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It is Time for Banks to Evolve

The fact that today’s bank deposits are at risk is not a signal that the depositors failed to perform due diligence, it is a signal that our banking system is obsolete, and that you can only put so much lipstick on a pig.

Banks provide two services, the first being one of convenience. Acting as a trusted third party, banks enable entities to both store and transfer wealth, measured in dollars. While the physical form of the dollar has evolved from paper notes to an electronic ledger entry in the cloud, the service itself has not changed. If this was all that banks provided, it would be a stable & transparent business, complete with a simple fee structure.

Bitcoin has proven that modern math-based crypto algorithms can securely and efficiently transfer wealth without the overhead of a trusted third party. Due to its price volatility, Bitcoin is not as useful as a short-term storage of wealth and is presently unable to scale into a useful payment system for the masses. But development continues, and my expectation is that a crypto-based payment system will eventually become widespread, perhaps followed by a crypto dollar.

The transition from a paper to a digital dollar did provide benefits. There is scarce need today for paper checks or ATM machines, and most day-to-day bank transactions can be conducted on a smartphone. When was the last time you set foot inside an actual bank building? Which begs the question, why are there still over 30,000 barely occupied bank branches, and who is paying for their upkeep?

Which brings us to the second much more profitable service banks offer, which is the creation of credit and the issuing of loans.

Your monthly bank statement is just an IOU, as your bank long ago loaned out some of your wealth, and more so. By more so, I mean that per the system known as fractional reserve banking, within a loop of loans and deposits and more loans, the banks have collectively expanded the money supply. Which devalues the dollar and without their explicit consent, “borrows” wealth from all holders of dollars, so that a few loan officers can decide where to reallocate this “borrowed” wealth.

If the loans are paid back, the created credit disappears, and the dollar will revert to its original strength. Suggesting that this loan made good economic sense, that the economy has benefited.

If the loan default rate remains low, with a reserve requirement of 10% this can be a very profitable business for banks, as ten dollars can be created and loaned for every dollar deposited. The banks are collecting interest on ten loans while paying interest on just one deposit. The caveat is that this system is inherently unstable as there is a built-in assumption that most depositors for a given bank will not simultaneously attempt to withdraw their wealth, which is neither present nor available.

Which as recently demonstrated by Silicon Valley Bank, can and will happen. Almost certainly accelerated by social media, such a “run on the bank” event can happen quicker than ever if the depositors suspect that a bank might become insolvent. Or perhaps a “Wall Street Bets” type of organization will short a bank stock, and then utilize social networks to create a run on that bank.

This banking system has worked well enough for the last several hundred years, but given the advances in technology, is this really the best way to optimally reallocate excess economic wealth? A lot of band-aids are required to keep our banking system semi-stable, certainly at the expense of taxpayers, and perhaps at the expense of economic growth.

In the past people would choose between a bank account and stashing cash under the mattress, but those days are long gone. Why should anyone’s wealth be at risk simply because they deposited it into a bank? Perhaps it is time to question the system, to question the cost of maintaining 30,000 bank buildings, to question why the executives of failed Silicon Valley Bank were paid so much, to question why the dollar needs to be devalued to reallocate wealth. Why has our banking system failed to evolve? Why has there been no transformational Uber for the banking system?

How else can excess wealth be borrowed from the masses, and reallocated to entities that are “good economic investments?” Why not expand on the GoFundMe concept, create online regulated private credit funds where people knowingly invest their excess wealth in exchange for a modest return? Use an A.I. algorithm instead of a human loan officer to choose the loan recipients?

It is time to think outside of the box.

Eric Johnson is a Rancho Santa Fe based active angel investor, and the author of “What the Hell is an Economy?”

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