually then get less in the dollar and unsecured, well, if they are lucky, they get anything at all.

Some bankers would go to great extents to make loans in order to boost their revenue and their profile to be as successful as possible. That is when credit crises happens, when there is a meltdown of loans because some people just aren't able to repay. Usually in boom times, everything is rosy and there is asset price inflation, stuff like this do happen. When the boom is over, only then do those who lent out such money will be penalised for their mistakes.

For an investor, invest in conservative banks who would grow steadily over time, despite booms or busts. They are the kind who does not get carried away with the crowd at any moment but maintains the momentum at which they are going at. In my personal opinion, the credit business hasn't changed much over the 100 years since it started. It's more a matter of management of the business. Certainly an area to look into.