How Banks Work

Summary

This video script offers an insightful journey through the history and functioning of banks, from ancient Mesopotamia to the modern era. It explains the evolution of banking systems, the gold standard, and the shift to fractional reserve banking, highlighting its impact on economic growth and stability. The script also delves into different types of banks, their services, and the role of central banks in monetary policy and financial regulation, emphasizing the enduring significance of banking in the global economy.

Takeaways

• 😀 Alux is a bootstrapped company that is safe and healthy, with no investments from SVB and a profitable app.
• 🏛 The history of banking dates back to ancient Mesopotamia, with the Code of Hammurabi reflecting early financial systems and regulations.
• 📈 Banking evolved through Roman times, the Middle Ages, and the Renaissance, with the Medici family developing the double-entry bookkeeping system.
• 💼 The Industrial Revolution saw the rise of joint-stock banks and central banks issuing banknotes, managing the money supply, and providing economic stability.
• 🌐 The 20th century introduced the gold standard, regulatory bodies, multinational banks, and electronic payment systems, with the internet revolutionizing banking in the 21st century.
• 💰 The gold standard linked a country's currency to gold reserves, providing stability but limiting economic flexibility, which contributed to the Great Depression.
• 🏦 Fractional reserve banking allows banks to hold only a fraction of deposits in reserve, enabling credit creation and economic growth but also risks like bank runs and inflation.
• 🛒 Retail banks serve individuals and small businesses, offering various banking services including loans, credit cards, and payment processing.
• 🏢 Commercial banks cater to businesses, providing financial services like business loans, trade finance, and treasury management.
• 🌟 Investment banks specialize in capital markets, offering services in mergers and acquisitions, underwriting, asset management, and market making.
• 🏛️ Central banks oversee the nation's money supply and monetary policy, acting as lenders of last resort and regulators for the banking sector.

Q & A

What does 'bootstrapped' mean in the context of a company?

Bootstrapped refers to a company that is started from the ground up using only the founders' own resources, without external investment.

What is the historical significance of the Code of Hammurabi in relation to banking?

The Code of Hammurabi, from ancient Mesopotamia, contains laws related to financial transactions, property rights, and commercial activities, providing insights into early financial systems and regulations.

What role did the Knights Templar play in the development of banking?

The Knights Templar established an early form of international banking, allowing pilgrims to deposit and withdraw funds across their network of commentaries.

What is the purpose of a central bank?

A central bank oversees the nation's money supply and monetary policy, ensuring the stability of the currency and the economic system as a whole.

Why did the gold standard system eventually collapse?

The gold standard collapsed due to its inflexibility during economic crises, as the money supply was tied to gold reserves, making it difficult for governments to increase liquidity and stimulate economic growth.

What is fractional reserve banking and how does it differ from the gold standard?

Fractional reserve banking is a system where banks are required to hold only a fraction of their customers' deposits in reserve, allowing the remainder to be loaned out or invested. This differs from the gold standard, where the value of currency was directly linked to a fixed quantity of gold.

What are the advantages of fractional reserve banking for economic growth?

Fractional reserve banking allows banks to create credit and stimulate economic growth by facilitating lending and investment, increasing the money supply, and fueling investment and consumption.

What are the potential risks associated with fractional reserve banking?

Risks include bank runs, where customers withdraw deposits simultaneously, leading to a crisis of confidence; inflation, if the money supply grows faster than economic output; and excessive risk-taking by banks, which can lead to asset bubbles and financial instability.

What services do retail banks typically offer to individual customers and small businesses?

Retail banks offer services such as checking and savings accounts, personal loans, auto loans, mortgages, payment services, and foreign exchange.

How do commercial banks differ from retail banks in the services they provide?

Commercial banks cater primarily to businesses, offering services like business loans, trade finance, treasury management, and hedging instruments to mitigate risks associated with international transactions.

What is the role of investment banks in the financial sector?

