How a bank works

You pay your salary into the bank. You imagine it sleeping in a vault, in your name. That is not at all what happens.

A bank keeps only a small part of the money deposited. That is the principle of fractional reserves.

It lends out the rest. Because depositors never all come for their money on the same day.

Second principle: maturity transformation. You can withdraw your deposits tomorrow. What the bank lends is for twenty years.

Borrow short, lend long. It is useful: without it, no home loan would exist. But it is also the weak point.

Third principle: the interest margin. It is what keeps the bank alive.

For the example, one hundred million of deposits, paid at one per cent. The bank pays one million euros a year.

It lends these hundred million at four per cent. It receives four million euros.

The difference, three million, is the margin. It pays the wages, the branches, the losses on loans that go bad.

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So far, the bank looks like a middleman: it takes some people's money to lend it to others. Here is the twist.

When a bank grants you a two hundred thousand euro loan, it does not take that money from anyone's deposit.

It writes two hundred thousand euros into your account. In one stroke. This deposit did not exist a second before.

The loan creates the deposit. Not the other way round. The Bank of England spelled it out in black and white in two thousand fourteen.

Most of the money in circulation was created this way, by bank loans. Not by printing presses.

And when you repay, that money disappears. Money is born and dies with loans.

The bank cannot create it endlessly: it must find creditworthy borrowers, hold capital, and follow rules.

That leaves the weak point. In March two thousand twenty-three, in the United States, Silicon Valley Bank saw clients request about forty-two billion dollars in a day.

It had put deposits into long bonds. Rates had risen, and those bonds were worth less. The next day, it was closed.

Borrow short, lend long: when everyone wants their money at the same moment, no bank can keep up.

That is why deposit guarantees exist. In France, up to one hundred thousand euros per person and per bank.

A bank is a promise to give you your money on demand, while it is lent out long-term. It holds as long as everyone believes it.