How do i industry sign banking missouri document fast
you we want to start our discussion today where we left off last time we're talking about basically reasons that we have banks functions performed by banks and what we talked about is that in these situations where we have a saver and a borrower or I should say savers and borrowers that direct transactions between these two groups have problems with them and these two problems basically come down to there's asymmetrical information unequal information held by these two parties savers just don't have the information borrowers do and so when this money is handed over there are a very high risks of the savers not being repaid and I grouped all of those problems those risks into two different categories last time the first one one of the types of risks the asymmetric information that exists at the time the loan is made and we call those adverse selection or I should say risks that occur because of adverse selection adverse selection means hey because of the way these markets would work out we would end up adversely selecting only the worst borrowers we would only be making bad loans remember why that was we sent a price for loans and interest rate for loans and then the people who are the safest borrow safe has to borrow or does just go away they say that's too high and they go away and so all that's left is bad borrowers we are adversely selecting borrowers in that process okay and then after a loan is made we have a problem called moral hazard and moral hazard results in high losses on loans moral hazard refers to the fact that after alone has been made the borrowers start behaving irresponsibly hey I'm playing with your money and so any negative consequences of whatever I do fall on you and so now I behave less responsibly the borrower does it then if the borrower using his or her own money and so anyway and the saver says boy I wish you'd treat this like it's your own I she'd be really careful in the bar what goes why would I do that if there's a loss it falls on you I can't pay you back sorry so anyway at the time other loan and after the loan is made there are these things these problems due to asymmetric information that makes it unlikely less likely unlikely that the borrower repaid the saver back and so that means that savers will just go you know I don't want to have any part of this I'm just not gonna lend my money up and so then when savers say I don't want any part of it I call in my money out then what that means is loans aren't being made and I don't want to go down this path but the same problems exist in the stock market in the bond market and so as soon as these people these savers just say I don't want any part of it and then they go away then there are a lot of activities over here there are people who want to send their kids to college or people who want to own cars or people who want to own homes there are businesses that want to hire people and build factories and stuff like that and those borrowers just can't get money credit I should say funds financing and so there are a lot of desirable activities that just don't occur when this relationship breaks down and it breaks down because of asymmetric information so anyway we we discussed all that laid the groundwork this time what we want to talk about is this how do we solve this now I gave these practical examples last time of the lemons with the cars and the way we address that problem that's the adverse selection was what Carfax and we have experts look at our cars and we've only buy a car from some I'll give us a warranty and the moral has a problem we gave the practical example of the what insurance once somebody starts insuring your behavior then there's a tendency to start behaving irresponsibly well that means the insurance companies have to do something about that and they do things like raise your rates if you have claims or cancel your policy if you have claims and so forth and so there are ways of coping with these problems in financial markets there are ways with coping with the problems and that gives rise to a whole bunch of institutions and regulations we have regulations in the stock market Securities and Exchange Commission we have specialists in the stock market that called investment bankers that we don't really want to get into but there are ways of coping with those problems at stock markets we have in the bond markets we have these ratings by Moody's and Standard & Poor's in the loan market which is the part of the finance market that we want to talk about in the loan market these techniques are these ways of coping with adverse selection and moral hazard come down to banks so what we're saying is this the reason we have banks is to cope with this problem that people can't cope with on their own if people just had all the information the world and all the skills to handle these problems then the need for banks would more or less go away but we don't have those skills those abilities that information okay so how do banks cope with these problems first of all and again we're gonna talk about banks next but the key thing I believe I mentioned this last time the key thing that banks do is they make loans now they accept deposits but then they make loans I think I told you last time something on the order of 60 percent of all the dollars flowing into banks and vast amounts of money flowing to banks sixty percent of that becomes a loan and so that's the main thing bankers do with their money and so that is really what we're talking about here is this loan situation how do banks cope with adverse selection meaning how do they avoid making loans to people that aren't