Investment banks specialize in capital markets activities and advisory services, such as mergers and acquisitions advisory, underwriting, asset management, trading, and market making.

Outlines

00:00

🏦 Banking Basics and History

This paragraph introduces the video's aim to explain how banks work, following questions about the Silicon Valley Bank (SVB) situation. It reassures viewers about the financial health of Alux as a company, being bootstrapped and profitable. The video then dives into a historical overview of banking, starting from ancient Mesopotamia, through Roman banking, medieval times, the rise of modern banking with the Medici family, and the establishment of central banks. It continues with the Industrial Revolution's impact on banking and concludes with the 20th and 21st-century developments, including the gold standard, regulatory bodies, and the advent of online banking and digital currencies.

05:01

📊 The Gold Standard and Fractional Reserve Banking

The second paragraph discusses the gold standard monetary system, where a country's currency value was linked to gold, facilitating international trade but proving inflexible during economic crises, contributing to the Great Depression. It details the shift from the gold standard to fractional reserve banking, where banks only need to hold a fraction of deposits in reserve, allowing for credit creation and economic growth. Advantages include economic growth stimulation, bank profitability, and financial intermediation, while disadvantages are bank runs, potential inflation, and excessive risk-taking leading to financial instability.

10:05

💼 Types of Banks and Their Services

This section outlines the different types of banks and the services they provide. Retail banks cater to individuals and small businesses, offering checking and savings accounts, loans, and payment services. Commercial banks serve businesses of all sizes, providing loans, trade finance, and treasury management. Investment banks focus on capital markets, offering advisory services for mergers and acquisitions, underwriting, asset management, and trading. Central banks, distinct from others, oversee the nation's monetary policy and financial stability, acting as lenders of last resort and regulators for commercial banks.

15:07

🌐 Central Banks and the Future of Banking

The final paragraph emphasizes the role of central banks in maintaining economic stability and their tasks in monetary policy, acting as lenders of last resort, and supervising the banking sector. It mentions major central banks like the U.S Federal Reserve and the European Central Bank. The video concludes by reflecting on the enduring nature of banks throughout human history and invites viewers to share their thoughts on the future of banking, highlighting the importance of understanding banks as the foundation of the economy.

Keywords

💡Banking

Banking is the activity of accepting deposits of money from the public and lending those funds out in the form of loans. It is central to the video's theme, as it discusses the history and function of banks. The script traces the evolution of banking from ancient times to the modern era, highlighting the critical role banks play in economic systems.

💡Bootstrapped

Bootstrapped refers to a business that is started and operated without external funding, relying solely on the founders' financial resources. In the context of the video, Alux mentions being bootstrapped to emphasize their financial independence and stability, contrasting with the reliance on investors that can be a factor in the banking industry.

💡Depositors

Depositors are individuals or entities that place funds into a bank with the expectation of earning interest or for the safety of storage. The script clarifies the difference between depositors and investors in the context of the SVB situation, emphasizing the bank's customer base and their concerns during banking crises.

💡Fractional Reserve Banking

Fractional reserve banking is a system where banks are required to hold only a fraction of customer deposits in reserve and can lend out the remainder. This concept is integral to the video's explanation of modern banking, as it allows banks to create credit and stimulate economic growth, but also introduces risks such as bank runs.

💡Gold Standard

The gold standard was a monetary system where a country's currency was directly linked to a fixed quantity of gold, ensuring currency stability and facilitating international trade. The video discusses the gold standard's history, its inflexibility during economic crises, and its eventual abandonment, which led to the adoption of fractional reserve banking.

💡Bank Run

A bank run occurs when a large number of customers attempt to withdraw their deposits simultaneously due to concerns about a bank's solvency. The script uses the term to illustrate one of the key risks of fractional reserve banking, where a lack of sufficient reserves can lead to financial instability.

💡Inflation

Inflation refers to the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The video mentions inflation as a potential consequence of fractional reserve banking when the money supply grows faster than economic output.

