The banking sector is a major player in how business is run in our society. It is important in how a country handles and manages their finances, not to mention how the global economic system operates. The banking sector has advanced over the years, thanks to technological advancement that has made the banking industry change its operations making it easier for the citizens to access finances through mobile technology.
Although the current banking system is getting complicated by the day, it is important to highlight some of the most common misconceptions that people have over it. Let’s look at seven misconceptions that exist in the banking industry.
The world only has one type of banking system
This is a huge oversimplification of the banking system. There are other types of banking systems, and the most common one is Islamic banking. Islamic banking has been in existence for hundreds of years and it operates under the sharia law. Islamic banking has some commonalities with other banking systems except that it does not look for interests because Islam prohibits usury, but that does not mean that Islamic banking does not take any form of interest. For starters, the claim to function without interest is a myth, but in reality, Islamic banking uses a “three contract trick” to place interests on loans without the need of labeling it as interest.
Another alternative to traditional banking is credit unions. Although credit unions are under the central bank’s jurisdiction, they operate independently from central banks.
Banks lend out the deposits of customers
One major misconception is that banks take the deposits of customers and promise them an incentive called an interest in return. Then the money is lent out at a higher interest to make the promised profit for the depositor. But truthfully, that is not how banks have operated.
In the real world, each bank has a balance sheet that lists all their assets and liabilities. When a loan is made to a customer, it is deducted from the assets listed on the balance sheets, which is then transferred to another bank’s account as a liability. Although there is no creation of new money, a new deposited is created, and there is added money to the banking system.
All banks are restricted to create a number of new deposits through loan issuance. These are what are described as “reserve requirements,” and they vary according to the balance sheet of a bank. The reserve requirements can be raised or lowered depending on the economic conditions of a country.
Central banks have great authority
When you look at the Federal Reserve Act, you will understand why central banks are not that powerful. The Central bank has been granted great powers by the Act, but what is missing from the act is what is impressive.
For instance, credit rating agencies that determine the creditworthiness are not controlled by the central bank. Secondly, there is no central bank that has power over their so-called “Shadow banking systems” like wealth funds and hedge funds, which may operate as a bank but they don’t follow the same regulations.
Additionally, banks like HSBC, Goldman Sachs and Citibank are global banks, and they are subject to different country regulations.
Banks are the only ones who control interest rates
Credit rating agencies tend to have more power on interest rates compared to the central bank. The ratings of these agencies can build or crash a country’s economy. These ratings help to determine the loan costs given to countries, major corporations, and individuals. Before a bank offers a loan, it has to check the credit rating of an individual. If the credit rating is low, the more expensive it is to get the loans, and the harder it is to pay the loan; this has led many countries to fall into ruin.
You need your social security number to open an account
The notion of providing your social security number for opening a bank account is wrong, although you will not be told by the bank. The only people who are required to ask or know your number is the government and your employer.
Central Banks are at the top of the food chain, and they are not answerable to anyone
First of all, central banks are answerable to their nation. Beyond that, most banks are a member of the Bank for International Settlements (BIS). The BIS is a regulatory institution that comprises of different banks across the world. It started out in 1930 after the Great Depression; it works like the central bank of all central banks advising them on their conduct, and it helps to facilitate transactions amongst themselves.
Banks store a lot of money in their vaults
Banks store valuable items in safety deposit boxes, and they also keep enough money for a day’s transactions. Otherwise, banks don’t keep loads of money people think they keep in the vaults. Now, even if banks wanted to keep millions of dollars in vaults, it wouldn’t be possible. There are few categories in which a nation’s supply of money is divided: bank deposits, physical currency, traveler checks e.t.c. In America, only about a third of the physical currency is stored in the US banks, while the rest of the money is scattered around the world.