Unsound Banking: Understanding the Root Cause of Banking Collapse

Banking is expected to be dull, yet it appears that central banks worldwide are struggling to stay afloat, wishing for a more stable banking environment. This article aims to explain why the world’s banking system is precarious and how a sound bank differs from an unsound bank. However, only one out of a thousand people is likely to comprehend the distinction, and as a result, the world’s economy relies on unsound banks and currencies that have degenerated significantly from their origins.

Modern banking originated from goldsmithing in the Middle Ages, where the trade required a precious metal inventory and expertise in purchasing and selling metal and securely storing it. These skills smoothly transitioned into lending and borrowing gold, which means lending and borrowing money. Until the 1930s, the general public used gold coins for everyday commerce, and most national currencies were backed by gold at a fixed rate of convertibility. Banks were just another business that stored, lent, and borrowed gold coins as their primary business.

Bank deposits were classified into two groups, time deposits, and demand deposits, where the difference is now unclear but is a crucial element of sound banking practice. A time deposit involves a contract where a customer agrees to leave their money with the banker for a specified period, earning interest as compensation for their risk and inconvenience, and allowing the banker to use their money. To prevent loss, bankers prefer to lend on productive assets, only lend a fraction of the pledged asset value, for a limited time, and only to people of good character. The business of accepting time deposits makes the banker a dealer in credit, an intermediary between lenders and borrowers.

On the other hand, demand deposits are payable to customers on demand and the basis of checking accounts. The banker does not pay interest because they do not have the use of it, yet they charge a fee for keeping the money safe, available for immediate withdrawal, and administering the transfer of the money. An honest banker would not lend out demand deposit money as banknotes represented the warehouse receipts for gold. Currency, gold bullion, gold coinage, and banknotes made up the society’s transaction media, and their amount was limited to the amount of gold available to people.


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