If a broad long-term investment in the stock market is such a good deal, why don't banks do the "obvious" things?

Question

There is a fundamental discrepancy or paradox that has been keeping me, and many others, away from the stock market. Before I explain it, let me mention some selected popular questions on this site in which the consensus is that in the long term a broad investment in the stock market will yield a substantially positive average annual return rate:

Why should we expect stocks to go up in the long term?

Why do people claim that Stock Markets are broadly exponential in the long term?

Why isn't everybody rich?

Stock market long term risks

Is it a lie that you can easily make money passively in the stock market?

Are Index Funds really as good as “experts” claim?

In view of all this consensus, we can almost say that it has become "common knowledge" that investing in the broad stock market (sufficient diversification) from a long-term perspective (several decades) is a very good investment strategy. More precisely, the consensus seems to be that there is some average annual return rate, say 3% (replace this number by something higher/lower if you prefer), such that if your investment is diversified enough and your timespan is long enough, the risk that your actual average annual return rate drops below that rate tends towards zero.

Now comes the first question: Why doesn't any (serious) bank offer a savings account with a fixed 2% interest rate for an unlimited amount of time?

After all, a large bank has the optimal prerequisites for diversification and holding stocks for many decades, and if the above is true, then they would still earn at least 1% of their customer's account values each year by essentially doing not very much except buying and selling some index funds according to what customers want to withdraw or pay in.

My own first objection to the question would be the following: If there is a market crash and at the same time a lot of customers want to withdraw money from their accounts, the bank might be in big trouble because the total value of the stocks owned by the bank could be less than what the customers want to withdraw.

However, I feel that this is not really an objection because even without the above "obvious product" banks will always be in trouble if their customers want to withdraw too much money at once.

What's bothering me, even more, is the

Second question: Why don't all banks borrow a huge amount of money from the central bank and invest it in the stock market on a broad, long-term basis?

As far as I know, banks can borrow money from the central bank at quite low-interest rates (much less than the expected long-term average annual return rate of the broad stock market), in Europe that interest rate is currently even negative. So why don't all banks just buy index funds using this free money and just hold them forever, watching them grow in value?

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Edit: After the first few answers (and some downvotes) I immediately realized that it was a big mistake to specialize the question in the sense that I only asked why banks don't do the "obvious" things, rather than having simply asked why no-one or no specialized company does the "obvious" things. I am very glad that in the further course of events my question was received in a slightly more abstract way. Thank you all for your answers and upvotes, earning me a gold badge with my very first question on this site! If one could only trade in those badges for their real-world counterparts... ;-)

Answer 1

Fundamentally, I think there's a high level (and perhaps unsatisfying) answer to this. It's because that's not "banking" as a business, and a bank is established to do banking, not to get into the stock market. In other words, this question strikes me about the same as asking,

why don't ice cream shops stop selling ice cream, and instead get in the business of selling pancakes? After all, you can make a lot of money selling pancakes.

Well yes, you can get rich selling pancakes, but not every business is a pancake shop. Certainly, some businesses get rich selling pancakes, but other businesses with different motivations and risk tolerances decide to sell ice cream instead.

To make this clear in your banking context: such a business would essentially be called a hedge fund or investment management company, not a bank. It's fine if a company wants to be a hedge fund, but a company that is calling itself a bank can't secretly switch over to being a hedge fund, and still call itself a bank while supporting "banking" activities for normal consumers.

From a more practical perspective, most jurisdictions have carefully developed regulations that would essentially prohibit a business calling itself a bank from doing what you're discussing. Essentially, these regulations exist because of my first point - the business model you're describing isn't "banking." And, regulations are designed around that, in the sense that regulations keep banks acting like banks and stop them from trying to act like something that isn't a bank.