going to pay back that somehow or another we don't think they're gonna pay us back okay and they begin by gathering detailed information okay and you might say Oh anybody could get their detailed information you know you could sit around asking questions but it's not just a matter of asking questions but there's also thinking oh gee how could I be misled what kind of documentation do I need and there is information that you need some expertise in order to gain access to this and so they're gathering detailed information about borrowers and their plans and don't forget it's not only people that are borrowing money from banks but also companies okay so we want to know things about these these borrowers and their plans and we want to know about their income net income we want to know about their assets we want to know about their business activities we want to know about how they're spending their money all these things play a role and whether somebody's going to be able to pay a loan off or not okay in the case of a business if you go to the bank your management business you go to the bank you apply for a loan they don't just say gosh you know you've been in business selling not on old fish hooks for many many years they start saying what are you gonna do with this money and you tell them oh I'm gonna build this or that or I'm gonna acquire some asset and then they say why don't you bring us in a business plan just show us what your plans are for the next three years or whatever it is with this new business you're gonna build or this expanded business show us your business plan and then you come in with the business plan and it just looks like something you've written down on the back of a three by five card in five minutes and they just go it looks like you're not gonna pay us back denied then so you spend some time making up one of these business plans how many of you've had a course over in the College of Business where you've worked on business find anybody you have just one guy okay you're gonna have to do that but that is the point is that huh you've got a business plan you've got a little story here with some numbers but it's like here's what I intend to do here's what I'm gonna do in the first month in the second month on the third month here are assets I'm going to acquire here people I'm gonna employ here is an advertising technique that I'm going to use here is a technology here's how this is going to develop over the years here are new milestones that I think I'm gonna meet over the next six months and year and two years down the road a lot of things that go into that and then they say hey you've thought your way through this and that's really what you're doing with a business plan is you're telling the lender or it could be an investor but you're telling them I thought my way through this this is not just something where I'm rolling the dice and hoping things work out I've really got this all planned out I know who I'm gonna hire I know what technology I'm gonna use okay so after they acquire all this detailed information then what bankers will do is they'll screen that information meaning what's the screening process that really just means it will analyze it what's this all add up to what does this mean to us and the screening means that this information comes to them and then they'll say yeah no mmm no yes and they're screening out the the bad applications by analyzing all this information and possibly other information have available and trying to make some prediction about the future is this person gonna pay us back and so this analysis takes a lot of time and effort you know if let's just say you sit down here at the desk and you just say hey I'm gonna lend some money huh and you know we started off with the saber doing this a person who's pretty clever who's kind of experienced could come to you and trick you pretty easily they might go oh you know I've got the greatest idea in the world and they could tell you a story that you might say yeah that's oh okay yeah I see what you mean and after a while you're handing some money over and then after a while a person's moved to another country and they're living the highlife on your money you never see them again and so somebody with experience and insight who's gonna have to analyze this story you're telling to see if does this make sense does it hold water and sometimes it does sometimes it doesn't what happens in a bank is somebody gets a job the entry-level at and banking is very often teller jobs but other than a teller job the other entry-level type job is a loan officer and what they'll do is they'll set you down at a desk and you've of course taken some courses and learned a little bit about this but they'll set you down there and they'll give you authority to loan up to a certain amount not very much and then if somebody comes in applies for a loan and they want $10,000 maybe from your book learning your education you can make that loan or make a decision on that loan but if you want to go above some threshold ten thousand or twenty thousand dollars do you have to get your boss involved and your boss comes over and looks at your analysis and it says hey here's something you've overlooked this this is not gonna work or this is something that you should have asked that question or obtained this information and then if the loan is over a hundred thousand dollars let's say then your boss can't sign off on it you have to go to somebody with yet more information or more experience I should say in the banking industry who's been making the loans so there's a lot of experience that is required in order to analyze these applications because