Unsound Banking: Why Most Of The World's Banks Are Headed For Collapse

You’re likely thinking that a discussion of “sound banking” will be a bit boring. Well, banking should be boring. And we’re sure officials at central banks all over the world today—many of whom have trouble sleeping—wish it were.

This brief article will explain why the world’s banking system is unsound, and what differentiates a sound from an unsound bank. I suspect not one person in 1,000 actually understands the difference. As a result, the world’s economy is now based upon unsound banks dealing in unsound currencies. Both have degenerated considerably from their origins.

Modern banking emerged from the goldsmithing trade of the Middle Ages. Being a goldsmith required a working inventory of precious metal, and managing that inventory profitably required expertise in buying and selling metal and storing it securely. Those capacities segued easily into the business of lending and borrowing gold, which is to say the business of lending and borrowing money.

Most people today are only dimly aware that until the early 1930s, gold coins were used in everyday commerce by the general public. In addition, gold backed most national currencies at a fixed rate of convertibility. Banks were just another business—nothing special. They were distinguished from other enterprises only by the fact they stored, lent, and borrowed gold coins, not as a sideline but as a primary business. Bankers had become goldsmiths without the hammers.

Bank deposits, until quite recently, fell strictly into two classes, depending on the preference of the depositor and the terms offered by banks: time deposits, and demand deposits. Although the distinction between them has been lost in recent years, respecting the difference is a critical element of sound banking practice.

Time Deposits. With a time deposit—a savings account, in essence—a customer contracts to leave his money with the banker for a specified period. In return, he receives a specified fee (interest) for his risk, for his inconvenience, and as consideration for allowing the banker the use of the depositor’s money. The banker, secure in knowing he has a specific amount of gold for a specific amount of time, is able to lend it; he’ll do so at an interest rate high enough to cover expenses (including the interest promised to the depositor), fund a loan-loss reserve, and if all goes according to plan, make a profit.

A time deposit entails a commitment by both parties. The depositor is locked in until the due date. How could a sound banker promise to give a time depositor his money back on demand and without penalty when he’s planning to lend it out?

1 2 3 4
View single page >> |

Disclosure:  While currency crises, bank runs and episodes of economic collapse are devastating to paper assets, they often hand us opportunities ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.
Lyle Cosmopolite 6 years ago Member's comment

The threat hanging over fractional reserve banking is not deflation but inflation. Commercial banking is a vast cloud castle in the sky. As faith erodes in the ability of banks to honour their commitments to their depositors, funds are withdrawn and used to purchase bullion, real estate, durable goods, and equities. Inflation and interest rates soar. The Fed has kept inflation at bay by paying interest on reserves at the rate of 25 basis points per annum, at a time when the interest rate on T Bills is around 10 basis points per annum. I do not know how long this game can continue. But should inflation ignite, the willingness of banks to hold several trillion of excess reserves (since 2009 reserves have exceeded total demand deposits) will crumble, there will be a rush for the exits, and an inflationary firestorm will be underway. The Fed says that it has planned for such a contingency. I have no idea whether its plans will prove feasible in a time of crisis.

Bill Cargill 6 years ago Member's comment

Very descriptive article on banking and if you believe Robert Prechter among others that deflation is already occurring in various parts of the US economy and in various countries around the world then we may see the failure of the world financial system regardless of how much fake unbacked fiat money is printed. It's all now just a matter of time as to what will trigger the cascade of defaults and evident finance market collapse. No way out then without restructure of the entire system and people will be the losers not the fat cats who created this expansionist fractional banking system all so some elites could hold office and defer payment on their promises well into the future. Sorry no free lunches.