Understanding big bank profits

Understanding big bank profits

27 August 2010

Recently, the huge profits of the big 4 banks has been getting a considerable amount of media attention. Some people, like investors and shareholders are happy with the profits while others, such as politicians, are outraged. What does the average person on the street think about it though? Do they fully understand, or even care about, the financial systems that their money is a part of?

Unfortunately for many Australians understanding bank profits or financial practices is about as interesting as reading the complete operating manual on a new toaster. This is a real shame as understanding the way money works, and how it is managed, can help people achieve long-term financial security and a higher quality of life.

One important thing to understand about the big banks is that a large part of the profits earned must be used to pay back shareholders (investors). A shareholder is basically somebody who buys a share in, or a part of, the bank and expects a return on their investment. To be able to pay these investors, the big banks need to make profits through things like higher interest rates and fees. It goes to follow that the bigger the profit, the happier the shareholders.

The huge recent profits of the big banks then, from the point of view of a shareholder can only be seen as a positive thing. It follows too that as other investors see the big banks as a profitable investment more of them buy shares in these corporations. This leads to more money being available to spend on things like salesmen and advertising. Recent studies have found that ‘the big four banks spend over $1 billion every year on advertising – that’s more than it costs to run the ABC’.

In contrast, credit unions and building societies don’t have shareholders to pay. So they aren’t interested in chasing big profits. These mutual organisations exist for the sole purpose of providing their members with financial products and services. Not being tied to profits leaves these mutual organisations in a great position to provide trusted financial advice to their members. That is a pretty serious difference. It’s almost like the difference between asking a friend or a salesperson for advice on an upcoming purchase. One has your best interests at heart while the other must be influenced by their profit margins.