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LeoGlossary: Bank

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Financial institutions that are licensed by governments to receive deposits and make loans. Some might also be authorized to provide wealth management and currency exchange.

Lending can be directly from banks or through the capital markets.

Banks play a vital role in the economy. For this reason, they operate under heavy regulation. Today, most come under fractional reserve banking, which is overseen by the nation's central bank. This is the primary regulator of the commercial banking system.

Under this system, banks are required to keep only a portion of their asset liquid to offset potential claims on their liabilities. Banks do not have enough liquid assets, i.e. banknotes, to satisfy every deposit). The system understands this but operates under the premise that not all depositors will claim their money at the same time. When this does happen, bank runs are the result.

Money Supply

Banks are responsible for the creation of commercial bank money. This differs from central bank money in that the commercial banking system is what produces the legal tender that most people use, at least in digital form.

This is done through the loan process. When loans are paid, the money supply expands. As individuals pay back the principal, the money supply contracts. This is a process completely under the control of each individual bank.

By expanding the money supply, the banks directly input more money into the real economy. This is on contrast the the central banks which have to use indirect method, which has historically had mixed results.

Expanding the money supply is known as inflation. The reserve of that, deflation, is the contraction of the money supply. Many feel this is a power that is in the hands of the central bank but it really is the commercial banks that inflate or deflate the supply.

Types of Banks

  • Retail - ones used by average individual offering savings and checking accounts
  • Commercial - focus on business customers (also known as business banks)
  • Investment - raise capital in the financial markets
  • Private - exclusively for wealthy clients
  • Central - monetary authority for governments
  • Online - banks without physical locations

Products

Retail

Commercial

History

Modern banking can be traced back to the prosperous cities during the Renaissance. There is evidence that some features of banking go back to the ancient world. Concepts such as credit and lending can be seen in various forms during that period.

Some of the banking dynasties are:

  • Medici
  • Fugger
  • Welser
  • Berenberg
  • Rothschild

The oldest existing retail bank is Banca Monte dei Paschi di Siena which was founded in 1472. Berenberg Bank was founded in 1590 and is the oldest merchant bank.

Ledger

Ledgers, balance sheets, and accounting play an important role in money. Throughout the last 600 years, since the appearance of double-entry accounting, we see the value of the liability. This allowed for the tracking of who owed what, providing the possibility for credit.

Money and ledgers since that time has appeared at various levels. During the early modern era, it was common for merchants to issues credit to locals, using nothing more than a ledger. This became known as ghost money. It also helped business owners to overcome the handicaps of coin money such as shortages, unequal weights, and an lack of standard unit of account.

Throughout the evolutionary process, including with the advancement of technology, the monetary system changed. It morphed into one that is the combination of accounting along with communications. The bank are the primary accountants of the monetary system, serving to update and maintain the ledger so that all balances are settled and validated.

Cryptocurrency Threat

For the average person, cryptocurrency wallets can handle the basic sending, storing, and receiving currency, which are the banks services that most people use. This is what bank accounts gives to most people. At the same time, many of the offerings handles by investment banks are going to be serviced by Decentralized Finance (DeFi).

When we look at the core basis of what banking provides, the validation and addition to the monetary ledger. Much of this can be handled by blockchain. This technology allows for people to exchange value, receive payments, and settle the transactions completely.

The financial system is equally confronted with threats from this segment. We see, as an example, liquidity pools serving a role that was traditionally in the realm of exchanges. There are many aspects to traditional finance that could be disrupted by decentralized applications providing similar services through tokenization.

Wall Street institutions which include the large investment banks can see many streams of revenues dry up if people start to transition away. Before that can happen, a lot of infrastructure is required to provide the services the traditional institutions offer.

Bitcoin And The Great Financial Crisis

As a result of actions by the banking and financial system leading up to the Great Financial Crisis, Satoshi Nakamoto developed Bitcoin. The goal was to create a monetary system that was outside the control of banks and governments. This was done by creating a consensus mechanism that solved the double-spend problem in a decentralized manner.

Through the use of computers solving advanced equations, block producers (called miners) are able to vie for the opportunity to create a block and claim the block reward. This is now known as Proof-of-Work (PoW).

This system eliminated the counterparty risk associated with all aspects of the financial system. Satoshi set out to create a system that was permissionless and could help the unbanked and underbanked.

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