Banks and Banking:
What they are, and why it’s important to everyone.
What are Banks?
The 3 theories of banking (Werner 2014)
According to international banking expert, professor, economist, and investment manager, Richard A. Werner, there are 3 historical theories of what a bank does when it “lends money”. These are:
The Financial Intermediation theory;
The Fractional Reserve theory; and
The Credit Creation theory.
The 3 theories are mutually exclusive such that only one of them can be correct.
The Financial Intermediation theory
This theory of banks, says as the name implies, that banks are just “intermediaries” between depositors and borrowers that charge interest for their troubles. They take in depositors’ money and loan it out to borrowers.
No new money is created in the loan process.
This theory is dominant today in Economic departments, and came into prominence in the 1960s.
The Fraction Reserve theory
This theory has 2 meanings: a) that banks loan out deposits but are required to keep a nominal “reserve” on account, usually about 10% of money “deposited” with the bank … to handle the unlikely event of a “run on the bank”. Banks will “loan” out the other 90% of their deposits. And b) that individually banks do not create new money, but somehow, collectively banks in their inter-bank activity, create new money.
What the mechanism is for this money making, no one can adequately describe, no one is talking!
The Fractional Reserve theory was dominant from the 1920s to around 1960.
The Credit Creation theory
This is the oldest of the 3 theories and was well understood before 1920. This theory states that banks create new money whenever they issue a loan. That banks are the creators of the money supply.
Video illustration of the 3 theories of banking:
Video Presentations on Banking & Publicly Owned banks
On the 3 theories of banking by Richard A. Werner:
