The Modern Banking System
Banking is one of the least understood businesses throughout history, and yet, they are the very places that we dump our life savings. How does modern banking work? Banks make money through the interest on their loans, mortgages and other financial products. Now there is nothing inherently wrong with that. In fact banks play a crucial role in our economy and the way we live. With that said, banks are the only business that are legally allowed to print money.
Here is how it works. Say you want to deposit your paycheck of $10,000 into your bank account. The bank is only required to keep 10% of cash on reserve. This means that when you deposit that $10,000, the bank only needs to keep $1,000, and the rest of the 90% ($9,000) can be used to lend out or be financed to others as loans. In a nutshell, this is how money supply is “created.” Here is where it starts to get out of hand. Going with the same example, say we had a third party: You, the bank, and Vicky. When you deposit your money into the bank, the money supply or the money in circulation is only the amount that you put in or $10,000. When Vicky receives the $9,000 as a loan at 5% as an annual interest rate, the bank has now magically increased its money supply from $10,000 to $19,000. The bank now gets to collect Vicky’s interest every year at 5% or $450 from the money they created. The bank makes money by lending money that they created out of thin air from your money. Think about that. Now it gets more confusing; Vicky most likely won’t keep her $9,000 loan as cash under her mattress, so she decides to deposit it into her bank before using it. Since Vicky’s bank is just like the other banks and is there to make money, they only need to keep 10% of the $9,000 deposit or $900 in reserves. Then, Vicky’s bank can take the 90% or $8,100 and loan it out to other borrowers. That money supply jumps from $19,000 to $27,100 with the second loan. Look at all that sweet juicy interest that the banks get to collect from, well, essentially nothing. If you extrapolate this very simple example, you get our modern world’s banking system, known as fractional reserve banking.
You may also ask what happens when the customers want to withdraw over 10% of their money. This has happened before and is known as bank runs. To prevent this, the Government of Canada created a crown corporation called Canada Deposit Insurance Corporation (CDIC) in 1967 that guarantees up to $100,000 per bank account. This seems good, as your money is guaranteed to be held by the government, but it actually just poses another huge benefit to the banking industry. From the wealthy banker’s perspective: the people will always receive their money through a government bailout, so the incentives to loan out money to risky clients is high.There is nothing stopping the banks from deliberately giving loans to people as they gain more money through interests on those loans. For example, in the 2008 financial crisis, the US government spent over $700 billion dollars ($700,000,000,000) to bail out Wall Street. The worst case scenario is that they will just get bailed out by the government. Thankfully, what I have just described is only how the US banking system is operated. Our Canadian system has much more stringent regulations on loaning out to risky clients and businesses which ultimately safeguards us from a financial crisis and bailing out banks.
This goes off a tangent of my initial goal of this chapter, but I feel like everyone should learn the basics of macroeconomics. The video is titled “How is Money Created? — Everything You Need to Know” by Coldfusion on Youtube. It talks about money, inflation, how it is created, and the solution. Once you understand the monetary supply, it is quite apparent that what the central banks are doing is not sustainable. They have no savings, cannot go bankrupt, but can create unlimited money and buy government bonds. This is known as quantitative easing, or QE. A bond is an exchange of money for a promise that the government will pay it back, including interest. The problem is that this is just a bandage solution and is just kicking the can down the road for the future citizens of the country to pay back either though inflation or taxation. As a result, asset classes such as real estate, stocks, bitcoin, etc. have seen a massive price appreciation as many investors are “hedging” against the dollar.
Choosing Your Bank
Now you know how they work and how I feel about them, I believe that accessing our money should be free. Let’s be honest: most banks suck. They have account minimums that you need to maintain, monthly maintenance fees and horrendous interest rates for their “high interest” savings accounts. This is why I moved all my banking to financial services that offer free chequing and savings accounts. Personally, I use Simplii and Tangerine. Simplii and Tangerine are similar, but I find that Simplii has more locations if I want to access an ATM to deposit or withdraw cash. Keep in mind that if you are planning on applying for their credit cards, you need to also be banking with them first.
Tangerine — Get $50 — 55584831S1 (S not a 5)
Simplii — Get $50 — https://mbsy.co/3hvmDb