I'm editing to clarify a portion of your question, as an example of this disconnect. You said,

As far as I know, banks can borrow money from the central bank at quite low-interest rates

That's not really the whole story. Think of it this way. Imagine if you were to walk into a retail bank right now, and ask for a loan for a million dollars. The bank would certainly ask you some questions, including asking what you intended to do with that money and how you could show proof that you are able to pay it back. If you were able to prove that you have a large and stable income and that you were planning on using the million dollars to purchase a home that's actually worth a million dollars, you might get approved. But what if you told the bank, "I'm actually empty-handed, but I'm going to go invest this in the stock market, I think I have a proven way to make a positive return" - they might deny you on the spot, or at least they might have a lot more questions for you!

The relationship between central banks and retail banks is fundamentally similar. A retail bank can't just call up the central bank and say, "please wire me a billion dollars" and instantly, the money shows up. Retail banks essentially have to go through a process of validating their operational intentions, showing proof that they can pay the loan back, and perhaps even putting up collateral before the money changes hands. And, a retail bank with no collateral who indicated that they wanted to play the stock market would almost certainly get turned down by the central bank.

I'm making another edit to address another core flaw in your assumptions. You said,

we can almost say that it has become "common knowledge" that investing in the broad stock market (sufficient diversification) from a long-term perspective (several decades) is a very good investment strategy

While that may be a sound theory it's not a practical method for a bank to keep or invest assets, because of liquidity and predictability. It may be accurate to say that "in the long term" a diversified stock portfolio can be bulletproof. But banks can't issue cash to deposit customers based on long-term theories. They have to be able to predict the availability of funds very well - the stability of their outcomes, not just the expected result. In other words, if a bank has $10 billion in assets, they need to know precisely how much of that will be available to them tomorrow, or next Tuesday, or in six months. Your stock market theory may have the right expected outcome (positive growth), but it's got far too much potential variance on any particular day. Yes, "in the long run" you may make money, but can you tell me exactly how much cash you'll have next Tuesday? No, you can't. You might have an acceptable expected outcome on Average for all "next Tuesdays" - but what if coronavirus takes off in the US this weekend? Or something else happens? Banks aren't just concerned about the expected outcome, they're also concerned about variability in the range of expected outcomes. People do "banking activities" like deposit their paycheck into a deposit account, or take out a credit card loan, with the expectation of stability and availability of funds. Those "features" which are essentially the definition of retail banking come as a trade-off in terms of a slightly lower return (compared to your stock market portfolio).

Answer 2

Because a "bank" like this will fail

The question assumes a "buy low, sell high" system, or even extreme "buy, never sell" investment scheme for the "bank".

But that you proposed is not a bank, it's a geared fund. Both have "clients". Clients that can withdraw at the worst possible moment.

Recessions come hand to hand with markets down runs. Long recessions will cause massive withdrawals, that will force the proposed bank/geared fund to sell its assets with spiraling smaller prices, until there is nothing left.

Puff, your bank just failed.

Answer 3

Why doesn't any (serious) bank offer a savings account with a fixed 2% interest rate for an unlimited amount of time?

I don't want to assume your age but you may not remember that this was actually a completely real situation in the past. When I was a growing up in the 80's I recall my basic savings account had an annual interest rate of somewhere between 3-5%. It is sad to me that in this "new normal" any rate above 1% for hard working savers is considered an amazing deal.

The reason ("why") this no longer occurs is somewhat due to the current economic climate of ultra low central bank interest/long term bond rates, money printing and vast explosion of debt and cheap credit.

Answer 4

Banks have to have enough assets to cover the value of savers’ deposits at all times. Just relying on having enough cash on hand to cover withdrawals is what Ponzi schemes and fraudsters do. (Note that the assets don’t have to be liquid, so banks can still run into trouble when they can’t call in the long-term loans they have made to cover a sudden rush of withdrawals.)

So if a bank takes $1 million in deposits and invests them in the stock market, which then has a bad year and falls by 5%, they now have $950,000 of assets backing $1,020,000 of deposits, and get shut down by the banking regulators (unless they can raise another $70,000 in capital from shareholders or asset sales or wherever).

Answer 5

Why doesn't any (serious) bank offer a savings account with a fixed 2% interest rate for an unlimited amount of time?

If they did that, I would do this:

• Divide my money 50-50 between the bank account and stocks
• Balance yearly.