as I said before anybody can lend money it's getting it back that is a challenge and the way this is really important up front is figuring out is this person I'll pay me back can I predict can I look down the road and see what could go wrong what's most likely to go wrong looks like let it go right another thing that bankers do which reduce this adverse selection is they establish long term relationships with the borrowers you know if you are lending your own money out you as an individual I don't know a person who's saving for retirement might have a hundred two hundred three thousand hundred thousand dollars maybe multiple times that amount two or three four or five hundred thousand dollars that they've saved for retirement but you know that's not a vast amount of money when you start winning most people if they're gonna save a half million dollars they don't had that half million dollars till the day they are ready to retire and earlier in your life when you are 35 years old and you have a little bit of money to lend out you're not really in a position to establish a longer-term relationship of these borrowers maybe the first part comes along wants everything you have and so how you going to establish long term relationships with a large number of borrowers well that's not a problem for banks because banks will set up in your home town and there will be businesses in your hometown that have been around and conducting their business for 10 20 30 years and they keep going back to that same Bank to get loans and that banker has learned over the years about the nature of that business what the problems are what things can go right about it but these longer-term relationships get developed and then it's far easier for the banker to say hey this is a good idea that's a bad idea okay and so that is something that will happen with bankers is there I mean customers especially business customers but frequently just individual borrowers too will go back to the same banks over and over and over and then as time passes the banker has a lot more insight about whether that borrower is going to pay the owner okay one thing that happens in these longer-term relationships and this is really for businesses is there will be a line of credit a line of credit is basically a pre-approved loan and I'm going to work this back to the long-term relationship here in a second what will frequently happen let's say that you've got a business a small business or a medium-sized business and you go to a banker what you might say is something like this you know I'm not ready to do it right now but sometime over the next six months or a year I kind of think that I'm gonna go out and I don't know build onto the restaurant or let's say remodel the restaurant you know the kitchen or something like this or buy a new delivery truck or some large expenditure I don't know exactly when and you know what maybe it won't happen this year maybe it'd be next year but when the time's right I'm going to do this and so then you might go to your banker and say so like I'd like you to kind of set something up where we kind of reach agreement and we'll sign a piece of paper and so forth or that if we get to that point you will you promise to loan me that money because I don't want to go out and hire an architect or negotiate a deal and then find out I can't get the money how about let's just work things out right now between us and the banker says okay and they will then after looking at all the details they'll pretend it's going to be alone and go through all the process of extending the loan and then just not give you the money and then you have a line of credit and they might say something like this in the line of credit we will at your discretion lend you $200,000 and any old time you want you can just go out and negotiate for that delivery truck or add-on to your restaurant or whatever it is you feel like you need to do up to $200,000 just write a check and when the check comes back we'll honor that will become alone on that day now by the way this sounds like a credit card right and it is a credit card is this no piece of plastic but it is a pre-approved loan that businesses are range from usually fairly large amounts with their bankers now here's what that does that relationship right there ties that borrower that business to that banker in a long-term relationship because now I've already made plans for alone six months or a year or two years down the road I'm gonna still do business that Bank over this longer period of time then just this line of credit is something that does tie them together and that Bank that makes the banker feel more comfortable about their relationship okay another thing that bankers do to reduce these adverse selection problems is they require collateral now collateral is an asset and it's an asset that you pledge if you're the borrower you pledge that asset and say if I don't pay you then you can take this away from me this as
