Have you ever wondered how banks work?
We all use their services to varying degrees but do we know how they operate and make money?
A short thread
We all use their services to varying degrees but do we know how they operate and make money?
A short thread
The business of banking is quite straight forward.
Take money from depositors, pay them interest. Lend money to borrowers , receive interest.
As long as the interest received exceeds the interest paid, the bank is happy and profitable.
Banking is one of the oldest businesses
Take money from depositors, pay them interest. Lend money to borrowers , receive interest.
As long as the interest received exceeds the interest paid, the bank is happy and profitable.
Banking is one of the oldest businesses
Historically, banks would maintain sufficient "reserves" (cash/gold/silver/bronze ) to give depositors their money back on request.
This is how it should work right? But that’s not the case today. There was an increasing need to grow the economy by increasing spending power..
This is how it should work right? But that’s not the case today. There was an increasing need to grow the economy by increasing spending power..
This birthed “fractional reserve banking”
After all, people don’t save their money because they want to spend it all right?
Fractional reserve banking allows banks to only maintain a fraction of deposits in their reserves.
If the reserve requirement is 10%, a bank with $1, 000 in deposits only has to maintain $100 in reserves.
This has huge up and down side (double edged sword). See example below:
If the reserve requirement is 10%, a bank with $1, 000 in deposits only has to maintain $100 in reserves.
This has huge up and down side (double edged sword). See example below:
Jills brother Benjamin gives him $10,000 to start a business and Jill places it in his bank.
Let’s call it Dynamic bank! 😉
If dynamic bank’s reserve requirement is 10%, then it only needs to keep $1,000 and can lend out 9,000 with the aim of collecting interest on this loan.
Let’s call it Dynamic bank! 😉
If dynamic bank’s reserve requirement is 10%, then it only needs to keep $1,000 and can lend out 9,000 with the aim of collecting interest on this loan.
Rebecca collects this loan of $9,000 to buy a car from Toyota, who put this cash in their bank(dynamic bank) and give Rebecca a brand new corolla!
Dynamic bank keep $900 dollars in the bank, loan out another $8,100, to Billy who wants to buy some 🏗 equipment
Dynamic bank keep $900 dollars in the bank, loan out another $8,100, to Billy who wants to buy some 🏗 equipment
Through the influence of fractional reserve banking, $10,000 turned into $27,100 almost three times the spending power
Benjamin started his business 💼
Rebecca bought her car and 🚘
Billy bought his construction equipment 🏗
See the upside?
Benjamin started his business 💼
Rebecca bought her car and 🚘
Billy bought his construction equipment 🏗
See the upside?
Now the downside,
If Benjamin hasn’t been feeling like himself lately and visits the hospital and discovers he has an illness and needs surgery($9,000) Bill. Dynamic Bank might not have it, it might need to call in its loans, or take a fresh loan to honour Benjamin’s request.
This could lead to a whole lot of chaos and rubble and no one wants that!
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