I was recently listening to The Tipping Point and Revenge of the Tipping Point, Malcolm Gladwell. In one of the two, I can’t remember which one, he does a good job of describing the idea behind bank lending.
More or less, a baker wants to open a shop, has no money. The banker considers the baker a reasonable risk, loans her $1M which she gives to a contractor, who deposits it in the bank and starts on her building. Inevitable cost overruns happen, and he needs another million to finish. She’s stuck in, so asks the banker, who is also stuck in, so he loans another $1M to her, goes to the contractor, who deposits it in the bank. That can happen up to something like ten times under current rules, so that $1M in capital is now $10M in a loan and $10M in an account at the bank.
Of course, there’s not $10M or anything close to it if bad things happen and there’s a run, there’s $1M. And that minimum amount is what’s being fought over.
YMMV I am not an economist.
Edit to add - fractional reserve banking is what I was trying to describe apparently, like I said, I’m not an economist.
According to the article, since the 2008 recession, the federal reserve uses a set of “stress tests” to ensure the bank has enough to handle an emergency. Presumably it handles different mixes of customers and accounts better, as well as different types of emergencies. The banks claim that results in them having to hold too much reserve cash to handle “unpredictable” results.
Oh darn, they can handle emergencies better. Don’t you hate when that happens? Real emergencies should be more predictable, and none of this would be necessary
If you think that’s bad, imagine for a moment that they are the only money in the whole system, then charge interest on the loans, and then fast forward to a time when all the loans resolve and everyone is paid back. It’s actually impossible, because there’s not enough money in the whole system to both pay back the loans and charge interest. You have to print money to make the system keep working, but doing so devalues the currency. To cover the loss of value, prices go up to compensate (inflation).
If you haven’t had a chance to read Harari’s Sapiens (and his other books, all great) I highly recommend it. He talks about the banking system and goes into detail on the concept of shared fiction. The idea that we live in multiple realities, the one where the lion eats you being the physical one, but also the one where all the stuff we have made up exists, which can also eat you.
The bit where he compares a priest waving his arms and poof god exists to a lawyer, waving his arms and poof a corporation exists is perhaps my favorite.
I was recently listening to The Tipping Point and Revenge of the Tipping Point, Malcolm Gladwell. In one of the two, I can’t remember which one, he does a good job of describing the idea behind bank lending.
More or less, a baker wants to open a shop, has no money. The banker considers the baker a reasonable risk, loans her $1M which she gives to a contractor, who deposits it in the bank and starts on her building. Inevitable cost overruns happen, and he needs another million to finish. She’s stuck in, so asks the banker, who is also stuck in, so he loans another $1M to her, goes to the contractor, who deposits it in the bank. That can happen up to something like ten times under current rules, so that $1M in capital is now $10M in a loan and $10M in an account at the bank.
Of course, there’s not $10M or anything close to it if bad things happen and there’s a run, there’s $1M. And that minimum amount is what’s being fought over.
YMMV I am not an economist.
Edit to add - fractional reserve banking is what I was trying to describe apparently, like I said, I’m not an economist.
According to the article, since the 2008 recession, the federal reserve uses a set of “stress tests” to ensure the bank has enough to handle an emergency. Presumably it handles different mixes of customers and accounts better, as well as different types of emergencies. The banks claim that results in them having to hold too much reserve cash to handle “unpredictable” results.
Oh darn, they can handle emergencies better. Don’t you hate when that happens? Real emergencies should be more predictable, and none of this would be necessary
If you think that’s bad, imagine for a moment that they are the only money in the whole system, then charge interest on the loans, and then fast forward to a time when all the loans resolve and everyone is paid back. It’s actually impossible, because there’s not enough money in the whole system to both pay back the loans and charge interest. You have to print money to make the system keep working, but doing so devalues the currency. To cover the loss of value, prices go up to compensate (inflation).
If you haven’t had a chance to read Harari’s Sapiens (and his other books, all great) I highly recommend it. He talks about the banking system and goes into detail on the concept of shared fiction. The idea that we live in multiple realities, the one where the lion eats you being the physical one, but also the one where all the stuff we have made up exists, which can also eat you.
The bit where he compares a priest waving his arms and poof god exists to a lawyer, waving his arms and poof a corporation exists is perhaps my favorite.