<p>Because it is still profitable for bank to do so.</p>
<p>Your question is analogous to the question, &quot;why do some car companies create cheap cars with low markup when there are luxury cars that often have higher profit margin&quot; (eg according to <a href="https://jalopytalk.com/profit-margin-on-luxury-vehicles/" rel="nofollow noreferrer">this</a> article regular cars have profit margins around 3-8% and luxury cars 8-10% with some as high as 25%).</p>
<p>There is only so much demand for money on capital markets the same way as there is only so much demand for luxury cars. If there are other profitable markets even if they are much less profitable it makes sense for firms to service them.</p>
<p>Also banks do not just lent out their own capital but they can always borrow more reserves. If interest rates on reserves is sufficiently lower than the interest rate on mortgage banks will be happy to issue the mortgage.</p>

CC BY-SA 4.0
2022-07-14T12:52:35.403Z
"Because it is still profitable for bank to do so" is this actually the case? I can think of two instances in my lifetime where banks lost mind-boggling amounts of money related to mortgage loans going bad and had to be either bailed out at great expense or have their creditors simply eat the loss. I mean, I guess in a sense it is still profitable *for the bank* since society at large implicitly subsidizes and insures against systemic risk for them, but it still seems weird to me to say that they're profitable.
Jared Smith
CC BY-SA 4.0
2022-07-14T13:08:46.800Z
@JaredSmith yes they are and were profitable. That period had more to do with moral hazard. Banks knew the system was set up in a way they have to be bailed out. For economic decision making you care about profitability in terms of benefits - costs, if costs are paid by taxpayers then from the view of the bank the their costs are 0. In addition there is difference between ex ante and ex post profitability… for example, decision to enter a gamble where you get 1million dollars with 99% probability and you will loose 1 million dollars with 1% probability would be still profitable and
1muflon1
CC BY-SA 4.0
2022-07-14T13:09:21.557Z
Profit maximizing decision to take, regardless that you can end up in a scenario where there is loss.
1muflon1
CC BY-SA 4.0
2022-07-14T19:30:11.547Z
@jaredsmith I think this is a very bad characterization of the financial crisis in 2008. If banks did their jobs, they would not have lost money in the financial crisis when people defaulted on mortgages. That's because they are supposed to take an expected default into account and charge enough interest such that when the default occurs, the costs are already recuperate. The problem is that there is government regulation on how much interest can be charged so if the interest exceeds this value, they should have been declined the loan. Instead, people who were likely to default still got loans
uberhaxed
CC BY-SA 4.0
2022-07-14T20:01:32.100Z
@uberhaxed I'm not sure you are actually contradicting what I'm suggesting: that mortgage lending is not actually profitable. It doesn't really matter (at least not to me, for the purpose of this exchange) *why*: whether it's government regulation or principle-agent problems (moral hazard) or whatever. Although 1muflon1's points are well-taken, especially ex ante vs ex post notions of profitability, they answered my question pretty well.
Jared Smith
CC BY-SA 4.0
2022-07-14T20:09:50.993Z
@jaredsmith Mortgage lending is profitable when banks actually reject unqualified applicants from getting loans. The problem is that when banks reject a bunch of people (to reasons that can be summed up as "they don't have the money to repay the loan") and due to systemic problems this happens to be mostly the same group of people (e.g. black people), it looks like the bank is using race as a disqualifier and it opens them up to class action lawsuits. So they instead make the decision to accept unqualified people to improve the optics. This is what ultimately collapsed the system in 2008.
uberhaxed
CC BY-SA 4.0
2022-07-14T20:15:22.350Z
@uberhaxed if something is profitable under a set of assumptions (in this case that banks will make sound decisions about who to loan money to) but those assumptions don't actually hold it isn't actually profitable. As I said, it's not like this happened once, it instead seems to happen about once a generation.
Jared Smith
CC BY-SA 4.0
2022-07-14T20:22:11.247Z
@jaredsmith Yes. What part of "if banks did their jobs" is unclear? All bets are off when people break the rules. Banks could have just risked the lawsuit, won and carried out business as usual. But chose not to do so for whatever (probably valid) reasons.
uberhaxed
CC BY-SA 4.0
2022-07-14T20:44:52.927Z
@uberhaxed I think you are mixing here normative and positive economics. It is fine to say that normatively banks should be moral and take into account their effect on society. However, that is moral ought statement. From a positive perspective (what is) banks that want to maximize their profit (as business do) have little reason to take into account their bad effects on society. That’s why we have pollution (negative externalities) in industry, morally it’s fine to say that firms should take into account the fact they cause global warming but it’s positive fact that profit max firms won’t
1muflon1
CC BY-SA 4.0
2022-07-14T20:52:25.967Z
@1muflon1 I didn't mention morals at all. I was talking about the financial cost of a lawsuit (especially a class action). In a lot of cases, it's worth it to take the chance of a lawsuit and factor in things like fines as the cost of doing business, many US companies do in the EU.
uberhaxed
CC BY-SA 4.0
2022-07-11T11:02:45.277Z
2022-07-13T20:56:06.490Z
2022-07-13T20:56:06.490Z
1muflon1
<ol>
<li><p>Banks are in the business of lending money. If they didn't do this, then they wouldn't be called a bank. They would be called a fund manager or stock broker or some sort.</p>
</li>
<li><p>Mortgages are safer investments. If a bank buy a stock for $100,000 and the company goes bankrupt (which most companies do even over short period so this is an eventuality) then the stock becomes worthless and the bank loses 100% of it's investment. If a bank lends a person 100,000 to buy a house and the person goes bankrupt, the loan is <em>collateralized</em> so the bank can repossess sell the house and recuperate the costs of the loan. In theory, the interest rate is supposed to be a calculation of how much money the bank can receive before an individual goes bankrupt and combined with the depreciated value of the collateral it should meet some target value (usually some percentage of the value of the collateral like 110%). In reality of course, you're more likely to sell a house for more in the future than when you bought it so it's generally a safe bet even with 0% interest.</p>
</li>
<li><p>Revenue is less variable. Stocks can grow by a lot, a little, and even lose value. Interest on a loan, collateralized or not, has a fixed rate or a variable rate which is known ahead of time. This allows a bank to efficiently plan for future revenue since the value they are getting is fixed. Even in the case that a person defaults on a loan, since it is collateralized, the bank will likely not lose any money if they did their due diligence in underwriting and charged an appropriate amount of interest.</p>
</li>
<li><p>Banks need to lend money. This means that the bank need to get paid in money so they can lend more money. A stock going up means that the bank can theoretically get money if they sell at that moment. Since selling and rebuying stock every time you need money is a huge waste of money (because taxes, broker fees, etc.) the only alternative is to leverage, which would be taking out a loan against the value of a stock. A bank buying a stock and borrowing money against the stock to lend to someone else is a house of cards that is waiting to fall (not to mention the bank loses money paying interest to someone else).</p>
</li>
</ol>
<p>Although I'm not understanding the aim of the question. If you wanted to give someone money to invest it, there are fund managers for that. Banks are basically providing a public good by giving the public a well regulated, insured, and safe way to borrow money without the risk of a loan shark breaking their kneecaps.</p>

