Q: Can you explain what banks are and how they work?
A: Certainly! Banks exist for several reasons. First, they are a place to deposit assets in a safe environment. You might keep substantial sums at a bank to use in the future. Due to having a stable economy and government guarantees of the deposit’s safety, you will feel comfortable leaving some of your wealth there. The bank will always keep some of your deposit as a “reserve” for those who are taking out their money at any one time.
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Depending on circumstances, the bank usually will pay you a fee (interest) while you leave your money on deposit. This is not always true, however — banks sometimes paid no interest, and in fact charged depositors to keep funds “safe” in European banks during parts of the last decade.
I noted above that a bank will keep some of your deposit available for either you or others that need money in the short term. The second main activity of most banks is to take part of its depositors’ money and to either buy securities that will help make profit, or to lend out deposits (loans) which are paid back with interest (profit for the bank if most of their loans are paid back).
If a bank miscalculates how much of their depositor’s money is on demand at any one time-we call this a “run on the bank.” The bank might just not have enough liquid funds to make those taking withdrawals whole. This happened commonly in the Great Depression and even happened in the last couple of years when two banks lending to tech companies did not have the funds (liquidity) to cover the withdrawals demanded at that time. The U.S. government had to step in and provide measures of liquidity as well as some new guarantees that depositors would not lose their money.
The world before banks, electronic transfer
Banks also allow the rapid transfer of funds for commerce in a trusted manner. If you wanted to buy a product from a store across the country before banks existed, you would have had to physically deliver whatever the store of value was at that time and place (shells, gold, etc.). Now banks can electronically guarantee the delivery of your money to somewhere else in microseconds in a secure transaction.
Most countries now also have what are called “central banks” (which in the U.S. is called the Federal Reserve). The Federal Reserve holds some bank deposits, issues our national currency, and tries to regulate the supply of money and interest rates through several means. Importantly, the Federal Reserve guarantees the safety of deposits up to certain limits in all the smaller banks. The “Fed” also tries to moderate inflation, which is the erosion of purchasing power as a dollar buys less “stuff” each year.