et and sell it and get the money I owe you and there is a way of reducing the likelihood going into it that the loans gonna be bad well if it is bad then I still get my money okay a lot of times not so much with businesses but a lot of times for individuals when we go get a home owned or a car loan those would be the biggest loans then the asset itself is the collateral and so what would happen is this let's say you're buying a house that's a hundred thousand dollar home I'll just put a hundred thousand dollars then what they would do is the banker might say something like this I want you to put twenty thousand dollars as a down payment and then I will loan you eighty thousand dollars okay and for the bank or this downpayment is a key because then what we'll do is this you go out you buy the house there will be a deed which is basically a title we'd say title for a car but there will be a deed to that house and it'll have your name on it and that will be filed downtown that says you own that house except that banker's name will also be on that deed say you and a banker it doesn't really say the banker owns it it says this you cannot sell that home transfer ownership to it to the home to somebody else unless the banker signs off on it so then what you do is you say to the banker hey I promise I'll make these monthly payments and if I don't you can come take this house away from me and sell it and the banker says hey if I take this hundred thousand dollar house away from you and sell it I bet I can get my money back now if this is only a five thousand dollar downpayment and uh ninety five thousand dollar on I don't know maybe I can't seize that house and sell it and get ninety five thousand and so the bigger this down payment the safer the loan is for the banker and a traditional downpayment would be 20 percent this is traditional that doesn't mean it always is and there have been over the last decade there have been a lot of banks get in trouble by requiring five percent or even zero percent down payment if somebody says oh no down payment I'll loan you a hundred thousand dollars then what they're saying is this if you get behind on those loans or those monthly payments I'll take that house away from you and I'll sell it and get my hundred thousand dollars back really well that's not what experience shows because usually when people get behind on their house they stop painting it and fixing the plumbing right taking the trash out doing all those things and then very often they kind of skedaddle out of town and then we don't even find out there's a problem until you know the rats are living there and stuff like that the roofs leaking so what I'm saying is the people who do not make those payments and their homes frequently when we take their home and sell it we cannot get the purchase price out of it so what that means is when bankers are making small down payment requiring small down payments bankers very often if the loan goes bad bankers are going to lose something on that deal maybe they sell that house for only I don't know $90,000 and they lost $10,000 and that is the reason for a down payment is to reduce the bankers risk okay same deal on the car but what I'm saying to you and I guess the example I'm giving is for individuals usually it'll be the house that stands for collateral on the home loan if you go out and buy let's say a twenty five thousand dollar car then they might say something to you like hey we want you to put oh I don't know let's say twenty five percent that's a hard number let's say 10 percent 20 percent down I'm looking for a number I can work with down payment and so will loan you $20,000 is that 20 percent yeah and so anyway and then here's the loan and if you miss the payments they come out and take the car away from you to sell the car and hope they can recover $20,000 from the cell in that car okay now it's not always this way with businesses businesses have quite a few other assets like if you've been out here operating a business let's say that you've got a I don't know a mail-order company and you're selling things by mail and online and things like that you've got some assets it might be that you own a warehouse it might be that you have some inventory in this warehouse and it might be that you've got receivables where people owe you money and you're going to be collecting this at the end of the month or within 90 days and you might have a lot of assets and so you might go down say I want to borrow some money and then I'll pledge one of these other assets as collateral for the loan okay so very often the collateral is not the item the asset that is being purchased when we're talking about a business but one way or another the key here to our story is that if we require collateral then what we do is we reduce the likelihood that we're going to get into a loan situation where we can't collect okay or where we lose then bankers are better at doing that than other people somebody could come on let's just say you're doing your own lending and somebody comes to you and says hey I want to borrow some money maybe you've got vast amounts of money and somebody says hey I want to borrow $100,000 from you to buy a house and you say him you want to buy a house well I had money in banking class and I happen to know you might be thinking this not telling him I happen to know that I better require some collateral here so you say I think what I'm gonna do what did you say that houses were a hundred thousand dollars I'll tell you what I'm gonna do all on you eighty thousand dollars and we'll put my name on the deed this is the saver who's doing the London will put my name on the deed so you cannot transfer this without getting my say so my approval and they say okay that sounds reasonable and so then you make the longer somebody and they have put down $20,000 and you own am $80,000 and everything looks okay here's what you didn't know they've got a friend who's an appraiser a property and the friend appraised this property and said it's worth $100,000 but really it's only an $80,000 house but they've got the official appraisal here it is and you say yep there's an official appraisal it's from the ABC appraisal company says this $100,000 house you put up 80 thousand bucks 20 thousand bucks all in UAT you Linum 80 you've really made a hundred percent alone they didn't really put