CC BY-SA 4.0
2022-07-12T03:06:55.417Z
Well regulated implies a partial remediation against marginal damages, and insured investment is regulated how? The government allows borrowers to not be physically harmed for lenders’ failures?
Nick Carducci for Carface Bank
CC BY-SA 4.0
2022-07-12T05:06:04.303Z
@Nickcarducci I'm not sure I understand your comment. Almost everything a bank does is regulated from charging interest, to savings accounts, to how much money they must have on hand, to transfers, etc. I didn't say anything about insured investments. If you money in a (US) bank, then you are protected from (e.g.) a bank run for quite a large amount of money (usually 1/4 million). Perhaps banks work differently in your country?
uberhaxed
CC BY-SA 4.0
2022-07-12T16:31:22.167Z
5. When banks offer mortgages, they're bringing in customers that are likely to use the bank's other revenue-generating services as well.
bta
CC BY-SA 4.0
2022-07-12T19:15:41.267Z
@bta this goes for every consumer facing business so I figured it wasn't worth mentioning. E.g. a gas station selling gas, a movie theater selling tickets, a ball game selling tickets, etc.
uberhaxed
CC BY-SA 4.0
2022-07-11T22:13:15.653Z
2022-07-11T22:13:15.653Z
uberhaxed
<p>Traditionally, Banks are in the business of converting interest rate periods.</p>
<p>Suppose you want to lend 1000\$, but get at it whenever you want.  If there are 1000 of you, that is 1 million dollars.</p>
<p>Now, you know some people who want to borrow money, but want to be able to keep it for a period of time without having to replay it on demand.  Say, they want to spend 1000\$ on an upgraded tool, which will make them an extra 100\$ a year for the next 30 years.  They won't have the cash to pay off that tool for a decade or more; so a loan that can be called back &quot;on demand&quot; might bankrupt them.</p>
<p>The bank facilitates this.  The bank takes the million\$ of demand deposits, and lends some of it out as a term loan.  Most of those people depositing 1000$ in a demand account won't take it out all at the same time; so the bank can &quot;safely&quot; lend that money for longer terms than they guarantee.</p>
<p>They can even do a bunch of 6 month rotating deposits and make it even less likely that the money will be needed before the long term loans finish.</p>
<p>The profit comes from giving the short-term deposits a lower interest rate than the loans you hand out.</p>
<p>This is a kind skimming out of being the middle man.</p>
<p>If things go really badly, that bank can <em>sell</em> the loan it owns for short-term cash to pay off the short-term deposit demand for cash.  So long as the loan is healthy and the market is liquid, this can return a profit long before the loan actually matures.</p>
<p>Now, suppose if instead of doing a long term loan, they went off and invested in the stock market.  The problem is that the value of stock market assets are <em>less stable</em> than the loan.</p>
<p>So now the bank buys up a bunch of stocks with the 1 million dollars in deposits.  The stockmarket drops by 50%, and a bunch of people lose their jobs, and start withdrawing their savings from the bank.  Now the bank has to pay off the bank account withdrawals with a distressed asset!</p>
<p>In theory, the mortgages are <em>more stable</em> than the stock market assets.  The same economic crash that cause stocks to drop by 50% might drop real estate by 10%, which in turn makes (healthy) mortgages worth 5% less (as they are guaranteed against the principle).</p>
<p>The same call on deposit cash is then easier to answer; sell off some mortgages, and cash is easy to provide.  While the asset is slightly distressed, it isn't half value.</p>

CC BY-SA 4.0
2022-07-12T08:37:24.797Z
Bank don't lend out deposits. It's the other way round. Loans create deposits.
BrsG
CC BY-SA 4.0
2022-07-11T19:31:18.023Z
2022-07-11T19:31:18.023Z
Yakk
<p>Some reasons have already been mentioned, another would be that banks lend not only their own money, but also the money of private individuals and let them share in the interest income.</p>
<p>If a bank lends 3% and half of the money comes from private individuals/investors, then the bank's interest rate is 6% on its own capital.
If the bank now gives 2% to investors, it still has 4% interest on its own capital. In this way, banks can increase the interest income on their own money.</p>

CC BY-SA 4.0
2022-07-12T08:44:24.743Z
2022-07-12T08:44:24.743Z
Andreas
<p>In the United States at least, mortgages are subsidized by the federal government via Fannie Mae and Freddie Mac. These quasi-public entities are required by law to purchase mortgages from loan originators (i.e. banks), even during unfavorable markets, and can themselves borrow at very low rates because they're backed by the government and seen as very unlikely to default. Because there is a guaranteed buyer of mortgages - assuming they meet certain conditions set by public policy - there's a constant downward pressure on the interest rates of loans within those parameters. (One of those parameters is no penalty for early repayment, which is somewhat mystifying to see in such a long-term low-interest financial instrument, without the context that the government is subsidizing loans with that condition.)</p>
<p>From the bank's perspective, issuing loans that meet the purchase criteria <em><strong>need not even be an investment</strong></em> - they have a guaranteed way to cash out immediately, and use that cash to make money elsewhere. Most banks will sell some fraction of the mortgages they originate, while keeping others. Some banks buy mortgages from other banks, but they're competing against the guaranteed buyers.</p>

