What can banks do with your money?
For someone not familiar with the topic, it reads like a weird question, to begin with — it’s my money after all right?
Here's the good news: thanks to the emergence of cryptocurrencies, more and more people are now educating themselves on our monetary policies as well as the inner workings of banks and other financial institutions… and what they discover is far from pretty.
Indeed, there are many layers to this question, so let’s slice this into three main ones:
- Can I spend the money I stored at the bank freely?
- What does the bank do with my “sleeping” money?
- When I invest in a financial product, where does the money goes to?
We will try to cover them all today, but more than anything, illustrate any major points with examples: it won’t be too hard! Indeed, when people find out that there are limitations on what they thought was their money, they tend to be pretty angry about it and share their discovery.
ℹ️ The topic is already complex enough, so we will focus solely on commercial banks to preserve readability. This article does not constitute any form of investment advice. Think twice, own your keys, use condoms.
1. Can I spend the money I have in the bank freely?
Welcome into the first layer of horror. The quick answer is simply no, and we all have a basic understanding of it:
- If you try to empty your whole bank account at an ATM, your bank won’t let that happen.
- If you go abroad and try to pull some money from an ATM or make a large purchase, you might be blocked as well.
While these two scenarios somehow make sense from a safety perspective, they clearly illustrate that your bank:
- Knows any ingoing or outgoing transactions happening on your account,
- Monitors them (at least to prevent suspicious activities),
- Is able to block transactions on the fly if they raise any flag.
Cryptocurrencies are a good tell, the answer is no
The problem arises when banks adopt a paternalistic view and decide, for you, what you should be able to invest in or not
So far, it seems pretty safe, and even reassuring. The problem arises when banks adopt a paternalistic view and decide, for you, what you should be able to invest in or not. Of course, the best example of that are banks blocking transaction to cryptocurrency exchange services, like Coinbase or Kraken.
However, this is nothing new: they have been blocking gambling or adult entertainment services for a while already, and closing account of men and women involved in the sex industry on “moral” or “ethical” grounds — because they have no legal basis to do so. Here is the endless list of financial services discriminating against sex workers.
Even custodial crypto services can partake: for instance, Coinbase explicitly lists gambling in their list of prohibited uses in its user agreement: “Gambling: Lotteries; bidding fee auctions; sports forecasting or odds-making; fantasy sports leagues with cash prizes; internet gaming; contests; sweepstakes; games of chance.”, and take measures against gamblers.
The blocking of cryptocurrency exchanges is thoroughly documented across the web, so let’s do a quick world tour:
- Indians are now threatened to have their bank account closed if they move money in or out a cryptocurrency exchange service. The first letters announcing the closure of accounts were sent.
- Several French banks prevent people from moving money in/from exchanges, on the pretence of protecting them from the risk involved. Even when people go through great lengths to demonstrate that they are highly informed about the risk, they still cannot partake. (Example in French)
- In the US, Bank of America, Citigroup, JP Morgan, Capital One, and Discover all banned at some point, or are still banning the purchase of cryptocurrencies. (Source)
It’s not infrequent to see banks being more zealous than their local governments when it comes to preventing cryptocurrency purchase or sale.
The issue is widespread. We see reports coming from all around the world, including Chile, Malta, Canada, or Bulgaria. The legal status of cryptocurrencies widely varies around the globe (full overview here) but it’s not infrequent to see banks being more zealous than their local governments when it comes to preventing their purchase or sale.
This has gotten to the point where the community is now compiling list of banks who prevent fiat-to-crypto transactions and the ones that are crypto-friendly:
So there you have it!
Your bank monitors every transaction happening on your account. It’s probably fine if you only consider the safety or convenience angle. However, as we’ve seen, it goes beyond that. Edge cases such as gamblers or sex workers demonstrate that banks are often overzealous and will restrict their service on moral pretences.
So now, let’s have a lot at what happens with your sleeping money — the one sitting in your checking account that you haven't invested in any financial products.
2. What does my bank do with my “sleeping” money? Is it invested?
The first thing to understand here is that the money you have on your account at your bank is not yours, in the stricter sense of the term. From the bank perspective, it’s a liability: if you deposit $1000 — the bank owes you $1000. Essentially, your deposit at the end of the day is nothing more than an entry in the bank ledger.
your deposit at the end of the day is nothing more than an entry in the bank ledger.
However, you actually sent your $1000 to the bank in order to get that ledger update, so where does this go? Well, in the bank perspective, it’s a cheap source of reserve — the actual “physical” dollars they are legally required to own. Depending on the country, the legal requirements vary. Currently, in the US, the marginal reserve requirement equals 10 percent of a bank’s demand and checking deposits.
Now that was only you making a deposit to your account — which is one of the least interesting situations for the banks. The real cash cow is overdraft fees (2.4 billion £ were collected just by UK bank in 2018 — so much that even the FCA couldn’t ignore it) and lending.
Overdraft fees are pretty explicit, feel free to check out the piece from the Guardian linked above if you want to learn more; let’s focus on lending from thereon. So why is lending such a source of profit for banks?
It pertains to the yet another highly complex concept — fractional-reserve banking. Here’s a rough explanation of it, please read the article linked above if this interests you:
0.1 = 1: Welcome to banking
A central bank emits a monetary base allowing commercial banks to issue currency by themselves through loans. When Bob comes to Lloyds to deposit $10,000, Lloyds is not pulling money from its reserve to credit Bob’s account.