💡Economic Growth

Economic growth is the increase in the production of goods and services in an economy over a period of time. The script highlights how fractional reserve banking can stimulate economic growth by increasing the money supply, fueling investment and consumption.

💡Central Banks

Central banks are institutions responsible for the stability of the currency and the economic system as a whole. They control the money supply and interest rates, acting as lenders of last resort and overseeing the banking sector. The video describes the role of central banks in maintaining financial stability and their tasks, such as monetary policy and regulation.

💡Investment Banks

Investment banks are金融机构 that specialize in capital markets activities such as mergers and acquisitions, underwriting, and asset management. The video script distinguishes investment banks from other types of banks by focusing on their role in serving large corporations, institutional investors, and governments in capital-raising and market-making activities.

💡Financial Intermediation

Financial intermediation refers to the process by which banks and other financial institutions connect borrowers and lenders, facilitating the flow of funds in an economy. The script explains how banks play a crucial role in financial intermediation, extending credit to borrowers and providing savers with a place to store their money.

💡Regulatory Bodies

Regulatory bodies are organizations that oversee and regulate various industries to ensure compliance with laws and to protect consumers and the stability of the market. In the context of the video, regulatory bodies are mentioned in relation to the creation of insurance schemes to protect depositors and the establishment of rules following the Great Depression and the 2008 financial crisis.

Highlights

Alux company is safe and healthy, being bootstrapped and profitable for years.

The difference between investors and depositors, especially relevant to the SVB situation.

Ancient banking origins dating back to 2000 BCE in Mesopotamia with grain loans and valuables repositories.

Roman banking involved currency exchange and deposit taking, with significant roles by argentari and money lenders.

Medieval banking continued in the Byzantine Empire and Islamic world, with the Knights Templar establishing early international banking.

The Medici family developed the double-entry bookkeeping system during the rise of modern banking.

Central banks like the Bank of Amsterdam issued the first paper money, influencing later European banks.

The gold standard linked a country's currency value to gold, providing stability but limiting economic management.

The gold standard's inflexibility contributed to the Great Depression and was eventually abandoned.

Fractional reserve banking allows banks to loan out most of the deposits, stimulating economic growth.

Advantages of fractional reserve banking include economic growth, bank profitability, and financial intermediation.

Disadvantages include bank runs, inflation, and excessive risk-taking leading to financial crises.

Retail banks serve individuals and small businesses, offering various banking services and loans.

Commercial banks cater to businesses, providing loans, trade finance, and treasury management.

Investment banks specialize in capital markets activities, mergers and acquisitions, and asset management.

Central banks oversee the nation's money supply, monetary policy, and banking sector regulation.

The future of banking is likely to involve further development of online banking and digital currencies.