anything down why because they control this appraisal process now couldn't you figure this out well possibly but how much contact do you have with appraisers this bankers making loans daily you're making one loan every 5 years or 10 years or something like this and you don't know the appraisers like they you know like a banker does you have had an opportunity to find out which appraisers are accurate and which ones are not that's so it's easy for you to lose your money so I'm just saying to you that there are things that bankers can do and they reduce the problem going into it that most people would not be able to deal with now what about moral hazard how do banks deal with that what are the bankers do after the loans made how do they make sure they don't lose at that point first of all what they'll do is they'll monitor these payments that are coming in and they'll monitor those closely you know what will happen is there be a loan officer they'll be setting their here's a list that they'll see every morning when they come to work and right there on the computer monitor there's a list of loans that they've got outstanding and then boom boom boom it's flashing hey here's a loan it's overdue they didn't make that payment they don't have anything to do but just come into work and of course eat some donuts but they don't have anything to do but that you get up in the morning you go to work right you've got to I don't know take your dog to the vet got to take the kid to school your boss is sending you on assignment you've got a lot going on in your life the loan officer comes and sits down eats a doughnut and there's this flashing deal late Late Late Late Late what do they do they get on a phone and call you you got nothing to do with that so they're monitoring this pretty closely I mean a large number of loans so this constant monitoring mmm there's something else they do they monitor compliance with collateral agreements we talked about collateral moment ago you pledged some asset guess what bankers do bankers are looking and I don't mean to say every banker all the time I'm saying this is a function of loan officers and their Department they are paying close attention to find out if you're trying to transfer assets that they think they got their name on and that they got a you know basically a claim on but they're watching down there are you filing some new deed that takes their name off of this asset and they're paying attention to these things I was in a bank one time and talking to actually that's not the right word begging a loan officer for a loan it was down on one knee so that does qualify as begging anyway and I was not proposing proposing that I get a loan I guess anyway so I was there and the phone rings and so one officer says hello well it's a car dealership used cars and the car dealership was calling up to make an appointment what this loan officer saying could you come over Tuesday you know at 10 o'clock or whatever time of the day a loan officer had made a loan to the car dealership the cars sitting out on the showroom floor out a lot and so forth we're collateral and the loan officer had these periodic visits over to the car dealership with a list of okay where's that you know 1994 Buick or whatever I want to see it says right here that you've got one now show me so these loan officers you know you don't just say I pledge and then them go okay I take your word for it they are keeping up with this and their first something goes wrong down the road they find out about it fast and then that's when they start going hey you know we had this deal where we loaned you that money and you signed your name at the bottom of the page and then you remember all that yeah well you know what you broke your end of the deal so why don't you just pay us off and we'll go our own ways first time I bought a house I I won't go into all the details above first time I bought a house I paid for it on a Saturday that was my mistake the realtor is acting as an agent in this deal says I will take this money down on Monday and pay off the previous lender of this house and so Monday title will be transferred wouldn't transfer debt day I gave the check that day but title wasn't transferred a Monday I'll go down and do this I said okay that's fine so then I'd go down on I don't know Tuesday and I filed a deed in my name I now own that house and then I went about my business and that house needs some remodeling I hired some people they were in there they were working on it and I don't know six weeks later something like that phone rings hello and it was a guy with the savings alone he was a nice man as it turned out a lifesaver he said hey I had somebody down at the recorders office recorder of the deeds I had somebody on the recorders office going through the records and I see that you filed a deed on such-and-such a house at you know an address and I said yeah I bought that house he said well you can't really buy that house because I still have our bank still has its name on the title on the deed it sounds good what does that mean because I didn't know what that meant I had enough money to buy a house but I didn't have enough sense to avoid losing all that money and what had happened was this realtor who was going to go down on Monday and pay that house off what I found out later was he was speculating in the real estate market and so when I gave him this cashier's check he cashed it he him put it into an escrow account he didn't pay off that loan he took that money and bought some property because the price is gonna go up and he's gonna get rich he thought and then something happened was he wasn't able to sell that property