To understand what exactly Marah wanted to discuss with the board, it was helpful to know how banks worked:

If you wanted to get a loan from a bank, the bank used its own criteria to decide whether the deal would be worthwhile for them and what interest rate they would offer you. If the customer's creditworthiness was high, the offer was at a low interest rate. If the customer's creditworthiness was low, the offer was with a high interest rate. Perhaps this raised the question of why they wanted a higher interest rate from someone who was already unsure whether they could repay the basic amount. The higher interest rate was there to absorb the higher losses within the respective risk group, but of course also as a risk premium for the bank. The bank did not have to grant a loan, because if it made a mistake and could not recover any other value, it had to pay for the loss itself. However, a surprisingly high interest rate could also mean that the bank was not in a good shape.

If a loan was granted, the bank credited the amount to the borrower's account. That was the important part. Many people thought that a bank took money from savers and gave it to borrowers. One person saved. The next person got a loan. This idea was wrong. Banks did not need money to lend money. The moment a bank employee wrote the figures in the book, new money was created. This process was called creation.

In the modern system, all banks created money through credit. If you went to the bank and got a loan, you always got money that had not existed before. The bank did not discuss the granting of credit with anyone. The banks created money on their own. Of course, they could not create an infinite supply of money for loans, because the demand for loans was limited and of course a bank also had a motivation to make a profit from the business. Anyone who took out a loan promised to repay the basic amount with interest. If the repayment was doubtful from the bank's point of view, it would not grant a loan. Only if the bank believed that the borrower would be able to repay the loan in full was the money made available for the loan. In addition to demand, there were also a variable number of other factors that could restrict the banks' money creation. The most important of these were certainly the minimum equity capital, the minimum reserve and the central bank's interest rates.

That was the level of commercial banks. Commercial banks were universal banks and specialized banks. Universal banks were, in simple terms, banks that offered all standard banking services. Specialized banks were, in simple terms, banks that only offered certain services. Universal banks included private credit institutions, public credit institutions and cooperative banks. Two of the terms were certainly self-explanatory. A cooperative bank was, in short, a bank where customers could become partners of the credit institution by becoming a member.

There was one more thing worth mentioning. Private credit institutions were also called private banks in some places in the world. This was not the case in Baele. There were no public credit institutions in Baele and also in some neighboring countries. No commercial bank belonged to the state. All commercial banks were privately run. Many people had no bank account. Many people only had cash. Nobody used the term commercial banks in Baele. Commercial banks were called private banks in Baele.

Individuals and companies had their account with a private bank with book money. The private banks all had an account with a central bank with central bank money. It was a two-tier monetary system. A central bank was the managing bank of a currency area. It needed a central bank as the upper authority to manage a currency and to control the many private banks. A central bank was more or less independent of its government in the fulfillment of its tasks, but what these tasks looked like was determined by the government. A central bank could not refuse to comply. Despite its free rein, it was still an instrument of the state.

But why did the private banks need accounts with the central bank with central bank money?

The central bank money was possible cash for the private banks. The private banks were not allowed to create cash themselves. Only the central bank was allowed to do so. The private banks could exchange their balances at the central bank for cash or exchange it in the other direction. The private banks needed the central bank money not only as cash for their customers, but also for payment transactions with the other private banks.

If a customer wanted to make a transfer from his account to the account of a customer of the same private bank, this could be done within the private bank, but if the customer wanted to make a transfer to the account of a customer of another private bank, then the private bank had to instruct the central bank to transfer funds from its central bank account to the central bank account of the corresponding private bank and inform the private bank of the purpose for which it received this money from them. The private banks did not trust each other and the central bank did not trust the private banks, so the central bank fully supervised the cashless movement of money between all banks.

Under certain circumstances, the private banks also needed the central bank money to maintain a minimum reserve set by the central bank. The minimum reserve was the minimum amount that a bank had to hold in its central bank account in relation to certain values of its balance sheet. For example, a private bank had to hold at least 1% of its customers' deposits in book money as central bank money at the central bank. The minimum reserve nevertheless only marginally restricted lending and was not intended to do so. It was created so that private banks could obtain sufficient cash in an emergency. In addition, the minimum reserve only had to be maintained as an average value over a fixed period of, for example, one month. Not all central banks required a minimum reserve either. As a rule, a private bank did not check whether it was still complying with the minimum reserve before granting a loan, since under normal circumstances it could obtain new central bank money from another private bank or from the central bank at any time.

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How could the private banks obtain new credit balances at the central bank?

Central bank money was created in exactly the same way as book money. Both were created using the same methods. A loan was taken out or, alternatively, assets such as precious metals, real estate or securities were exchanged for new money.