CC BY-SA 4.0
2022-07-14T11:50:50.430Z
Question is about the Netherlands, which works a bit differently. There's a quasi-governmental scheme  ("Nationale Hypotheek Garantie") which insures the default risk. This means the bank doesn't carry the risk, so it can offer a lower interest percentage.
MSalters
CC BY-SA 4.0
2022-07-14T15:20:15.083Z
@MSalters that sounds like good info to add as an answer - I just wrote from what I know and tried to clearly state that I was giving context from elsewhere in the world. I don't know Dutch so it'd be a bit hard for me to research with confidence how similar the situation is in the Netherlands.
Willa
CC BY-SA 4.0
2022-07-11T21:22:29.780Z
2022-07-11T21:22:29.780Z
Willa
<h2>Because they are allowed to lend you money they don’t actually have.</h2>
<p>When a bank releases money for your mortgage, it actually comes from nowhere. They <em>magically</em>¹ make it appear on your account, or <em>magically</em>¹ transfer it to the seller party or notary. They simply record that you now have them a loan, and that the other party has the money – assuming it is in the same bank.</p>
<p>This is basically the main mechanism of <a href="https://en.wikipedia.org/wiki/Money_creation#Role_of_commercial_banks" rel="nofollow noreferrer">money creation</a> in the current economical system. It also means that, when you reimburse your mortgage, the money actually gets <em>destroyed</em>¹.</p>
<p>Of course, there are limits to the amount of money a bank can create like this, mainly the <a href="https://en.wikipedia.org/wiki/Reserve_requirement" rel="nofollow noreferrer">reserve requirement</a>. This reserve money will be used when money is transferred to another bank: over a day, you have a lot of transactions between banks in all directions. At the end of a day, the balance is computed for all banks, and reserve money transfers will compensate them (possibly with loans between banks).</p>
<p>Let’s say this requirement is 10%, it means that if a bank has \$100 in reserve money, they are allowed to lend \$1000 to customers. As you can see, the interest rate will be 3-4% over \$1000 and not \$100, which would give them \$30-\$40 a year.</p>
<p>Commercial banks are not allowed, however, to use this money creation mechanism to invest on markets. So if they place the same \$100 on the markets, they can only hope for that \$10 yearly return, with possibly more risks.</p>
<p>Risk assessment is also obviously an important factor as well, as described in the other answers. Loans are usually less risky than investing on the markets, but creating money for a loan increases that risk. If loans don’t get reimbursed, the bank might end up without enough reserve money for when customers ask to retrieve it, leading to the bank bankruptcy.</p>
<p>¹ <sub>As you know, there is no <em>magic</em> in this world. Even if this process does not actually move any money, the created money corresponds to an asset of the bank, i.e., your loan. Read <a href="https://www.riksbank.se/en-gb/payments--cash/what-is-money/" rel="nofollow noreferrer">What is money?</a> and <a href="https://voxeu.org/article/banks-do-not-create-money-out-thin-air" rel="nofollow noreferrer">Banks do not create money out of thin air</a> – thanks to @Dick Larsson
and @csilvia for those links.</sub></p>