and since he couldn't sell the property he didn't have my money back and since he didn't have my money back he didn't go down pay off that other home and since he didn't pay off that other home that previous lender still had their name on the deed and that meant my name couldn't be on the deed so when I filed as owner of this property alarms go off he calls me up he goes you don't own that property you just paid for it huh now he has to explain this to me like three times because I couldn't breathe I said hon that means what does that mean well it means that you paid that money and you have no house huh turned into a very lengthy thing and it really was lengthy and it took maybe two months to get this resolved and during that period you would be surprised at how many times I would wake up in the morning like at 4:30 and go in and sit in the kitchen and just put my head here and go oh what am I gonna do I finally got in touch with there's a real estate board and this was a realtor that did this and all this stuff to me but anyway there's a real estate board in the capital there are three people that said on that board and each one of us from a different part of the state and I talked to one guy that was on that board and he represented this part of the state and so I explained it and he said oh just a second that is not gonna happen in my district and he said you're talking to the right guy I'm gonna handle this and so he did handle it and then just a few days later that money was transferred over the previous lender was paid off and then the deed that I had filed did get transferred over to my name this is what happens when we do our own stuff and so anyway I did get the house the funny part of the story is this the guy who did that and I won't mention his name here but the guy who did that was pretty well known in town and he had this real estate agency he was the he was his name on the agency and he was I don't know pretty close to retirement age very heavy about 300 pounds and was not in good health and so and one of the things that this fella told me that called me up the one who said hey I still have my name on that deed you can't own it or our institution does he said don't go over and get this guy and like pressure him too much because all he has to do is fall to the ground and clutch his chest and say oh oh you caused me to have a heart attack I'm gonna sue you you know cuz he said this guy's in money troubles he's having money problems right now and he's looking for a way out and so he said don't go confront him I said okay that's a hard thing not to do by the way so I didn't go confront him and so I went through this whole experience finally it's all paid off and then like three years later I was over here getting on a Saturday afternoon I was getting a lunch at some mall sandwich shop up the street and was in August this is like I say two three even four years later several years later and it was in August and oh I mean it was one of those days where it's a hundred degrees out and you know the sweats just pouring off and no so anyway I drove up this sandwich shop and got out and here comes this guy this 300-pound guy who had tried to cheat me out of all this money he came out of the sandwich shop and he's walking along and I look at him and I think who is that guy and you know it's like a familiar face and I say hi and he says oh hi to me you know and then he goes on and I go on in and by the time I'm standing or ordering my sandwich I know who this guy is and so I think don't even you know don't turn around so I go ahead and I get my sandwich and I got it to go so I'm walking up to my car and this guy is out there and he's in his car and he's trying to get it started and remember me remember and it just will not start and it's just turning over turning over and then the battery's going dead and so I got in my car and I'm just thinking hey you know don't be having a problem here so I get in my car and I've got the air conditioning on of course and so I push the button the window goes down and I said hey buddy you have in trouble now and here's this guy it's three hundred pounds it's 100 degrees and the sweater blow and off of him you know and and he'
doing all this kind of stuff I said hey buddy you having trouble you need some help and he said yeah thanks a lot and I said that is a damn shame and I put it in reverse backed up and just drove on down the street anyway that's the kind of guy I am and so I had my own little laugh you know after all of a sudden I learned a valuable lesson from that a really valuable lesson and that's what I'm telling you is if you start doing your own business there's always somebody over there it's smarter than you more experienced maybe not smarter IQ wise but got the experience that take advantage you and that's why this doesn't work out this direct finance is what it would be called where we directly handle these investments it's a difficult thing to do and so lenders people that have been lending hundreds and hundreds and hundreds of loans over the last three years they've seen it all and they are not so easy to to take advantage of they monitor spending now not so much for you or me but here's what happens if you've got a small business and you go in and you get a loan guess what that lender will say to you oh oh so your restaurant you want to own that's real good we want you to keep your checking account here and you say okay I don't care they they might say something to you like this no service charge you keep your checking account here they you say okay that's that's no problem you keep your checking account yes what the banker is doing they're