A non-bank obtained a loan from a private bank at the bank's interest rate and received book money. The private bank obtained a loan from a central bank at the central bank rate and received central bank money. The private bank always had to deposit additional assets such as securities with the central bank as collateral. A private bank purchased an asset and created a credit balance in book money for a non-bank. A central bank purchased an asset and created a credit balance in central bank money for a private bank.

The following example shows what a normal course of business might look like. To simplify matters, all interest claims are a fixed amount of their loan amount.

Reyji went to A-Bank to get a loan. A-Bank agreed and gave her a loan of 10,000 book money at 5% interest. Because an employee of the A-Bank, while getting a new coffee, happened to notice that the A-Bank had already fallen somewhat below the specified minimum reserve with the creation of the book money, the A-Bank itself later obtained a loan from the central bank of 100 central bank money at 2% interest and deposited securities as collateral.

Reyji withdrew all the money directly from her account and made a run for it. At that moment, A-Bank lost 10,000 book money from its books, but also 10,000 cash from its coffers. The minimum reserve was not affected. A-Bank had not made a loss either. After all, the loan claim was still in the books. Even if Reyji was running away, the employees at A-Bank were not worried at all. Reyji would certainly bring the money back, since she had scribbled her name on the contract. Nevertheless, the employees at A-Bank were a little annoyed that the money had not stayed in the bank, because due to that it might be necessary for A-Bank to obtain more new credit from the central bank in order to be able to exchange it for new cash for the branch, which would of course cost A-Bank money.

Lost in thought, Reyji strolled through the market with her new money, when a sparkle met her eyes. A diamond ring straight out of a fairy tale was for sale. The money was actually not all that important to Reyji, if she was honest. She bought the ring on impulse for 10,000 cash. The dealer was pleased and closed his stall for the day. Reyji went to her appointment with the ring in her jacket pocket, while the dealer went to the B-Bank with the cash in his trouser pocket.

The dealer paid everything into his account. When he was outside again, the employees at B-Bank grinned with satisfaction. The customer had just brought them money from another bank. B-Bank was now in a better position than before, because it had received 10,000 in cash. It was not a profit. After all, the money belonged to the customer. But as long as this money only existed as book money on their books, they could exchange the 10,000 cash at the central bank for 10,000 central bank money or, of course, simply pay it out to another customer. At this point, it was perhaps clear where the false assumption about savers' money came from. So it was true that a private bank might pay out one client's money to another client, but the bank was not limited to that. Any more or less healthy private bank could easily obtain new cash from the central bank.

In the evening, the dealer returned home. Unfortunately, his wife had noticed in the meantime that her wedding ring had disappeared. After a long conversation with his wife, the dealer realized that it had been a grave mistake to have sold the family heirloom. The next day, he therefore wanted to buy the ring back. Reluctantly, Reyji agreed to send it to him by post, but demanded not only the purchase price back, but also a hefty surcharge for her efforts.

The dealer had no choice and had 11,000 book money transferred from his account at B-Bank to Reyji's account at A-Bank. B-Bank was not at all happy about this, because in order to execute this order, it had to instruct the central bank to transfer 11,000 central bank money from its central bank account to A-Bank's central bank account.

A-Bank was thus able to repay its loan of 102 central bank money in full without falling below the minimum reserve and also got its security back. Reyji was also able to repay her loan of 10,500 book money at A-Bank and had even made 500 book money and a diamond ring in addition. A-Bank thus had 10,898 more central bank money than at the beginning and a profit of 498 central bank money from the customer loan minus the 2 central bank money interest for the central bank. B-Bank had 11,000 less central bank money than at the beginning, but at least it had not made a loss of its own. The couple had lost the ring and 1,000 book money.

The private banks thus needed central bank money to make payments to other banks and to exchange for cash. They needed the customers of other banks, or rather their money as deposits, in order to obtain central bank money more easily and possibly also to hold their central bank money more easily, as the private banks possibly paid a deposit rate on their balances at the central bank. This meant that the balances they had at the central bank may have decreased. If there was a minimum reserve and a deposit rate, then this deposit rate only applied to balances above a multiple of this minimum reserve. So if the minimum reserve was also higher due to higher customer deposits, the private bank had more safe central bank money. How high the deposit rate was and whether it was charged at all depended on the central bank's current objectives.

Some people who knew the system up to this point suspected a conspiracy. If all money was only created through loans, but the loan amount plus interest always had to be repaid to the bank, then all loans could never be repaid because the interest the bank wanted did not exist.

This was an incorrect assumption.

Loans did not always have to be repaid in one sum and banks had expenses of their own. So it was entirely possible that all debts could be repaid.

.../ End Part