Wednesday, April 17, 2013

A Major Modern Misconception About Banking

One of the biggest misconceptions that just about everyone in the modern makes is about the relationship between the consumer and their bank.  I suppose “relationship” is a strong word.  More like the agreement that you have with your bank.  The problem is that the consumer assumes that all the money he or she deposits into a bank is effectively theirs and that they can withdraw it whenever they want.

The problem with this concept is largely due to the fact that the average person doesn’t know how fractional reserve banking works.  Even more frustrating is that those who do tend to still think that banks are contractually bound to give you your money on demand.  The problem is, most people don’t understand the actual rules that govern modern banking.

There is nothing complex about it really.  Simply put, whatever money you deposit into a bank or other financial institution is no longer your money but the sole property of said institution.  I know that the popular theory is that this is not the case and that it is still your property; that the bank is simply holding it for you.

They are not.  They are using the money you’ve given them to make investments of their own.  Usually this is in the form of loans, but it could also be used to buy other things that bankers believe will give them profit.  It really depends on the bank and what kind of business they do.

This is why it is vitally important that the wise consumer look at what his or her bank is investing it.  Because said consumer is investing in the bank.  Every deposit you make is an investment in the bank.  Just because you are able to take your money out of it from time to time doesn’t mean it is yours.  You are simply cashing out some of that zero percent interest loan you’ve made to the bank.  The interest rate on your savings account is really just interest earned for loaning money to them.  It’s a shame that you can’t dictate the interest rate yourself, but that’s another topic of discussion.

The general point is, the bank owns your money and has the power to determine when you get it.  Generally, you can get it whenever you want, however, this does not mean that you can get it all the time.  As the citizens of Cyprus found out the hard way, the money you have in the bank is not yours.

Now, there is nothing inherently bad with this arrangement, other than the outright fraud involved with the terms of the contract.  Most often bankers will not tell you this simple truth because they, quite simply, either don’t understand this or they are merely shrewd businesspeople.  Either way, you won’t hear it from them, unless they are being honest.

So long as you understand the true nature of how the banking system works and are comfortable with investing in a bank, feel free to do so.  Now, I personally recommend that if you are going to use a bank, you’ll need to use local banks or credit unions and not the big banks.  At a local bank, you should be able to track the owner down in case of he makes some bad investments.  It’s kind of like owning a gun to deter criminals.

While I know that many libertarians and other assorted proponents of the free market will argue against what I have written here, I tell you that they do so from a more theoretical stance than a practical one.  Historically, the banks have always considered the money they have in their vaults to be theirs, regardless of who has claim to it.  Cyprus was just the latest example.  So please, spare me your pie-in-the-sky theories about how banking works.  Because like so many other idealistic dreams that come from man, it is never how it works in practice.

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