monitoring every deposit you make they're monitoring every check you write and that doesn't mean they care who you're writing the checks to they want to know if there's more being put in on a monthly basis and is going out on a monthly basis because if you have after month after month where let's say ten thousands going in eleven thousand going out there will be a day when there's no money there to make that payment and the banker wants to know that in advance and so they can monitor your spending behavior by basically having you keep your checking account there okay one thing that bankers do that and it's not really moral hazard so much is to minimize costs that what we've been talking about up to now how's how can I avoid making bad loans in the first place adverse selection how can I avoid loans going bad moral hazard well we still recognize that a certain percent of loans are going to go bad so how can I make it where when a loan does go bad it's not gonna put me out of business and they minimize their costs I should say of bad loans my bad loans defaulted loans by properly pricing loans and by pricing interest rates right we don't go down to the bank and say I want to take out a loan and then they just go okay six percent for everybody what they'll say is something like this you know we'll start with this benchmark interest rate and then if we think that loans of this nature have a 1 percent greater likelihood of going bad we're going to add one percent to the interest rate to that benchmark that we started off with if we think another category lence has a three percent likelihood of going bad that would mean that a three percent likelihood if we made a hundred of these loans in this other category three of them go bad and so what we're going to do is we're going to charge an extra three percent on all the loans in this category and that way the ones that don't go bad will collect enough extra interest to defray the cost of the ones that do go back and so what they need to do is calculate the likelihood even after they've taken steps against adverse selection after they've taken steps against moral hazard there's still a probability a possibility that loans go bad and then what they want to do is say what's the probability 1% 2% 3% 4% and of course there can be 1/2 percent and so very often what we'll see with business loans not so much personal loans but business loans and it'll start off with something called the prime rate that's the prime interest rate and that is beta this benchmark interest rate and then what they'll do is they'll price long is prime rate plus 1% prime might plus 2% plus 3% and the loans get riskier and riskier and there couldn't be some that are prime plus 0% that is to say a prime rate loan that would be for a safe loan that we just say there's virtually no chance this will not be repaid and so what the banker wants to do as I say even with the risk that still exists is to price that loan properly can I do that can you do that no my skill is talking about that but I've never actually done it somebody who's made a hundred or a thousand loans they can properly price these one okay so anyway this is how bankers deal with the lending problems that they have how they avoid these risks I want to talk about very quickly two other things that banks do remember are even though we've been talking about asymmetric information our bigger topic is this we want to know why do banks exist and in addition to dealing with adverse selection let's say here's reason number two that banks exist the first one was adverse selection a s and the second one is lowering transaction cost let's say you've got life savings $200,000 and you were out there trying to lend your own money that's a now you can make one loan of $200,000 but then you there's no diversification you're just taking a vast amount of risk if you've got two hundred thousand bucks which you ideally like to make do is make a hundred loans of two thousand dollars apiece and that way if a few of them go bad you still have most of your savings intact the only thing is there's high transactions cost of doing that a thousand loans Wow right we're gonna be out here and interview a thousand people there's very high transaction cost of doing it and also it may be that in order to minimize your risk you say I don't want just make loans in this town I'd like to make loans throughout the United States I'd like to make some internationals I'd like to diversify my risk the cost of actually making loans on such a vast scale required for diversification very high and you would eat up all the interest you would get on the loan just in these transactions cost borrowers borrowers might say hey I don't want to borrow the money at the bank I can issue a stock I can issue a bond yes but the transaction cost of doing that is very high you can't just issue stock by going to a copy machine putting a pretty picture on there and then you know running off a few copies and that's it that's not how we do that we have to hire experts and they require a charge thousands of dollars and so if you're trying to borrow a hundred thousand dollars if somebody charges you five or ten thousand dollars to do this stuff for you oh my gosh that's a very high rate and so bankers are basically handling this kind of stuff gathering money up and handing out on a vast scale and then the cost per loan you get or the cost per deposit you make is very small and that keeps the transactions cost down okay and so this is the other main function of banks what we will do next time is actually go on and talk about banking okay and this is our reason that banks exist I'll see you next time so on