CC BY-SA 4.0
2022-07-12T00:02:41.143Z
This answer is incorrect. First, banks do not create money "magically", they do it out of central bank reserves and by maturity transformation of future cash flows of borrower. The money also does not magically appears in your account it is transferred from the reserves banks can borrow from other banks or central bank. Second, banks can invest their money into stocks and so on, what they ordinarily can't do is to borrow extra reserves to do so from central bank (which can create as many reserves as it wants). However, there are whole investment banks that specialize in capital market
csilvia
CC BY-SA 4.0
2022-07-12T00:04:43.053Z
Third, the correct reason why not all banks invest in stock market is the one provided by Adam, it is risky.
csilvia
CC BY-SA 4.0
2022-07-12T00:31:31.607Z
@csilvia no money is actually transferred when a bank lends money. See also [Why Banks Don't Need Your Money to Make Loans](https://www.investopedia.com/articles/investing/022416/why-banks-dont-need-your-money-make-loans.asp). Your second point does not really contradict my answer, which says banks cannot create money to invest into stocks. My answer does not contradict Adam’s answer either, but profitability of loans cannot be computed the same as for investment since there is money creation involved, so it is not just a matter of risk assessment.
Didier L
CC BY-SA 4.0
2022-07-12T10:21:42.237Z
While this answer not completely wrong, it still greatly oversimplifies how fractional reserve banking works.
Philipp
CC BY-SA 4.0
2022-07-12T11:43:10.057Z
@Philipp I agree. I didn’t want to go into too much details but I think it would make sense to add more. I will try to update it when I have time.
Didier L
CC BY-SA 4.0
2022-07-12T18:08:04.823Z
Didier is totally right. 
Privat bank money is just that, bank money, it is NOT real money.
Will be super interesting to see how central bank digital currency will affect the market.
The Swedish central bank explains this on its web site.
https://www.riksbank.se/en-gb/payments--cash/what-is-money/
People still today believe that banks lend out money that other customers has deposited with the bank...and that is totally wrong.
Dick Larsson
CC BY-SA 4.0
2022-07-12T21:00:23.993Z
@Philipp But it does so **LOUDLY**. You don't have to be entirely correct if you assert things forcefully enough.
R.M.
CC BY-SA 4.0
2022-07-12T21:38:09.020Z
@DidierL You don't know what you are talking about. First, that investopedia article does poor job explaining this and has no references for its explanation of the mechanism so that is just a person behind the article talking about something they do not really understand like this answer. Investopedia also often has mistakes in their articles. Serious research like McLeay et al 2014 or https://voxeu.org/article/banks-do-not-create-money-out-thin-air explain how the money creation process actually work. Banks can't just create money without meeting their capital requirements
csilvia
CC BY-SA 4.0
2022-07-12T21:40:35.960Z
and to meet their capital requirements they need to borrow reserves from other banks or central bank. Plus they cannot just lend indiscriminately as that practice would lead to situation where they are unable to satisfy their capital requirements, so private banks (as opposed to central bank) cannot just create money out of nothing, they create them from reserves and by maturity and liquidity transformation. You are just spreading common misconception that laymen that do not really understand the mechanism have
csilvia
CC BY-SA 4.0
2022-07-13T18:49:35.480Z
@user253751 has made the most useful comment here.  The root of the belief that banks "create" money is the failure to understand that when you make a deposit you have made a loan to the bank.  The colloquial belief that the bank is just "holding onto" your money for you is false.  You have loaned them money, and they have agreed to give it back to you - on demand in the case of a checking account; after a given time frame in the case of a CD.  As long as not everyone demands their money back from the bank simultaneously, the bank is solvent.
tbrookside
CC BY-SA 4.0
2022-07-13T21:14:01.270Z
I have extended my answer with more details and an example. Thanks @DickLarsson and csilvia with the links, which I included in a footnote. I voluntarily admit that I am no expert, but I think we should focus on the content of the answer, which does not aim to explain how banks decide whether to grant loans since the question is focused on profitability.
Didier L
CC BY-SA 4.0
2022-07-13T21:21:45.453Z
@tbrookside private banks _do_ create money. Technically, it is private bank money and not central bank money, but it is the same for most intents and purposes. Moreover, there is no direct connection between the money you loan to the bank through a deposit, and the money people receive when they take a loan – no money is moved when that happens.
Didier L
CC BY-SA 4.0
2022-07-14T11:42:30.843Z
@user253751 - No, that is a misperception created by the fact that people think their deposits are still "their money", in a pile somewhere with their name on it.  They aren't.  The bank is borrowing money from you (your deposits) and lending it to others (their loans).  That is what intermediation *is*.  It's an accident of language and of economic history (along with some intentional sleight of hand on bankers' part for literal millennia) that leads people to believe "their money" is still theirs and that new money has been created.
tbrookside
CC BY-SA 4.0
2022-07-14T11:45:43.050Z
@user253751 No, they aren't.  *Once you withdraw them*, or transfer them to someone else, they are all those things.  And at the moment you withdraw or transfer them, the bank takes them out of a fungible pot of their capital, central bank loans, and other people's deposits to give them back to you and close out your loan to them of that amount.  Until you transfer them, they are an entry on a ledger promising to pay you back your loan on demand.
tbrookside
CC BY-SA 4.0
2022-07-14T11:57:06.417Z
@tbrookside Banks give out "credit" that is used as "money" in the economy. 
What we talk about here is the fact that the money that banks lend, is not money other people have deposited with the bank.
Here is a quote from the Bank of England "Therefore, if you borrow £100 from the bank, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account."
https://www.bankofengland.co.uk/knowledgebank/how-is-money-created
Dick Larsson
CC BY-SA 4.0
2022-07-15T07:09:31.483Z
@Didier_L's is the correct answer.
To put it in another way: Banks can -and do- create money for lending it to third parties, but can't they buy anything by themselves with that newly created money -imagine if they could self-loan and use the sums to buy... the whole world.
Of course, the reserve mechanism for backing the risks created with loans have to be considered, but that is another matter.
escaiguolquer
CC BY-SA 4.0
2022-07-11T20:16:16.397Z
2022-07-13T21:10:35.283Z
2022-07-13T21:10:35.283Z
Didier L
<p>Let me try to give a Dutch-focused answer.</p>
<p>Dutch banks are sitting on the largest amount of savings accounts ever; in 2021 it exceeded half a trillion euro's. Banks aren't paying any significant interest on this money. 0.01% is common enough. That may sound bad, but the situation can be even worse. Banks themselves, if they can't find a better destination, may be forced to park this money in either ECB accounts, or other low-risk assets like Dutch treasury paper - both of which have <em>negative</em> interests at the moment. In comparison, mortgages that pay 3-4% look very good.</p>
<p>Now, there's of course a long-term risk that somewhere in the next years the house owner can't afford to repay the load. The bank has to price this default risk in. But this is mitigated by two factors in the Netherlands. One, a large number of Dutch mortgages have semi-governmental default insurance (&quot;Nationale Hypotheek Garantie&quot;), where the insurance will cover under-water loans on default. Secondly, the risk of a loan being under water does depend quite a lot on the housing market. It's generally agreed that the Dutch housing market is missing about a million houses. The government has plans to build those in the upcoming decade, but many people have little trust in the Dutch government to deliver anything in a reasonable timeframe. So banks are reasonably considering the current housing market to be absolutely stable.</p>
<p>Is there a risk of a US-style forced sell-off due to recession? Here the larger Eurozone crisis comes into play. The Dutch economy, mostly despite the government, is quite overheated. The ECB sets monetary policy to keep the southern countries competitive; the Netherlands really don't need that. When the unavoidable recession hits the EU, the Netherlands is going so see a slow cooling-off. In addition, Dutch social unemployment benefits are pretty right-sized: most home owners who lose their jobs will be able to find a new job before being forced to sell their homes - even when the EU is in a recession.</p>

CC BY-SA 4.0
2022-07-14T22:36:25.973Z
2022-07-14T22:36:25.973Z
MSalters
<p>A bank (or anyone else) considering possible investments needs to consider both return and risk. Stock market investment is risky in two respects: a) individual stocks may achieve more or less return than the market average; b) even if an investor has a well-diversified portfolio of stocks so that their combined return in any one year is close to the market average for that year, the market will have good and bad years reflecting general economic conditions.</p>
<p>Investing in mortgages, by contrast, is less risky because: a) the interest rate is defined in advance (or perhaps variable at the lender's discretion); b) if the borrower cannot keep up their payments, the lender has the security of being able to  obtain possession of the property (which they could then sell to recover their capital). This does not provide complete security because the market price of the property may have fallen and become less than the amount lent, but it greatly reduces the risk to the lender.</p>

CC BY-SA 4.0
2022-07-12T04:52:44.607Z
Indeed, for b) to happen large-scale, the most likely scenario is an economic depression, in which case there's probably less money in the market that wants to buy those houses
Hagen von Eitzen
CC BY-SA 4.0
2022-07-12T13:59:00.093Z
@HagenvonEitzen Indeed, that's what happened during the Great Recession. Real estate crashed, but so did the stock market.
Barmar
CC BY-SA 4.0
2022-07-13T17:56:13.027Z
Not to mention mortgages are one of many diversified revenue streams for a bank.  IBM, as example, may be a good stock, but I would be remiss to dump all my resources there.
user3158591
CC BY-SA 4.0
2022-07-11T12:30:01.620Z
2022-07-11T12:45:47.203Z
2022-07-11T12:45:47.203Z
Adam Bailey
<p>Currently I'm learning about finance and I want to understand the following. In the Netherlands the interest on a mortgage is about 3%-4% depending on the payback period. When learning about stocks and ETF, I learned that the average market return is around 10%.</p>
<p>My question is therefore, why are banks bothering providing mortgages, while they also could invest the capital in markets?</p>