That way I would end up taking money from the bank account whenever stocks are low, and put money there whenever stocks are high. If enough people did this, it would force the bank to do the opposite: buy when high and sell when low, so that they had money to return to the withdrawing customers. When only a small percentage of customers withdraws, the bank can also take more loan from central bank and keep holding the stocks.

The long term expected returns stops to apply as soon as some external event forces you to sell early. For example, if you need to sell stocks when you lose your job in a recession, you could end up with much worse returns than expected.

Answer 6

the boring answer to the question of why banks don't borrow cheap money from the fed and invest in the stock market is bc federal regulations don't allow banks to invest depositor money in the stock market.

Answer 7

The answer is really about how to handle risks.

The general rule in investments is a high rate of return = high risk. Stock markets carry a risk -- they can turn down very quickly but they generally have a higher rate of return than a savings account.

The regulations set on banks are there to protect the saving accounts from banks taking too much risk. You put money into your savings or checking account should be protected from the bank taking stupid risks and losing your money.

Each day the banks have to calculate the sum of the "risks" (see last paragraph below for the correct term) they have on the books according to special formulas. The bank is not allowed to take more risk than a limit, which in turn is calculated from the equity of the bank.

In effect, the equity of the bank company limits what kind and how much risk the bank can take. And the bank will try to maximize the profit given that.

Giving you a fixed interest saving account actually calculates as a risk -- the bank has promised to give you interest in the future. Owning stocks on the stock market calculates as a risk. Borrowing money from the central bank calculates as a risk.

So what you propose: fixed-rate interest against possible stock market gains and borrowing from the central bank sums to a risk, eating into the maximum risk the bank is allowed to take.

A smart bank manager maximizes the use of risk in order to gain maximum profit (and that is why the regulations are so complicated -- too many smart bank managers have done too many stupid things). The manager could use the bank's limited risk maximum towards giving saving accounts a fixed rate, or it could be used for other, more profitable things.

The point is that, right now, there is more risk-adjusted profit to have in other areas.

I use the word "risk" very loosely above. The actual term used is "Capital Adequacy Ratio" -- I suggest a google on that.

Answer 8

Your question displays that you're really interested in the subject matter, and that's great to see! I'll answer your questions below, and I would helpfully suggest you do some background reading focusing on interest rates and credit risk. If you really want to get crazy you can progress to mean variance portfolio theory, the capital asset pricing model and then understanding gambler's ruin and the kelly criterion.

The second question has been answered above-- because the regulators don't allow it.

As for the first question...

(#1) "Now comes the first question: Why doesn't any (serious) bank offer a savings account with a fixed 2% interest rate for an unlimited amount of time?"

You're contradicting yourself. A savings account implies that the depositor can withdraw their money at any time while "an unlimited amount of time" implies that you're talking about a loan with a maturity far in the future.

Any bank would absolutely love to have someone lend money to them at 2% forever. Heck, I'll take however many loans I can at 2% interest to be repaid never.

Answer 9

This is sort of what a money market account is. If you have a regular bank offering a regular savings account to members of the general public, that's commercial banking. If the money is invested in the stock market, that's investment banking. A commercial bank doing investment banking is very illegal. As in, you'd better have given millions of dollars to politicians or you're going to prison for a long time illegal.

However, I feel that this is not really an objection because even without the above "obvious product" banks will always be in trouble if their customers want to withdraw too much money at once.

That's called a run on the bank. With a normal bank, even if there's a run, the deposits have been loaned out for things like mortgages, so the bank still has the mortgages to fall back on. They still have the assets, the assets just aren't very liquid. They can do things like sell the mortgages to other banks, or worst case scenario, there's the FDIC. If your money is in the stock market, and the stock money tanks, your assets aren't merely illiquid, they're flat-out worth less. And investing money protected by FDIC in the stock market? Again, super illegal.

Answer 10

What other answers are forgetting about is fractional reserve banking.

In other words if bank invests the deposit at 3% they can not use that deposit to create money out of thin air(when they give loans).

Creating money out of thin air is more profitable than stock market investing.