CHAPTER 3 – INTRODUCTION TO BANKING

A bank is a savings store. It is where you go to buy and sell savings. When you are paid interest for the money you deposit, this is the price you sell your savings for. When you pay the bank interest on a loan you take out, this is the price you buy savings for.

Just like a retailer purchases products from the manufacturer at cost, then sells them for a higher price, banks do the same thing. Savers are the manufacturers. Borrowers are the customers. Banks are the retailers.

The price at which savings are bought and sold fluctuates according to supply and demand. If a lot of people borrow money one year, there is heightened demand and lowered supply. The price (interest rate) goes up. If a lot of people save money the next year, there is lowered demand for borrowing, and a heightened supply. The price goes down.

Because the banker’s livelihood depends on being paid for the products (savings) he sells, he only loans money to people he believes are likely to pay him back. A loan may be to buy a home, pay for higher education, start a new business, pay unforeseen medical expenses, etc. Whatever the case, the banker carefully investigates all relevant factors to determine a customer’s likelihood of loan repayment. Factors could include employment history, education, income, collateral, and co-signers.

This system works marvelously when government stays in the background, stepping in only to punish fraud, theft, and coercion. However, modern governments, or the central banks they empower, always pervert otherwise free-market banking systems in three important ways:

1)      Price-Fixing

2)      Expanding the Money Supply

3)      Guaranteeing Loans

Let’s briefly look at each.

Price-Fixing

Central banks claim to want to help people borrow money more easily and stimulate the economy by fixing the price of borrowing (interest rates) low. This artificially heightens the demand for borrowing. It also heightens demand, and thus price, for the things people typically borrow money to purchase, like homes or higher education.

Normally a price ceiling like this would create a shortage. Banks would quickly run out of savings to sell. But modern economies circulate “fiat” money – that is, money that is not linked to anything of intrinsic value, such as gold or silver. Therefore, central banks can create new money out of thin air at virtually no cost. This leads to our second step.

Expanding the Money Supply

To sustain the aforementioned price ceiling, central banks constantly create new money to sell. The problem is that this is essentially theft. Every new dollar the central bank creates devalues all preexisting dollars. This punishes savers and incentivizes debt. As a result, people on average take on far more debt than they would if the price of borrowing was allowed to naturally rise. Such a system is contrary to scripture, which repeatedly extols the wisdom and virtue of saving while warning against the folly of debt. (Examples include Deuteronomy 28:12, Proverbs 10:4-5, 13:11, 22, 21:20, 22:7, 26-27, and Romans 13:8)

Guaranteeing Loans

Finally, governments claim to want to help underqualified borrowers get certain kinds of loans by guaranteeing their lenders’ repayment. This way they will have increased access to things like a new home or a higher education. The problem is that if a banker knows he will be paid back for a certain loan no matter what, there is no longer any incentive for him to carefully investigate whether the borrower can repay. The banker knows the government will cover him in case of default. In fact, he may actually be forced to make loans he knows will default just to stay in business. If all his competitors are doing it, following suit may be the only way to retain any market share.

Now that we understand some basic banking concepts, in the next chapter we’ll walk through banking in the United States.