CC BY-SA 4.0
2022-07-11T10:54:09.363Z
I see, but mortages are often for a long term period 15-30 years. So wouldn't it be more fair to use the same timescale to calculate the average return of the market?
Tim
CC BY-SA 4.0
2022-07-11T19:22:32.777Z
If my bank was making risky maneuvers with my money I'd bank elsewhere.
Turbo
CC BY-SA 4.0
2022-07-12T10:39:02.793Z
see also https://money.stackexchange.com/questions/105437/ , https://money.stackexchange.com/questions/116967/ , etc etc.
AakashM
CC BY-SA 4.0
2022-07-13T12:04:05.390Z
BTW, in the US it's extremely rare for a bank or a "mortgage company" to hold the mortgage.  They take the upfront lending (or transfer) fee and then sell the loan on various secondary markets.  The people who buy REITs or similar gizmos are taking on the mortgage risk.
Carl Witthoft
CC BY-SA 4.0
2022-07-13T14:41:22.493Z
There are also fees to pay to get a mortgage, which are collected up front and aren't lost if the borrower defaults. The return isn't simply the same as the interest.
chepner
CC BY-SA 4.0
2022-07-13T14:55:28.710Z
See also: https://money.stackexchange.com/questions/120858/if-a-broad-long-term-investment-in-the-stock-market-is-such-a-good-deal-why-don?noredirect=1&lq=1
MJD
CC BY-SA 4.0
2022-07-13T22:49:32.897Z
@Tim, speaking of the Netherlands, the AEX index was 682.45 on June 16th 2000 (22 years ago) which is above the current level of the AEX. So even if you look at the average return over 20 years, mortgages were providing more return to banks than investing purely in the AEX would have. Your return number is most likely from the s&p500 which is NOT what you can expect on average across all stocks or countries.
Alex
<banking><mortgage>
Why are banks providing mortgages?
Tim
# Why are banks providing mortgages?

(Asked by: username_0 on 2022-07-11)

Currently I'm learning about finance and I want to understand the following. In the Netherlands the interest on a mortgage is about 3%-4% depending on the payback period. When learning about stocks and ETF, I learned that the average market return is around 10%.

My question is therefore, why are banks bothering providing mortgages, while they also could invest the capital in markets?

**Tags:** banking, mortgage

> **Comments:**
> **username_0**: I see, but mortages are often for a long term period 15-30 years. So wouldn't it be more fair to use the same timescale to calculate the average return of the market?  
> **username_1**: If my username_10 was making risky maneuvers with my money I'd username_10 elsewhere.  
> **username_2**: see also https://money.stackexchange.com/questions/105437/ , https://money.stackexchange.com/questions/116967/ , etc etc.  
> **username_3**: BTW, in the US it's extremely rare for a username_10 or a "mortgage company" to hold the mortgage.  They take the upfront lending (or transfer) fee and then sell the loan on various secondary markets.  The people who buy REITs or similar gizmos are taking on the mortgage risk.  
> **username_4**: There are also fees to pay to get a mortgage, which are collected up front and aren't lost if the borrower defaults. The return isn't simply the same as the interest.  
> **username_5**: See also: https://money.stackexchange.com/questions/120858/if-a-broad-long-term-investment-in-the-stock-market-is-such-a-good-deal-why-don?noredirect=1&lq=1  
> **username_6**: @username_0, speaking of the Netherlands, the AEX index was 682.45 on June 16th 2000 (22 years ago) which is above the current level of the AEX. So even if you look at the average return over 20 years, mortgages were providing more return to banks than investing purely in the AEX would have. Your return number is most likely from the s&p500 which is NOT what you can expect on average across all stocks or countries.  

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## 8 answers

### Answer by username_24 on 2022-07-11. Score: 41 | Accepted answer

A username_10 (or anyone else) considering possible investments needs to consider both return and risk. Stock market investment is risky in two respects: a) individual stocks may achieve more or less return than the market average; b) even if an investor has a well-diversified portfolio of stocks so that their combined return in any one year is close to the market average for that year, the market will have good and bad years reflecting general economic conditions.

Investing in mortgages, by contrast, is less risky because: a) the interest rate is defined in advance (or perhaps variable at the lender's discretion); b) if the borrower cannot keep up their payments, the lender has the security of being able to obtain possession of the property (which they could then sell to recover their capital). This does not provide complete security because the market price of the property may have fallen and become less than the amount lent, but it greatly reduces the risk to the lender.

> **Comments:**
> **username_25**: Indeed, for b) to happen large-scale, the most likely scenario is an economic depression, in which case there's probably less money in the market that wants to buy those houses  
> **username_26**: @username_25 Indeed, that's what happened during the Great Recession. Real estate crashed, but so did the stock market.  
> **username_27**: Not to mention mortgages are one of many diversified revenue streams for a username_10.  IBM, as example, may be a good stock, but I would be remiss to dump all my resources there.  

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### Answer by username_9 on 2022-07-11. Score: 11

1. Banks are in the business of lending money. If they didn't do this, then they wouldn't be called a username_10. They would be called a fund manager or stock broker or some sort.
2. Mortgages are safer investments. If a username_10 buy a stock for $100,000 and the company goes bankrupt (which most companies do even over short period so this is an eventuality) then the stock becomes worthless and the username_10 loses 100% of it's investment. If a username_10 lends a person 100,000 to buy a house and the person goes bankrupt, the loan is *collateralized* so the username_10 can repossess sell the house and recuperate the costs of the loan. In theory, the interest rate is supposed to be a calculation of how much money the username_10 can receive before an individual goes bankrupt and combined with the depreciated value of the collateral it should meet some target value (usually some percentage of the value of the collateral like 110%). In reality of course, you're more likely to sell a house for more in the future than when you bought it so it's generally a safe bet even with 0% interest.
3. Revenue is less variable. Stocks can grow by a lot, a little, and even lose value. Interest on a loan, collateralized or not, has a fixed rate or a variable rate which is known ahead of time. This allows a username_10 to efficiently plan for future revenue since the value they are getting is fixed. Even in the case that a person defaults on a loan, since it is collateralized, the username_10 will likely not lose any money if they did their due diligence in underwriting and charged an appropriate amount of interest.
4. Banks need to lend money. This means that the username_10 need to get paid in money so they can lend more money. A stock going up means that the username_10 can theoretically get money if they sell at that moment. Since selling and rebuying stock every time you need money is a huge waste of money (because taxes, broker fees, etc.) the only alternative is to leverage, which would be taking out a loan against the value of a stock. A username_10 buying a stock and borrowing money against the stock to lend to someone else is a house of cards that is waiting to fall (not to mention the username_10 loses money paying interest to someone else).