Transcripts

after we posted the video about the svb

situation a lot of you guys asked us to

make a follow-up on how Banks actually

work so here it is now before we get

into the video alux as a company is safe

and healthy we're bootstrapped which

means we started this from the ground up

with no investor money other than our

own resources we've been profitable for

years the app is doing great which you

can check out at alox.com app we've got

enough cash flow to cover any type of

Crisis and the svb situation was really

business as usual also we're not

investors in svb but depositors now if

you don't know the difference between

those two terms you'll especially

benefit from watching this video so

here's how Banks work

welcome to a lux so let's start off with

a brief history and timeline of banking

because this wouldn't be a complete

video without some historical background

now would it it's important to

understand where everything began so

here's the timeline ancient banking

between 2000 BCE to 100 CE so the

history of banking is almost as old as

Humanity itself the first recorded

evidence of banking activity dates back

to ancient Mesopotamia where Merchants

provided grain loans to Farmers and

Traders temples and palaces in Babylon

Egypt and Greece served as repositories

for valuables and issued loans to

Citizens one of the most famous legal

codes from ancient Mesopotamia the Code

of Hammurabi contains several laws

related to financial transactions

property rights and Commercial

activities these laws provide insights

into sophisticated Financial systems and

regulations so yes our ancestors were

not as stupid as we like to believe

banking in Rome 100 BCE to about 500 CE

Roman Banks known as mensai were

involved in currency exchange deposit

taking and lending individuals known as

argentari Bankers or money changers and

faren editores money lenders played a

significant role in the financial system

this provided various financial services

such as money changing lending and

deposit taking and these individuals

often set up their businesses in the

Forum the center of commercial and

political life in ancient Roman cities

medieval banking from 500 CE to about

1400 CE after the fall of the Roman

Empire banking activity decreased in

Western Europe but continued in the

Byzantine Empire and the Islamic world

the Knights Templar a Christian military

order established an early form of

international banking allowing pilgrims

to deposit and withdraw funds across

their network of commentaries

the rise of modern banking from 1400 CE

to 1700 CE the Medici family an

influential banking Dynasty in

Renaissance Italy developed the double

entry bookkeeping system so this period

saw the establishment of central banks

such as the bank of Amsterdam in 1609.

the Swedish reichs Bank in 1668 and the

bank of England in 1694 which provided

stability and regulation to banking

systems the bank of Amsterdam was the

first bank to issue paper money and it

became a model for other central banks

that were established in Europe during

the 18th and 19th centuries

the Industrial Revolution 1700 CE to

about 1900 CE the Industrial Revolution

brought about rapid economic growth and

increased demand for banking services

joint stock Banks emerged allowing

people to pool resources and invest in

new Ventures central banks began to

issue Bank notes and manage the money

supply

the 20th century

during the late 19th and early 20th

centuries the gold standard became the

dominant Global monetary system

participating countries pegged their

currencies to Gold facilitating

international trade and investment the

gold standard provided stability but

restrict country's abilities to manage

economic fluctuations leading to its

eventual collapse during the Great

Depression and this led to the creation

of regulatory bodies and insurance

schemes to protect depositors the latter

half of the century saw the rise of

multinational Banks the automation of

banking services and the development of

credit cards and electronic Payment

Systems the 21st century

the Advent of the internet brought about

the proliferation of online banking and

digital currencies such as Bitcoin the

2008 Global financial crisis prompted

renewed regulatory efforts such as the

Dodd-Frank Wall Street reform and

consumer protection act of 2010 in the

United States aimed at bolstering

Financial stability and consumer

protection but the 2008 financial crisis

was never resolved only delayed and here

we are now still kicking that can down

the road so now that you've got this

context let's discuss how did Banks work

in the past and the era of the gold

standard the gold standard was a

monetary system in which the value of a

country's currency is directly linked to

a fixed quantity of gold so under this

system central banks committed to

exchanging their currencies for a

specific amount of gold upon demand

thereby ensuring the currency's

stability and facilitating International

Trade the origins of the gold standard

can be traced back to the use of gold

coins as a medium of exchange gradually

countries adopted the practice of

issuing paper currency backed by gold

reserves allowing for the expansion of

the money supply without the need for

additional Gold by the late 19th century

the gold standard had gained widespread

acceptance and it was adopted by many

countries including the United States

and Great Britain however the gold

standard had inherent flaws one of the

primary reasons was its inflexibility in

terms of economic crisis since the money

supply was tied to gold reserves it was

difficult for governments to increase

liquidity and stimulate economic growth

during recessions or depressions and

this inflexibility ultimately

contributed to the severity of the Great

Depression in the 1930s additionally the

gold standard required countries to

maintain large reserves to back their

currency which led to the hoarding of a

precious metal and this in turn resulted

in a limited gold Supply and slowed

global economic growth countries with

trade deficits often had to deplete

their gold reserves to settle their

International obligations causing

further economic instability the gold

standard also led to speculative attacks

on currencies when investors perceived a

country's gold reserves were

insufficient to maintain a currency's

value they would engage in a speculative

attack selling that country's currency

in anticipation of its devaluation

but during the early 20th century

countries began to abandon the gold

standard in response the outbreak of

World War One prompted many countries to

suspend the gold standard temporarily as

the need to finance War efforts

outweighed concerns for currency

stability in the 1930s the United States

and other countries began to abandon the

gold standard altogether in an attempt

to combat the Great Depression in the

aftermath of World War II the Bretton

Woods agreement established a new

international monetary system based on

the U.S dollar which was itself pegged

to Gold however this Arrangement proved

unsustainable as growing trade deficits

and inflationary pressures forced the

United States to abandon the gold

convertibility of the dollar in 1971.

