Banks are like good hygiene, like brushing teeth and wearing underwear. A thankless resource, though someone needs to do it. People don’t like bankers, but they need them. People don’t like bankers because they need them. I explained why in the second post I ever wrote. But how does banking work?
What Is a Bank?
Essentially, banks take your money and give it to somebody else. You could put your money in a sock under the mattress, but it’s a bit safer to choose someplace with big steel vault doors and complicated locks. Like Gringott’s. A bank might hold a Philosopher’s Stone, the royal treasury of the Lannisters, or the wealth of the InterGalactic Empire (who had Storm Troopers handling security). Modern banks spend huge sums on strong encryption systems–online vault doors–to keep your money safe.
Suppose your cousin Marvin wants to open a business, a combination sushi and ice cream store. Hey, they both need ice, right?! That’s Marvin’s business plan. The bank gives your money to Marvin as a loan.
Two problems here. First, Marvin may need more dough than your puny deposits, so the bank has to convince more friends and gather enough deposits in order to give out loans. Secondly, you may need some of your money back before Marvin can attract enough customers. He’s trying–he’s got the slogan: Come for the Eels, Stay for the Sprinkles! This is called a problem of liquidity.
The bank needs more deposits and makes more loans, perhaps to your other cousin, Daniella, who has a smashing idea to customize body wigs for poodles when they get over-clipped. But the bank still has to stick cash in the ATM so you can get your food truck burritos. Crazy ideas take a while to pay the loans back. Banks need a steady trickle of funds to give to depositors who need cash. That’s where interest comes in.
Paying Interest is Against My Religion
However, one stumbling blocks for banks in the past was that religions–Catholics and Muslims–prohibited charging interest, calling it Usury. Usury today means high interest, usually the 25% a week that Vinnie from that dodgy neighborhood charges. Vinnie doesn’t have vaults and ordinary deposits; he gets his cash from other sources (that’s wordsmithing for opiod sales). That is the difference between a bank and a loan shark.
In the past, usury meant any interest. How could banks exist, without charging interest? European banks handled currency exchange, establishing rates between cities who had their own coinage (e.g. Florence, florins). Bank profit was embedded in the exchange rate. It helped if you could run the city, run the bank, have your own coinage, and charge fees, like the Medicis.
It helped when the Pope would put money in your bank, too. It really helped when one of the banking family became Pope.
The Protestants didn’t have the same hangups over interest, and the Germans built up their own, strong, interest-charging banks. However, medieval Catholics didn’t want to put their money in Protestant banks. When the Medicis and others declined, they had to go somewhere. That somewhere was Switzerland.
Sprechen Sie Unbekannt?
The Swiss didn’t start out neutral or bankers. They grew post-Renaissance, when the Catholics starting carting in the tithes over the Swiss mountains in the 1780s. The Swiss insured the deposits, which helped build their reputation for security. Because Switzerland is mountainous and landlocked, it was ideal for mining gold and diamonds and replacing the ore with reinforced strongholds for bank vaults.
In 1713, the Swiss outlawed disclosing information about the source of banking funds, creating their famous bank secrecy. After Napoleon was defeated, the princes of Europe re-carved all the boundaries in the 1815 Congress of Vienna, and Switzerland talked their way into being established as a neutral country. When I was young, I thought it was really noble of Switzerland to not take sides in wars. After absorbing lots of spy novels, I learned that meant the Swiss would take anybody’s money–Hitler’s, Napoleon’s, Jews, Catholics, weapons manufacturers, Greenpeace–whoever. And they’d never tell.
Basel Is Not an Herb
This is where Basel comes in, Basel being both a town in Switzerland (famous for its fine art–wonder if any of it was stolen from Jews? that’s another movie...) and a series of key banking regulations created after the 1970s. The Basel accords tell banks that they need to hold enough capital–let’s call it cash that isn’t tied up in a loan–in case depositors need it. A bank might have tons of loans…”assets”… on its books. But if those are, say, all to Marvin and Daniella, or home mortgages made to borrowers who never could afford it, and the real estate market drops, then what the bank “owns” isn’t worth a yardful of weeds. Thus, banks need to enough money aside so you can go to the ATM whenever you want. Why they all agreed to let the Swiss set the rules, I don’t know, but the Swiss aren’t telling. They never do.
That, in a nutshell, is how international finance works.