Although I'm not understanding the aim of the question. If you wanted to give someone money to invest it, there are fund managers for that. Banks are basically providing a public good by giving the public a well regulated, insured, and safe way to borrow money without the risk of a loan shark breaking their kneecaps.

> **Comments:**
> **username_10**: Well regulated implies a partial remediation against marginal damages, and insured investment is regulated how? The government allows borrowers to not be physically harmed for lenders’ failures?  
> **username_9**: @Nickcarducci I'm not sure I understand your comment. Almost everything a username_10 does is regulated from charging interest, to savings accounts, to how much money they must have on hand, to transfers, etc. I didn't say anything about insured investments. If you money in a (US) username_10, then you are protected from (e.g.) a username_10 run for quite a large amount of money (usually 1/4 million). Perhaps banks work differently in your country?  
> **username_11**: 5. When banks offer mortgages, they're bringing in customers that are likely to use the username_10's other revenue-generating services as well.  
> **username_9**: @username_11 this goes for every consumer facing business so I figured it wasn't worth mentioning. E.g. a gas station selling gas, a movie theater selling tickets, a ball game selling tickets, etc.  

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### Answer by username_7 on 2022-07-11. Score: 7

Because it is still profitable for username_10 to do so.

Your question is analogous to the question, "why do some car companies create cheap cars with low markup when there are luxury cars that often have higher profit margin" (eg according to [this](https://jalopytalk.com/profit-margin-on-luxury-vehicles/) article regular cars have profit margins around 3-8% and luxury cars 8-10% with some as high as 25%).

There is only so much demand for money on capital markets the same way as there is only so much demand for luxury cars. If there are other profitable markets even if they are much less profitable it makes sense for firms to service them.

Also banks do not just lent out their own capital but they can always borrow more reserves. If interest rates on reserves is sufficiently lower than the interest rate on mortgage banks will be happy to issue the mortgage.

> **Comments:**
> **username_8**: "Because it is still profitable for username_10 to do so" is this actually the case? I can think of two instances in my lifetime where banks lost mind-boggling amounts of money related to mortgage loans going bad and had to be either bailed out at great expense or have their creditors simply eat the loss. I mean, I guess in a sense it is still profitable *for the username_10* since society at large implicitly subsidizes and insures against systemic risk for them, but it still seems weird to me to say that they're profitable.  
> **username_7**: @username_8 yes they are and were profitable. That period had more to do with moral hazard. Banks knew the system was set up in a way they have to be bailed out. For economic decision making you care about profitability in terms of benefits - costs, if costs are paid by taxpayers then from the view of the username_10 the their costs are 0. In addition there is difference between ex ante and ex post profitability… for example, decision to enter a gamble where you get 1million dollars with 99% probability and you will loose 1 million dollars with 1% probability would be still profitable and  
> **username_7**: Profit maximizing decision to take, regardless that you can end up in a scenario where there is loss.  
> **username_9**: @username_8 I think this is a very bad characterization of the financial crisis in 2008. If banks did their jobs, they would not have lost money in the financial crisis when people defaulted on mortgages. That's because they are supposed to take an expected default into account and charge enough interest such that when the default occurs, the costs are already recuperate. The problem is that there is government regulation on how much interest can be charged so if the interest exceeds this value, they should have been declined the loan. Instead, people who were likely to default still got loans  
> **username_8**: @username_9 I'm not sure you are actually contradicting what I'm suggesting: that mortgage lending is not actually profitable. It doesn't really matter (at least not to me, for the purpose of this exchange) *why*: whether it's government regulation or principle-agent problems (moral hazard) or whatever. Although username_7's points are well-taken, especially ex ante vs ex post notions of profitability, they answered my question pretty well.  
> **username_9**: @username_8 Mortgage lending is profitable when banks actually reject unqualified applicants from getting loans. The problem is that when banks reject a bunch of people (to reasons that can be summed up as "they don't have the money to repay the loan") and due to systemic problems this happens to be mostly the same group of people (e.g. black people), it looks like the username_10 is using race as a disqualifier and it opens them up to class action lawsuits. So they instead make the decision to accept unqualified people to improve the optics. This is what ultimately collapsed the system in 2008.  
> **username_8**: @username_9 if something is profitable under a set of assumptions (in this case that banks will make sound decisions about who to loan money to) but those assumptions don't actually hold it isn't actually profitable. As I said, it's not like this happened once, it instead seems to happen about once a generation.  
> **username_9**: @username_8 Yes. What part of "if banks did their jobs" is unclear? All bets are off when people break the rules. Banks could have just risked the lawsuit, won and carried out business as usual. But chose not to do so for whatever (probably valid) reasons.  
> **username_7**: @username_9 I think you are mixing here normative and positive economics. It is fine to say that normatively banks should be moral and take into account their effect on society. However, that is moral ought statement. From a positive perspective (what is) banks that want to maximize their profit (as business do) have little reason to take into account their bad effects on society. That’s why we have pollution (negative externalities) in industry, morally it’s fine to say that firms should take into account the fact they cause global warming but it’s positive fact that profit max firms won’t  
> **username_9**: @username_7 I didn't mention morals at all. I was talking about the financial cost of a lawsuit (especially a class action). In a lot of cases, it's worth it to take the chance of a lawsuit and factor in things like fines as the cost of doing business, many US companies do in the EU.  

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### Answer by username_12 on 2022-07-11. Score: 5

Traditionally, Banks are in the business of converting interest rate periods.

Suppose you want to lend 1000\$, but get at it whenever you want. If there are 1000 of you, that is 1 million dollars.