this marked the end of the gold standard

era and the beginning of the modern day

system which uses fractional Reserve

banking so fractional Reserve banking is

a financial system in which banks are

required to hold only a fraction of

their customers deposits in reserve

while the remainder can be loaned out or

invested in some ways it's the opposite

of the gold standard this practice forms

the basis of modern banking allowing

Banks to create credit and stimulate

economic growth by facilitating lending

and investment under fractional Reserve

banking when a customer deposits money

the bank is obliged to retain only a

certain percentage of that deposit as

reserves the reserve requirement is

typically mandated by a central bank or

other regulatory Authority the bank can

then use the remaining portion of the

deposit to extend loans or make

investments generating income through

interest and fees we've explained this

system in more detail in our video on

the Silicon Valley Bank collapse make

sure to check that one out because

massive knowledge bombs were dropped so

needless to say here are some advantages

and disadvantages of fractional Reserve

banking let's be nice and first to

discuss the advantages so first economic

growth by lending out a portion of their

customers deposits Banks help to

increase the money supply fueling

investment and consumption and this

stimulates economic growth encouraging

the creation of new jobs and industries

second profitability fractional Reserve

banking enables Banks to generate income

from interest and fees on loans and

Investments made with customer deposits

this income helps Banks to maintain

profitability which can lead to

increased shareholder value and further

investment in the financial sector

third Financial intermediation Banks

play a crucial role in financial

intermediation connecting borrowers and

Savers in the economy fractional Reserve

banking allows Banks to extend credit to

borrowers providing businesses and

individuals with the capital they need

to grow and innovate

now let's explore the disadvantages

well first bank runs fractional Reserve

banking can make Banks vulnerable to

bank runs a situation in which a large

number of customers choose to withdraw

their deposits simultaneously due to

concerns about the bank's solvency and

since Banks only hold a fraction of

their deposits in reserve they may not

have enough cash on hand to meet

withdrawal demands leading to a crisis

of confidence and potential Financial

instability you know the sort of stuff

we're hearing about these days

second inflation the process of creating

new loans in a fractional Reserve

banking system can lead to an increase

in the money supply if the growth of the

money supply outpaces the growth in

economic output it can result in

inflation eroding the purchasing power

of money and potentially causing

economic imbalances

third excessive risk taking

fractional Reserve banking can encourage

excessive risk-taking by Banks as they

seek to maximize profits through lending

and investment this can lead to the

misallocation of resources and

contribute to the formation of asset

bubbles in the event of a financial

crisis banks with high levels of risky

loans and Investments May face

insolvency necessitating government

intervention or bailouts so it appears

that since 2008 we've all seen these

things in action and by the looks of

things it seems like the pain has only

just begun now let's explain the types

of Banks and services so first up we've

got retail Banks also known as consumer

Banks retail Banks primarily serve

individual customers and small

businesses they offer a wide array of

banking services such as checkings and

savings accounts retail Banks provide

customers with deposit accounts that

enable them to securely store their

money while offering varying degrees of

interest and accessibility these Banks

extend various types of loans including

personal loans auto loans and mortgages

to help customers Finance their needs

and goals the cash that is deposited by

the customer is Lent out to other

customers at a higher rate of interest

than the depositor is paid at the

highest level this is the process that

keeps the economy humming people deposit

their money in Banks the bank then lends

out the money for car loans credit cards

mortgages and business loans the loan

recipients spend the money they borrow

the bank earns interest on the loan and

the process keeps money moving through

the system remember just like any other

business the goal of a bank is to earn a

profit for its owners for most banks the

owners are their shareholders Banks do

this by charging more interest on the

loans and other debt issue to borrowers

then they pay to the people who use

their savings vehicles for example a

bank might pay one percent interest on a

