Intelligent Investing #70 Glenn Leest, The US Banking System Part 1

Intelligent Investing with Glenn Leest

The US Banking System Part 1

1. Why are you doing an episode on the banking system?

o With the recent failure of SVB and other banks, educating my clients and others about how our banking system works will help us be better investors.

o The more you understand about our monetary, the more you will be able to understand what is happening with our money and why it is happening.

2. What is the US Banking System?

o The banking system is a network of financial institutions that provide a variety of services to individuals and businesses. The basic function of banks is to accept deposits from customers and use those funds to make loans and investments.

3. So the banking system takes deposits of its customers and invests it and loans it out? Can you walk us through how that is done?

· The US banking system creates new money through the lending process in a few ways:

o Fractional reserve banking: Banks are required to hold a fraction of their deposits as reserves, but they are allowed to lend out the rest. This means that when a bank makes a loan, it creates new money by increasing the borrower's account balance. For example, if a bank has $100 in deposits and a 10% reserve requirement, it must hold $10 in reserves and can lend out $90. If it makes a loan for $90, the borrower's account balance increases by $90, and the bank's liabilities (the borrower's deposit) also increase by $90. The bank now has $100 in deposits and $90 in loans outstanding, which means it has created $90 in new money.

o Interest: Banks charge interest on loans, which means that borrowers must pay back more money than they borrow. This increases the money supply because the additional money paid back in interest did not exist before the loan was made.

o Secondary market transactions: Banks can sell the loans they make to other financial institutions, such as investment banks or government-sponsored enterprises like Fannie Mae and Freddie Mac. This can free up the bank's balance sheet to make more loans, and the purchasers of the loans can use them as collateral to borrow additional funds. This process can increase the money supply in the economy.

o Overall, the US banking system creates new money through the lending process by expanding credit through fractional reserve banking, charging interest on loans, and facilitating

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