Now, you know some people who want to borrow money, but want to be able to keep it for a period of time without having to replay it on demand. Say, they want to spend 1000\$ on an upgraded tool, which will make them an extra 100\$ a year for the next 30 years. They won't have the cash to pay off that tool for a decade or more; so a loan that can be called back "on demand" might bankrupt them.

The username_10 facilitates this. The username_10 takes the million\$ of demand deposits, and lends some of it out as a term loan. Most of those people depositing 1000$ in a demand account won't take it out all at the same time; so the username_10 can "safely" lend that money for longer terms than they guarantee.

They can even do a bunch of 6 month rotating deposits and make it even less likely that the money will be needed before the long term loans finish.

The profit comes from giving the short-term deposits a lower interest rate than the loans you hand out.

This is a kind skimming out of being the middle man.

If things go really badly, that username_10 can *sell* the loan it owns for short-term cash to pay off the short-term deposit demand for cash. So long as the loan is healthy and the market is liquid, this can return a profit long before the loan actually matures.

Now, suppose if instead of doing a long term loan, they went off and invested in the stock market. The problem is that the value of stock market assets are *less stable* than the loan.

So now the username_10 buys up a bunch of stocks with the 1 million dollars in deposits. The stockmarket drops by 50%, and a bunch of people lose their jobs, and start withdrawing their savings from the username_10. Now the username_10 has to pay off the username_10 account withdrawals with a distressed asset!

In theory, the mortgages are *more stable* than the stock market assets. The same economic crash that cause stocks to drop by 50% might drop real estate by 10%, which in turn makes (healthy) mortgages worth 5% less (as they are guaranteed against the principle).

The same call on deposit cash is then easier to answer; sell off some mortgages, and cash is easy to provide. While the asset is slightly distressed, it isn't half value.

> **Comments:**
> **username_13**: username_10 don't lend out deposits. It's the other way round. Loans create deposits.  

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### Answer by username_14 on 2022-07-12. Score: 3

Some reasons have already been mentioned, another would be that banks lend not only their own money, but also the money of private individuals and let them share in the interest income.

If a username_10 lends 3% and half of the money comes from private individuals/investors, then the username_10's interest rate is 6% on its own capital.
If the username_10 now gives 2% to investors, it still has 4% interest on its own capital. In this way, banks can increase the interest income on their own money.


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### Answer by username_15 on 2022-07-11. Score: 3

In the United States at least, mortgages are subsidized by the federal government via Fannie Mae and Freddie Mac. These quasi-public entities are required by law to purchase mortgages from loan originators (i.e. banks), even during unfavorable markets, and can themselves borrow at very low rates because they're backed by the government and seen as very unlikely to default. Because there is a guaranteed buyer of mortgages - assuming they meet certain conditions set by public policy - there's a constant downward pressure on the interest rates of loans within those parameters. (One of those parameters is no penalty for early repayment, which is somewhat mystifying to see in such a long-term low-interest financial instrument, without the context that the government is subsidizing loans with that condition.)

From the username_10's perspective, issuing loans that meet the purchase criteria ***need not even be an investment*** - they have a guaranteed way to cash out immediately, and use that cash to make money elsewhere. Most banks will sell some fraction of the mortgages they originate, while keeping others. Some banks buy mortgages from other banks, but they're competing against the guaranteed buyers.

> **Comments:**
> **username_16**: Question is about the Netherlands, which works a bit differently. There's a quasi-governmental scheme  ("Nationale Hypotheek Garantie") which insures the default risk. This means the username_10 doesn't carry the risk, so it can offer a lower interest percentage.  
> **username_15**: @username_16 that sounds like good info to add as an answer - I just wrote from what I know and tried to clearly state that I was giving context from elsewhere in the world. I don't know Dutch so it'd be a bit hard for me to research with confidence how similar the situation is in the Netherlands.  

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### Answer by username_17 on 2022-07-11. Score: 3

## Because they are allowed to lend you money they don’t actually have.

When a username_10 releases money for your mortgage, it actually comes from nowhere. They *magically*¹ make it appear on your account, or *magically*¹ transfer it to the seller party or notary. They simply record that you now have them a loan, and that the other party has the money – assuming it is in the same username_10.

This is basically the main mechanism of [money creation](https://en.wikipedia.org/wiki/Money_creation#Role_of_commercial_banks) in the current economical system. It also means that, when you reimburse your mortgage, the money actually gets *destroyed*¹.

Of course, there are limits to the amount of money a username_10 can create like this, mainly the [reserve requirement](https://en.wikipedia.org/wiki/Reserve_requirement). This reserve money will be used when money is transferred to another username_10: over a day, you have a lot of transactions between banks in all directions. At the end of a day, the balance is computed for all banks, and reserve money transfers will compensate them (possibly with loans between banks).

Let’s say this requirement is 10%, it means that if a username_10 has \$100 in reserve money, they are allowed to lend \$1000 to customers. As you can see, the interest rate will be 3-4% over \$1000 and not \$100, which would give them \$30-\$40 a year.

Commercial banks are not allowed, however, to use this money creation mechanism to invest on markets. So if they place the same \$100 on the markets, they can only hope for that \$10 yearly return, with possibly more risks.

Risk assessment is also obviously an important factor as well, as described in the other answers. Loans are usually less risky than investing on the markets, but creating money for a loan increases that risk. If loans don’t get reimbursed, the username_10 might end up without enough reserve money for when customers ask to retrieve it, leading to the username_10 bankruptcy.

¹ As you know, there is no *magic* in this world. Even if this process does not actually move any money, the created money corresponds to an asset of the username_10, i.e., your loan. Read [What is money?](https://www.riksbank.se/en-gb/payments--cash/what-is-money/) and [Banks do not create money out of thin air](https://voxeu.org/article/banks-do-not-create-money-out-thin-air) – thanks to @username_20
and @username_18 for those links.