savings account and charge six percent

interest for its mortgage loans earning

a gross profit of five percent for its

shareholders

credit cards

these Banks issue credit cards that

enable customers to make purchases on

credit and repay the balance at a later

date typically with interest

payment services

consumer Banks facilitate various forms

of payment processing such as check

clearing electronic fund transfers and

bill payments

foreign exchange these Banks also offer

currency exchange services assisting

customers in converting one currency to

another for travel or other purposes

second up we've got commercial Banks so

these Banks cater primarily to

businesses both small and large

providing a range of financial services

to support their operations and growth

here you'll find business loans

commercial Banks provide businesses with

loans and lines of credit to finance

expansion working Capital Equipment

purchases and other needs

trade Finance they offer trade Finance

Services as well such as letters of

credit and guarantees to facilitate

international trade and mitigation risks

associated with cross-border

transactions treasury management

commercial Banks provide cash Management

Services helping businesses optimize

their cash flow manage liquidity and

process payments efficiently as well as

foreign exchange and hedging they offer

foreign exchange services for businesses

involved in international transactions

as well as hedging instruments to

mitigate currency interest rate and

commodity price risks

third up we've got investment Banks so

these specialize in capital markets

activities and advisory Services

primarily serving large corporations

institutional investors and governments

they handle mergers and Acquisitions

advisory investment Banks advise clients

on corporate transactions such as

mergers Acquisitions and divestitures

providing strategic guidance and

valuation expertise

underwriting investment Banks assist

clients in raising Capital through debt

and Equity offerings acting as

intermediaries between issuers and

investors and underwriting Securities

offerings Asset Management these Banks

also manage portfolios of Securities and

other Financial assets on behalf of

institutional clients such as Pension

funds mutual funds and insurance

companies

trading and Market making these banks

are engaging in Securities trading

acting as market makers by buying and

selling securities to maintain liquidity

and facilitate efficient price Discovery

in financial markets

and fourth up we've got central banks

unlike the banks above central banks do

not deal directly with the public a

central bank is an independent

institution authorized by a government

to oversee the nation's money supply and

its monetary policy as such central

banks are responsible for the stability

of the currency and the economic system

as a whole they also have a role in

regulating the capital and reserve

requirements of the nation's Banks the

primary tasks of a central bank are the

following

monetary policy so central banks control

the money supply and interest rates to

achieve macro economic objectives such

as stable inflation economic growth and

low unemployment

lender of Last Resort they act as a

lender of Last Resort to commercial

banks in times of financial distress

providing emergency liquidity to

maintain the stability of the financial

system and last but not least

supervision and regulation they oversee

the banking sector establish Prudential

regulations and monitor the solvency and

risk management practices of banks to

ensure their soundness and stability the

U.S Federal Reserve Bank is the Central

Bank of the U.S the European Central

Bank the bank of England the bank of

Japan the Swiss National Bank and the

People's Bank of China are among its

counterparts in other nations some

people love Banks While others despise

them especially when they're talking

about central banks but no matter your

stance banking as mentioned in the

beginning of the video is as old as

Humanity itself so as long as economics

exists Ben banks are not going anywhere

now this should cover most of the theory

behind how Banks work this is a lot to

unpack but we hope you're left with a

better understanding of how the current

Financial system works

understanding Banks means understanding

the foundation upon which the entire

economy is built so we really encourage

you to watch this video as many times as

you need to in order to make sure you

can put together each piece of the

puzzle and with that being said it's

time to wrap up this video but not

before we ask you the following how do

you think the future of banking will

look in the coming years drop your

answers in the comments below we're

always curious to hear your vision as

always thanks for watching a Luxor we'll

see you back here tomorrow