Every day most of us do transactions through banks, whether using a credit card, a debit purchase, the accreditation of our salary, issuance and collection of checks, depositing money in different modalities, requesting credits to buy houses, vehicles and a lot of other operations, but ...

How does a bank work? How are banks born? Was it the idea of a government or a group of people? What are the bases? And so there is an endless series of questions that we could ask ourselves about them.

So, since we use the banking system every day and we are part of it in some way, I propose that we look at how this system was born, how it evolved and how it affects us in our day to day life.

How it is born

Banks and money, it could be said that they are born together and to explain better this I am going to resort to a hypothetical story, which describes how probably a goldsmith of the middle age could have started this system. (I clarify that this is just a story, not a journalistic chronicle)

The story tells that there was a time when almost anything could be used as money, something similar to "barter". As the main requirement, it had to be portable and of interest or useful to the rest of the people, so that it could be exchanged. The GOLD and the SILVER were the most attractive for the majority, and also they were light and comfortable to take.

A goldsmith of the time, Mr Johnson, worked gold and silver into coins and then standardised them. Mr Johnson built a kind of vault in his house, and there he kept his gold and silver in coins that were accepted by all.

First banking operation

Over time, his neighbours began to ask him to rent a place in his "vault" to keep their gold, and he issued them a kind of "check" that certified that the gold was stored there. We could say then that this was perhaps the first banking operation that took place in the world.

Once people took their trust in Mr Johnson, they all started renting space in his vault until get filled, and so Mr Johnson got rich.

A Familiar Pattern that gives birth to the banking system

Mr Johnson, as time passed, could notice a familiar pattern about people: they rarely withdrew their gold. Instead, they used the certificates that he issued to exchange it for other goods and only sometimes, some people they came to withdraw their gold.

First credits

That pattern allowed Mr Johnson to start lending his gold with an interest rate, He issued them to people loan certificates and these people then returned it with interest. This new modality helped the protagonist of our history to get richer and richer.

Following the story, Mr Johnson, based on the pattern mentioned above, not only began to lend his gold but also the gold of the other people who had deposited it in his vault (now much more extensive than before). He could do this because the people who asked for loans, did not ask for gold, they only asked for the checks, which were much more portable and easy to exchange. And he kept getting richer.

The limit that triggers the functioning of the current banking system

There came a time when Mr Johnson, observed that his lending capacity had a limit, the gold that existed in his vault, but he also noted that at that time the world was in full expansion and the need for credit was big.
Then Mr Johnson had another idea, TO LEND MORE GOLD THAN HE HAD IN HIS VAULT.
How could he do this?
He was able to do it for the following reasons:

1. Only him knew the actual amount of gold in his vault.
2. The checks were already accepted as money or gold substitutes.
3. Depositors were rarely going to ask for their gold, and if they did, they never went at the same time.
4. He would only have to guarantee the gold return from that minimum number of people who were going to withdraw it.

Then, as long as nobody realised this, he could become incredibly wealthy and, as long as people paid their credits, the system would work correctly.

Create money from nothing

Then, Mr Johnson was creating money, since he only wrote it on a certificate and people used it as if it were gold.
As incredible as it seems, Mr Johnson created money that he did not have, lent it and charged an interest rate for it.

Present

Currently, the banking system is quite similar to this story. Governments have legalised the ability to produce money that does not exist, and in some places they have set a limit, for each dollar or other currency deposited by people in the bank, it can lend 9 dollars.

Still can't believe it?

That is true; this is how the banking system works, let's go over it differently (a bit simplistic but describe how it works):
Let's suppose that you have the possibility of setting up a bank, you are an entrepreneur and wants to make money. Taking advantage of this legal possibility, you rent a building and open its doors to the public and put down an initial capital, let's say $1000.

According to the laws, since you are a bank and have $1000 in your vault, you can lend $9000. So your first customer comes in and asks for a loan of $4500.

What do you do as a bank?

• As you can lend up to $9000, you create a record in your computer system with the data of the customer, and in his/her account, you write that has $4500.
• Then he/she must pay every month the fee with the corresponding interest.
• Remember that those $4500 did not exist, it was created.
• Finally, every month, you charge to your customer the instalments, and you keep the interest.

So as you can see, having a bank is a big business, and if then another customer comes and deposits $1000 more in cash, then you can lend another $9000 more and charge more interest.

Another important fact is that, to those who deposit money in your bank, you pay them less interest rate than what you charge to those customers that you give them credits.

I know this is a very simplistic description, but that's how a banking system works.

What are the bases?

• The familiar pattern of the people, who never go at the same time to withdraw their deposits, they only do it from time to time.
• Trust in the system.

What are the risks?

If people lose confidence in the system they all will try to withdraw their deposits, but since the bank has lent more than it has, there is not enough money in the bank to pay back to all customers, and the system collapses. That is what is known as a bank run.

What can be done in these cases?

Almost nothing, once the system collapsed, there is no turning back.
They can only try to influence people so that they do not withdraw their money and regain confidence, or, make a bank freeze, Which is a restriction decreed by the government to prevent banks from opening their doors to prevent citizens from withdrawing their money simultaneously, sinking the financial system.
According to the banking legislation, central banks will try to help the local banks where the bank freeze take place, but if the system collapses in a general way, then there is nothing that can be done.

How does it affect us?

In many ways, since almost all of us are either depositors of money in a bank or have acquired a loan.

The credit, according to the thought of many, is something necessary and if the possibility of credit did not exist many people could not access to have their own house, their vehicle, or get funds to start a business.

It is also true that the system is based on people trust, which today, in a globalised world is very volatile, or can be influenced by the media for good or for bad.

Questions without answers

How long will this system be sustained? Or how much money there is in the world? Those are questions that have no answers for now.
Is this the best system we could have? Probably the answer is No since it has proven to be manipulated by the big economic powers or corporations.
And if it did not exist?
We probably would not have the possibility to have a house, a car or have a dream holiday since they could not give as many credits as they are currently given, but I am only making assumptions.

Conclusion

That is a brief and simplistic description of the banking system, and I have prevented many details, but it explains in essence how the system works.

Most of us were born in a world where this system already existed, then the best we can do is to know how it works, learn about it and try to adapt to the rules of the game, since it will be complicated to change (never impossible).

We must know that when we ask for a loan, we are supporting that system and we are helping to create money that does not exist. Know that when we deposit money, we are trusting the trust of other people in this system (forgive the redundancy) and if the rest of the people stop believing, we will probably lose our money.

How to avoid this? As I said, learning how the system works intensely, to have tools not to get caught when trust is lost.