In Chapter 8, I wrote about how saving is important in capital raising. I stressed how savings reduce the debt burden of projects. I noted how savers are able to fund banks to enable them to lend money to other individuals or companies that have great ideas but require debt/working capital. This is why I concluded that without savings there would be no lending and no banks.
Today I write about how savings can earn you interest. For some savers this is one of the reasons for saving. With higher savings and a stable currency, savers can live from the interest they earn from their savings. This is normally the case for people in retirement who do not want to take a risk on their lifetime savings.
Savers are able to see their savings grow over time. Depending on the type of investment they use they are also able to withdraw some or all their money relatively easier than when they invest in property or other immovable assets.
Have you ever imagined how we used to save our wealth prior to the establishment of banks? Back then savings would typically be in goods that the saver owned. This could be in a variety of items such as sheep, goats, cattle, gold, beads and other items considered of value. They would see their savings grow as their animals bred and multiplied while the value of gold, silver or beads could also increase over time. Through feeding their animals would mature and become more valuable.
Overtime, banks created money to act as a store of value, a unit of account and a medium of exchange. When money is invested in a savings account with a bank, the bank has the opportunity to lend to those that have ideas but need debt/working capital to bring their projects to life. The borrowers pay the bank interest for the money they would have borrowed while the bank in turn pays the saver for his/her money that they would have used to lend to the borrower. The difference between the interest rate at which the money is lent and the rate paid to savers is the bank’s profit known as the Net Interest Margin.
As indicated in Chapter 8, borrowers need savers to be able to implement their projects and it is the role of the bank to make sure that the money they would have received from the savers is prudently managed by lending it only to those borrowers who have the ability to service the borrowing by settling the agreed capital and interest on the loan on time.
It follows that for the saver to earn more interest they must save more over longer periods of time. Those that deposit money in the bank and withdraw it at short notice are not the ideal saver and tend to get little or no interest, while the long term savers enjoy higher interest rates as the banks are able to deploy the funds without fearing that the saver will demand their money before borrowers repay.
There are times when borrowers require more money than the savers have accumulated. This creates a shortage of funds normally referred to as “tight liquidity”. When this happens, banks tend to pay higher interest rates to savers to incentivize them to deposit more with the banks to fund the high demand for loans. Banks will also levy higher interest rates to borrowers in recognition of the scarcity of funds. Accordingly, those that save higher amounts during tight liquidity tend to earn far more interest thereby building their wealth faster.
The interest a saver earns is therefore dependent on the amounts saved, how long savers keeps the money in the bank and the liquidity in the market.
I leave you with a quote by Sam Zell which reads; “The single biggest issue that I am very sensitive to is inflation. I am very concerned that this extended period where the interest rates were quite low and stimulated a lot of activity could breed inflation and create a problem for us”
This is why you must talk to your banker or financial consultant today and enjoy the reward of saving when others are spending!
Author: Ralph Watungwa
BAZ President
ENDS