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How the current banking system works

How the current banking system works

Throughout history, political power has always been interested in controlling the economy to a greater or lesser extent. The most effective way to achieve this objective is to control the demand and supply of money through central banks and regulate those that put it into circulation, conventional banking. If money is the blood and private banks the veins that supply the financial system, the banco venezuela are in charge of dictating monetary policy: they decide how much blood and how many veins make the economy flow. Central banks are quasi-independent agencies of governments, with a technical profile and a high degree of self-government, but with political representatives on their councils or governors directly elected by them.

Monetary policy is based on controlling the money supply through the interest rate, the price at which central banks lend money to traditional banks. With it you can influence the growth or decrease of the economy, the rise or fall of prices (inflation), the exchange rate with other currencies and even the level of unemployment. Monetary policy is a crucial instrument for the development of a country and its mismanagement can lead to a currency becoming worth almost nothing or, conversely, to having value by itself, as in the case of the Venezuelan bolivar and the currencies linked to the gold standard, respectively.

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Misconceptions about the way a bank operates

Conventional banking, however, is a company that is in charge of intermediating between citizens, companies or public entities that seek financing, and those that can provide it, normally for profit. There are two misconceptions about the way a bank operates: that it only lends the money that savers have deposited in it and that, conversely, a bank can even lend money created out of nothing. If the second statement were true, banks would never fail, because they could always self-finance and bail out; Furthermore, only banesco en linea have the power to create money. As for the first statement, conventional banking does lend much more money than savers have given it. So even though banks can’t create money, they do lend more money than they have. How do they do that?

When the bank lends money, it does so on the basis of the reserves given by the savers, who have promised to return if they are asked to do so. However, savers do not usually ask for all the money at once or all at once, giving the bank room to lend more money than it actually has in reserves: only if all savers asked for their money at the same time would they It would show that the bank cannot return it for having loaned it to other users. In this way, the bank is not creating money, but it is putting into circulation a debt that did not exist before and that pretends to be real money, the so-called “money substitute”. This phenomenon is known as the “multiplying effect of banking” and it manages to economize enormously on the use of money, which facilitates its circulation.

Conventional bank Debt Limit as per the law

The maximum amount of debt that a conventional bank can issue is regulated by law and is measured by means of the reserve ratio, also known as the “cash ratio”. Thus, a reserve ratio of 5% would allow the bank to lend 1,000 euros while having only 50 euros in reserve. This tool of monetary policy is behind the great benefits of banking, but it also contains the reasons for economic growth and crises. When credit flows in the right direction, the economy advances and grows; when a bank takes too many risks, lending money without analyzing repayment capacity, for example, increases the possibility of a crisis. A punctual default is not a problem, the real problem is that this malpractice is structural: a very low reserve ratio favors more debt in the economy and, therefore, more risk that the loans will not be repaid. In addition to loans, the main source of income for banks is the opening, maintenance or administration of the accounts, and other services that they charge their clients.

Conventional banks at an interest rate

In addition to getting money from their clients, banks can finance themselves through liquidity auctions. This is the way central banks have to put money into circulation, lending it only to conventional banks at an interest rate determined according to their monetary policy and with very advantageous repayment conditions. Private banks can also lend money to each other, in which case transactions must be channeled through the central bank or clearinghouses. The precedent of these organizations is found in the Genoese bankers of the Modern Age, who met four times a year to offset debts they had contracted among themselves and thus avoid the risk of a banking crisis due to excess debt. Currently, the process is similar: banks cancel each other’s debts and only real money is required to pay off the final balance. For example, the Chips clearinghouse channels $ 1.5 trillion in daily transactions with $ 3 billion: you only need 0.2% real money, the remaining 99.8% is debt that has been cleared.

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