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As some of you know, I took out a 24k loan from my credit card at 0%.  The zero rate was only for 6 months so I took the money and placed it in a high yield CD earning 8%.  The gross profit on this transaction will be about about $1200.

The 0% rate runs out in December and I was planning on opening a new credit card account and transfer the balance to another 0% card but I recently received my credit card statement and lo and behold there more 0% checks to extend it another 6 months.

I’ll hold off on opening a new account and hold off using the checks until late October or early November but this “generosity” from the credit card bank got me thinking as to why they do it.

The common wisdom is that banks offer 0% as a teaser and simply wait for you to default so they can pop the rate to 25% or more but I’m not convinced this is the whole story.

Banks have sophisticated credit models to know how likely a person is to default on their credit.  With me, personally, I have been doing business with this particular bank for years and have NEVER been late nor will I ever be.  This partially explains why they have given me higher and higher credit limits.

My suspicion is that banks KNOW that a certain number of their customers are doing Arbitrage deals and THEY benefit more from it than we do.  How?

With the advent of “fractional reserve banking” bank can lend out 90-99% of the money in their accounts out as loans.

So let’s take a look at how my particular transaction would work:

Credit Card lends me $25,000 at 0% (they know I’ll pay them back so it’s relatively risk free)

I take $25,000 and deposit it at Emigrant earning 5.15% (I earn ~ $1300)

Emigrant takes $25,000 in as a deposit and can lend out $25,000 at say 10% interest (more credit card loans) and accumulates $25,000 in interest from those loans.

This turns into a win-win for banks.  On the one hand, they have the potential to earn 25%+ interest on a credit card loan of 25k if I default and on the other hand, they have the ability to lend out 10 times the amount it has on deposits courtesy of my deposit.

It seems to me that banks can truly optimize their returns and profit if they can find people like me that will arbitrage their own money back into their accounts.  We’ll see which one does it first.