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QUESTION: If I start a bank , how many credit cards I can issue ? Can I issue 10 millions credit cards with 1 million credit limit ?

ANSWER: If you have the funds available, you can issue as many cards as you want.  Here's how it works:
1) Someone applies for a credit card.  That gives them a credit limit, but they haven't actually used the funds yet.  The money available for them to spend is still in your bank account earning interest.

2) The person uses their credit card to buy stuff.  Through electronic transfer using a processor, money is taken out of your bank account to pay for their purchase.

3) The person pays you back, including interest, for their credit card purchase.

The problem is that getting money to lend to credit card holders costs more money.  Let's say you borrow $1,000,000 to lend to credit card borrowers at a 2% interest rate.  That's $20,000 per year in interest you need to pay!  So, when lending to others, you need to make sure you are charging more than 2% interest WITH enough extra to pay for your operating costs.  Remember that part of the cost of lending money is the risk that some people will default on their loans (meaning that they go bankrupt, or otherwise don't pay you back), so you need to charge enough interest to make-up for these default losses.  This type of risk is called credit risk.

Even if you don't borrow any money, if you lend too much money to borrowers, then you will have none left for yourself to pay the bills.  Sure, people owe you a lot of money and you'll get it in the future (which gives your company value), but since you don't have cash-on-hand, you run the risk of not being able to pay for company operations.  This type of risk is called liquidity risk.

So, if you start a credit card company, then you can lend as much as you want, but there's the risk you will lose money.  This actually happens in "the real world", which is what caused the 2008 financial collapse.  Banks lent too much money in the form of high-risk mortgages (called subprime loans), then when the economy started to slump, these loans went into default and the banks were no longer able to pay for operations.  Many banks went out of business, while others went begging for money from the federal government.

To use economic terminology: A bank will continue to issue loans until MC = MR (marginal cost equals marginal revenue).  That means that for each additional person to which a bank lends money, revenues will stay constant or actually decrease because the bank must lend to increasingly risky individuals to lend more money at all.  They try to make up for these costs of credit risk by increasing interest rates on high-risk loans, but the people that are at the highest risk are also those who can't afford high interest rates, so as interest rates and credit risk increase, the number of potential customers decreases (price goes up, demand goes down).  So, as a bank lends to each additional person, cost/person increase and revenue/person decrease, and a bank will continue to lend money until costs exceed revenues for the next possible customer.

---------- FOLLOW-UP ----------

QUESTION: Thank you so much . But If credit card holder borrows from me 1million ,in next month he pays me 1 million back , do I need to pay 2% interest rate ?  I have another question : as a new bank , what do I need to borrow from central bank ( federal reserve bank ) .  And how much money federal reserve bank can lend without making inflation ? I heard that fed can lend as much as GDP to not make inflation .

Whether you get interest depends on your credit card terms and how frequently interest compounds.
Let's start with 2% annual interest.  That's the amount of interest you'll make in a given year on the balance of a credit card.  That's why it's called 2% APR (annual percentage rate).

So, if you pay back your credit card in 1 month from the time of using it, the amount of interest you'll pay will be based on how it's compounded.  Most credit companies compound monthly, so the borrower would pay you 0.167% extra in interest (2%/12 months = 0.167).

Let's say, now, that your rate compounds weekly.  If you kept the balance for exactly 1 month, you would accrue 0.038% interest each week.  That the same 2% APR, but then they are charged interest on the interest they owe, instead of just the principle balance.  So, although your annual interest rate hasn't changed, you end up paying more in interest because it is compounding more frequently.

Here are two calculations to illustrate the difference.
Simple interest: I = Prt (interst = principle*rate*time); I = $100(0.02)(1 year) = $2 per year
In this example, interest would only accrue once per year, using the ending balance, and the person would owe $102 to borrow $100.
Continuous Interest: A = Pe^(rt) {Amount = Principle*(e^[rate*time])};
A = $100(e^(0.02*1)) = $5.44
In this example, instead of just $2 interest in that year, they are paying $5.44 in the year because they are being charged interest on the interest they've already accrued at a constant growth ratio e (2.71828).

In both cases, the person is being charged 2% interest every year, but the manner in which the balance is calculated changes.  The first example, the balance is only calculated once per year, so if the person pays their balance before the year is up, they pay no interest.  In the second example, interest is accrued and compounded constantly, so they will end up paying some interest no matter when they repay their balance.

As for your question about opening up a new bank, you do not need to borrow money from the central bank.  That's an option, yes, but you aren't required to... at least not in the US.  There are many different options to source capital; borrowing money from other businesses, raising capital by selling equity, etc.  The most common way for a bank to raise money is to accept bank accounts.  People come in and open a bank account to store their money, then the bank uses a percentage of that money to lend to other people, earning income by generating interest.

Since the central bank controls bank reserve requirements (the amount of deposits they are required to keep on-hand, to pay for customer withdrawals and pay bills) as well as interest rates, they could technically lend an infinite amount without influencing inflation.  This is purely theoretical, since it would never happen, but if the central bank lent $1 quadrillion to other banks at 0.00% interest, while increasing bank reserve requirements by a total of $1 quadrillion, then inflation won't be directly influenced since the borrowed money has not entered the currency supply; it's completely unusable and it's also not increasing interest costs for the bank, so there's no reason for it to directly influence inflation.  That being said, people would notice what is happening and lose confidence in the currency, causing inflation as investors and producers will both want more of a currency they are afraid is having problems.  So there will be an indirect influence given such bizarre behavior by the central bank.  As I said, this example is theoretical, though.  It wouldn't accomplish anything, so it would never be done.  It's purely a thought experiment.

Under normal circumstances, though, the central bank can not increase money supply at a rate greater than GDP growth without creating inflationary pressures.  Note that, during a recession when a currency is deflationary already, doing such a thing can actually be useful to increase employment and demand.  That's your limit on inflationary management, though; money production at a rate greater than GDP growth, assuming all other inflationary pressures equal 0.


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Michael Taillard


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Economic Consulting: American Red Cross; US Strategic Command -- Economics Lecturing: Bellevue University (Bellevue, NE) Huijia College (Beijing), OPII Schools (Omaha), Madonna University (Livonia), Schoolcraft College (Livonia), ZomBCon (Seattle), Zombiefest (Lincoln) -- Media Appearances: Dead Man Working (2012 Movie documentary), The Heartland News (Omaha local news outlet)

American Economics Association, Business Networks International, Midwest Writer's Guild, Zombie Research Society

Economics and Modern Warfare: The Invisible Fist of the Market (Palgrave Macmillan) -- 101 Things Everyone Should Know about Global Economics (Adams Media) -- Corporate Finance for Dummies (Wiley) -- Psychology and Modern Warfare (Palgrave Macmillan) -- Analytics and Modern Warfare (Palgrave Macmillan)

PhD (Financial Economics; honors) -- MBA (International Business Finance; honors) -- Grad School Certificate (International Business Management; honors) -- BS (International Business Economics; honors) -- AA (Business Administration; honors) -- Certificate (Chinese Language and Culture) -- Trade School (Transportation Logistics; honors)

Awards and Honors
Philanthropy awards and nominations for the OPII Schools economic experiment

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