Learning Banking – How Banks Work

Banks and Economics

Banks and other financial institutions hold a lot of sway in the current global economic environment and as a result, take the bulk of the flack when it comes to consumers railing against the man. However, the hat seems to be overlooked is that without banks, we wouldn’t have had the wide-scale global social and economic development that has moved our planet into the civilised world.

Banks are the cornerstone of organised funding, whether it is providing financing for a farmer to pay for his seed and fertiliser ahead of the harvest pay-out, or a contractor to buy the raw materials with which he builds a client’s house.

Without the bank providing bridging finance through a loan, these small businesses would have no way to function. Furthermore, banks grew out of the concept of barter or exchange. While it is simple to swap a pig for your neighbour’s wheat crop, moving that pig 1000 miles to the north to pay for another commodity is a little more difficult.

The development of money

Thus, the development of money – or tokens – ensued. People were able to create a token that represented an intrinsic value of things and utilise it to pay for goods. However, a token was only worth something if there was an institution’ that recognised and backed up its worth i.e. a bank. The need to formalise payment systems through money/coin was also driven by the fact that markets expanded and people wanted access to more opportunities and goods.

There needed to be a common form of compensation for goods that didn’t necessitate a like for like swap, but rather allowed people to pay with a token that represented a value. A token they could cash in’ at a bank should they need to do so. To get a sense of the history of banking to take a look here

Another advantage of banks is that they are required to apply a standardised set of rules and regulations to how they work, how they protect money and how they charge consumers for their services. The basis of modern-day banking is that banks pay customers interest in order to be able to use the customer’s money to fund other activities.

Banks and customers

Banks also charge customers for the privilege of having access to money that isn’t theirs to fund their own initiatives – for example, the farmer of builder mentioned above. The banks’ ability to recoup the cash lent or pay the customer’s interest on what they keep in their account is based on a sound governance structure, informed risk assessment and top-notch security. Well at least, that’s the basics of it.
However, if you want to take a deeper look into what else happens, try this video:

Sadly, in many markets where people are not that financially literate, there continues to be a suspicion towards banks. Financial literacy refers to a person’s ability to understand how money works, how it functions in an economy and how to use that knowledge to make sound financial planning decisions around spending, saving and retirement provisions.

In less financially literate markets, people often fall prey to the plethora of avaricious microlenders who skirt around the requirements of the formalised banking sector. These lenders provide ready cash to unwitting individuals at extortionate interest rates. This means that the borrower, who is usually at breadline salary levels, is often left paying four or five times the amount lent in order to repay the loan.

This is why the formalised sector is so important. The advantage of a bank is that while yes, they certainly charge interest on the money they loan (they are a capitalist construct and they charge for their service), it is usually at sustainable rates and they ensure that the client does not overextend – this is a requirement of governance, something a micro-lender often disregards.

Furthermore, banks are necessary for economies to expand. And for individuals, they are the responsible choice for a fair deal, offering the informed customer a chance to achieve financial inclusion at competitive rates.