No, what happens instead is this: the amount written in Lloyds’ ledger next to Bob’s name is increased by 10,000, and 10% of the amount bank got from the deposit goes into its reserve. The remaining can be used for various purposes, including financing other loans, allowing for a circle of intertwined loans:
The confidence in the banking system is preserved through the mandatory reserve, corresponding to a fraction (~10%) of the loaned amount. It effectively means that if more than 10% of the balances are withdrawn simultaneously (bank run), your bank defaults and your money is gone.
The diagram presented above also does a pretty good job of explaining the Money Multiplier Effect. Since the mandatory reserve is low, banks are able to increase their overall outgoing balance from one borrower to the next (re-lending) with a minimal commitment on their end: in the final situation, the bank has a reserve of $271 despite $3439 being emitted in the system.
There are some safeguards for this, for instance in Europe the customer bank accounts are insured up to 100 000€: Deposit Guarantee Schemes. However such mechanism has never been used yet, and given the ties between banks and insurance, you might not be eager to be among the first ones to try it out.
The bottomless issues of infinite supply
The 0.1 = 1 absurdity depicted above is more than a mere bank problem: it’s a system-wide issue. It has to do with what money even means for those in charge, and the monetary policies enforced.
In the long run, the best way to protect your assets might be to simply to pick a currency where this cannot happen. The cool thing with Bitcoin and Ethereum, for instance, is that 1 = 1: 1 ETH is always worth 1 ETH, and “backed by 1 ETH”.
While this can seem basic or obvious, as we've seen above, this is no longer true for fiat currencies, since $1 dollar existing in the system can be backed by only $0.1 “physical dollar” (monetary base) at the bank, or even less through the re-lending process.
Moreover, cryptocurrencies like Bitcoin have a finite supply of units, with set rules governing the emission/minting. For instance, we know that there will never be more than 21 million BTC — it’s defined at the protocol level. The supply of Ether, on the other hand, is not finite, but at least public and predictable.
On the other hand, here is Alan Greenspan’s take (13th Chair of the Federal Reserve) on the solvency of the US Federal Government:
The United States can pay any debt it has because we can always print money to do that.
3. When you invest in a financial product, where does your money goes to?
The question is so wide that it will be hard to answer systematically. However, despite the sheer amount of possibilities you have here, they tend to all share the same high-level issues: the financial products are unnecessarily complex, transparency is generally lacking, and finally, the users usually have little control over the actual usage of its funds.
Financial products are unnecessarily complex
ℹ️ In the following section, we address this issue from an US-perspective. However, the problems we point out are similar all across the globe.
The subject is immensely complex, which is an issue by itself: most (63%) Americans don’t understand the intricacies of it. Between the fees, which plan to choose, how to time it and many other factors to consider, it quickly turns into a nightmare if you want to dive into this.
It is sadly not US or 401K-specific issue: ask around (or yourself) — do you really know what your money at the bank is invested into? Not the type of asset it’s into (equities, bonds…) but the actual industry/services it’s financing down the line? Only financial-literate people who invest directly in the stock markets, picking the actions themselves, are able to answer that question.
Which makes them cryptic
The complexity of financial products like a 401K and other retirement plans punishes people who are not financial-literate: they are unable to make the best call according to their present and future situations.
Between the 1-page report for 104€ billion invested and the blurriness of the law surrounding it, it’s hard to say where the money actually goes to
One might be convinced by the necessity to declare a climatic emergency to fight global warming, yet heavily invested in major polluters like energy companies through his/her saving plan.
In France, there is a special saving account called “responsible and sustainable saving account” (LDDS — Le livret développement durable et solidaire). Don’t get your hopes up, it’s just a name!
Indeed, between the 1-page report for 104€ billion invested and the blurriness of the law surrounding it, it’s hard to say where the money actually goes to. The only certainty is that 80% of the money is invested in SMEs (Small and Medium Enterprises), but we have no idea of their repartition and the share of “sustainable” ones (French source).
And rob users of their sovereignty
The high-level systemic issues faced by the saving plans are mostly shared with the other major investment vehicles available to households around the globe. On top of the complexity and lack of transparency, they face another major issue: the lack of control — investors have no way to blacklist an industry or a given company.
This lack of control is critical. Whether you adhere with the “vote with your wallet” (dollar voting) theory or not, you should have the possibility, if not the right, to inspect where your money goes and prevent any investment you oppose, whatever your reasons are.
Else we can reach the absurd situations where, at the personal level you might be fighting and boycotting a company/industry, yet (unknowingly) supporting them through your retirement plan or other investments.
It’s much more than a matter of money
We chose those three questions because they clearly highlight the limitations of our current banking system. While some limitations are motivated by the need to safeguard users assets, we think the situations presented in this article clearly demonstrate that banks are past that stage.
To us, the main issue with consumer banks lies with their business model. The profit made they make (and distribute to their shareholders) from consumer deposits is redirected away from consumers to the banks' own benefits. This seems fundamentally broken. As Mischa eloquently puts it:
The problem with banking as we know it is that the profits are for the few and the losses are socialised.
Somehow, banks and the NSA are increasingly sharing a similar assumption: everybody is a suspect and a potential terrorist/money-launderer, so everybody should be monitored, at all times.
We are among the ones who think life in a global prison is not worth living.
"A new mode of obtaining power of mind over mind"
Indeed, as the society gain knowledge over this practice, our behaviour “normalize”: we adapt to try to match the expectations of the watchers (Hawthorne Effect). This is nothing new, the philosopher Jeremy Bentham used this as the base concept to design the ideal prison, the Panopticon. That was more than 170 years ago, yet the observations he stated in his introduction are truer than ever. He described the mechanism as “a new mode of obtaining power of mind over mind”.
The stake of the banks’ game are bigger than mere money exchanges: your freedom, free will and liberty of action are at stake.
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