> **Comments:**
> **username_18**: This answer is incorrect. First, banks do not create money "magically", they do it out of central username_10 reserves and by maturity transformation of future cash flows of borrower. The money also does not magically appears in your account it is transferred from the reserves banks can borrow from other banks or central username_10. Second, banks can invest their money into stocks and so on, what they ordinarily can't do is to borrow extra reserves to do so from central username_10 (which can create as many reserves as it wants). However, there are whole investment banks that specialize in capital market  
> **username_18**: Third, the correct reason why not all banks invest in stock market is the one provided by username_24, it is risky.  
> **username_17**: @username_18 no money is actually transferred when a username_10 lends money. See also [Why Banks Don't Need Your Money to Make Loans](https://www.investopedia.com/articles/investing/022416/why-banks-dont-need-your-money-make-loans.asp). Your second point does not really contradict my answer, which says banks cannot create money to invest into stocks. My answer does not contradict username_24’s answer either, but profitability of loans cannot be computed the same as for investment since there is money creation involved, so it is not just a matter of risk assessment.  
> **username_19**: While this answer not completely wrong, it still greatly oversimplifies how fractional reserve banking works.  
> **username_17**: @username_19 I agree. I didn’t want to go into too much details but I think it would make sense to add more. I will try to update it when I have time.  
> **username_20**: username_17 is totally right.  Privat username_10 money is just that, username_10 money, it is NOT real money. Will be super interesting to see how central username_10 digital currency will affect the market. The Swedish central username_10 explains this on its web site. https://www.riksbank.se/en-gb/payments--cash/what-is-money/ People still today believe that banks lend out money that other customers has deposited with the username_10...and that is totally wrong.  
> **username_21**: @username_19 But it does so **LOUDLY**. You don't have to be entirely correct if you assert things forcefully enough.  
> **username_18**: @username_17 You don't know what you are talking about. First, that investopedia article does poor job explaining this and has no references for its explanation of the mechanism so that is just a person behind the article talking about something they do not really understand like this answer. Investopedia also often has mistakes in their articles. Serious research like McLeay et al 2014 or https://voxeu.org/article/banks-do-not-create-money-out-thin-air explain how the money creation process actually work. Banks can't just create money without meeting their capital requirements  
> **username_18**: and to meet their capital requirements they need to borrow reserves from other banks or central username_10. Plus they cannot just lend indiscriminately as that practice would lead to situation where they are unable to satisfy their capital requirements, so private banks (as opposed to central username_10) cannot just create money out of nothing, they create them from reserves and by maturity and liquidity transformation. You are just spreading common misconception that laymen that do not really understand the mechanism have  
> **username_22**: @user253751 has made the most useful comment here.  The root of the belief that banks "create" money is the failure to understand that when you make a deposit you have made a loan to the username_10.  The colloquial belief that the username_10 is just "holding onto" your money for you is false.  You have loaned them money, and they have agreed to give it back to you - on demand in the case of a checking account; after a given time frame in the case of a CD.  As long as not everyone demands their money back from the username_10 simultaneously, the username_10 is solvent.  
> **username_17**: I have extended my answer with more details and an example. Thanks @username_20 and username_18 with the links, which I included in a footnote. I voluntarily admit that I am no expert, but I think we should focus on the content of the answer, which does not aim to explain how banks decide whether to grant loans since the question is focused on profitability.  
> **username_17**: @username_22 private banks _do_ create money. Technically, it is private username_10 money and not central username_10 money, but it is the same for most intents and purposes. Moreover, there is no direct connection between the money you loan to the username_10 through a deposit, and the money people receive when they take a loan – no money is moved when that happens.  
> **username_22**: @user253751 - No, that is a misperception created by the fact that people think their deposits are still "their money", in a pile somewhere with their name on it.  They aren't.  The username_10 is borrowing money from you (your deposits) and lending it to others (their loans).  That is what intermediation *is*.  It's an accident of language and of economic history (along with some intentional sleight of hand on bankers' part for literal millennia) that leads people to believe "their money" is still theirs and that new money has been created.  
> **username_22**: @user253751 No, they aren't.  *Once you withdraw them*, or transfer them to someone else, they are all those things.  And at the moment you withdraw or transfer them, the username_10 takes them out of a fungible pot of their capital, central username_10 loans, and other people's deposits to give them back to you and close out your loan to them of that amount.  Until you transfer them, they are an entry on a ledger promising to pay you back your loan on demand.  
> **username_20**: @username_22 Banks give out "credit" that is used as "money" in the economy.  What we talk about here is the fact that the money that banks lend, is not money other people have deposited with the username_10. Here is a quote from the username_10 of England "Therefore, if you borrow £100 from the username_10, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account." https://www.bankofengland.co.uk/knowledgebank/how-is-money-created  
> **username_23**: @username_17's is the correct answer. To put it in another way: Banks can -and do- create money for lending it to third parties, but can't they buy anything by themselves with that newly created money -imagine if they could self-loan and use the sums to buy... the whole world. Of course, the reserve mechanism for backing the risks created with loans have to be considered, but that is another matter.  

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### Answer by username_16 on 2022-07-14. Score: 2

Let me try to give a Dutch-focused answer.

Dutch banks are sitting on the largest amount of savings accounts ever; in 2021 it exceeded half a trillion euro's. Banks aren't paying any significant interest on this money. 0.01% is common enough. That may sound bad, but the situation can be even worse. Banks themselves, if they can't find a better destination, may be forced to park this money in either ECB accounts, or other low-risk assets like Dutch treasury paper - both of which have *negative* interests at the moment. In comparison, mortgages that pay 3-4% look very good.

Now, there's of course a long-term risk that somewhere in the next years the house owner can't afford to repay the load. The username_10 has to price this default risk in. But this is mitigated by two factors in the Netherlands. One, a large number of Dutch mortgages have semi-governmental default insurance ("Nationale Hypotheek Garantie"), where the insurance will cover under-water loans on default. Secondly, the risk of a loan being under water does depend quite a lot on the housing market. It's generally agreed that the Dutch housing market is missing about a million houses. The government has plans to build those in the upcoming decade, but many people have little trust in the Dutch government to deliver anything in a reasonable timeframe. So banks are reasonably considering the current housing market to be absolutely stable.

Is there a risk of a US-style forced sell-off due to recession? Here the larger Eurozone crisis comes into play. The Dutch economy, mostly despite the government, is quite overheated. The ECB sets monetary policy to keep the southern countries competitive; the Netherlands really don't need that. When the unavoidable recession hits the EU, the Netherlands is going so see a slow cooling-off. In addition, Dutch social unemployment benefits are pretty right-sized: most home owners who lose their jobs will be able to find a new job before being forced to sell their homes - even when the EU is in a recession.


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