Topic page
Banking and Money
- Banking 1
- Banking 2: A bank's income statement
- Banking 3: Fractional Reserve Banking
- Banking 4: Multiplier effect and the money supply
- Banking 5: Introduction to Bank Notes
- Banking 6: Bank Notes and Checks
- Banking 7: Giving out loans without giving out gold
- Banking 8: Reserve Ratios
- Banking 9: More on Reserve Ratios (Bad sound)
- Banking 10: Introduction to leverage (bad sound)
- Banking 11: A reserve bank
- Banking 12: Treasuries (government debt)
- Banking 13: Open Market Operations
- Banking 14: Fed Funds Rate
- Banking 15: More on the Fed Funds Rate
- Banking 16: Why target rates vs. money supply
- Banking 17: What happened to the gold?
- Banking 18: Big Picture Discussion
- The Discount Rate
- Repurchase Agreements (Repo transactions)
- Federal Reserve Balance Sheet
- Fractional Reserve Banking Commentary 1
- FRB Commentary 2: Deposit Insurance
- FRB Commentary 3: Big Picture
- LIBOR
Banking 1 Introduction to how banks make money and the value they (potentially) add to society.
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- Let's learn a little bit about just
- how a plain vanilla bank works.
- So let's say that I'm an entrepreneur
- and I see a problem out there in the world.
- You have all of these hardworking people
- -- whatever they do-- doctors, lawyers, engineers, construction workers--
- whatever they might do.
- They work, they provide services to each other
- and they have savings, right?
- So right now, they're just-- whatever.
- They're burying it in their backyards.
- And they're just collecting there, right?
- That "money" is doing nothing.
- They've provided some goods and services to someone else.
- Those people gave them something,
- whether it's gold or a green piece of paper, that essentially says,
- this gold or this green piece of paper entitles you
- to some future goods and services.
- And those people said, that's a useful thing that I have.
- Let me just put it into my mattress.
- There's this pool of savings
- and let's say there's this other pool of entrepreneurs
- and they have a bunch of really good ideas for projects.
- They're like, you know what?
- If I could just to get-- let me put this here:
- projects or investments.
- Let's say that there's some other entrepreneur
- and he says, boy, you know what?
- I have no claims on any goods and resources,
- but I have an idea.
- I have an idea that
- if I could get a bunch of people to dig canals to the crops,
- that we'll be able to grow more crops throughout the year
- and we'll all be richer because we'll all have more food
- and that's a true good and service in its best sense.
- But how am I going to get these people
- to build this ditch for me?
- I mean, I could maybe promise them in the future
- that once all of this is done, I can do something,
- give them more food, but that's not the way it works.
- No one's willing to work for me unless they can feel very secure
- that they're going to get something in return.
- So we have an interesting problem here.
- You have a bunch of people
- who have already provided goods and services to the world
- and the world has given them trinkets--
- whether it's gold coins or paper money. Let's just say it's gold, right?
- And I want to make this point
- because everyone always talks about gold as if it's something special,
- as if it really represents wealth,
- while paper money really does not represent wealth.
- And that's just not true.
- There's nothing about gold.
- Gold is not useful other than the fact that it is pretty.
- That's the only thing that makes gold useful.
- Actually, it's pretty and it's hard to counterfeit.
- Paper money-- not so pretty, but it has other advantages.
- It's lighter, and at least the paper money we use now,
- is not so easy to counterfeit.
- I always want to make that--people always somehow feel
- that gold is somehow better than paper money.
- And we'll talk in the future about inflation and deflation
- and the fact that there is a constraint
- on how much gold can be produced, but you can print money.
- But we'll talk about that in a little bit.
- So in our modern world
- that savings are these green pieces of paper,
- but let's say we're talking about some primitive culture and they're using gold.
- So a bunch of people perform a bunch of goods and services
- and they get these little coins.
- And these coins are essentially this society's way of agreeing--
- if you have one of these coins in the future,
- if you give this coin to someone else,
- they'll do something for you.
- And how much of that coin you have to give
- for them to do it?
- It's based on supply and demand and price, whatever.
- These projects-- I say, well
- if I only had some way of convincing someone to dig a canal,
- it would be hugely beneficial and it will create wealth--
- or dig irrigation ditches.
- But how do I do that?
- Well, if I had gold or if I had these little coins,
- I could give these coins to these people,
- they would dig the irrigation ditch
- and then I could charge people the service of using my--
- or maybe I'll charge people access to water
- and then I could essentially generate a return. But how do I do that?
- Well, what if I could borrow some of these people, right?
- These people have these units of goods and services
- called a gold coin.
- If I could borrow some of their money
- and use it to pay people that will essentially do the goods and service
- or do the new project, then I'll generate wealth.
- And then I could share it with these people,
- maybe in the form of some type of interest.
- Well, it's very hard in a vacuum
- for these people to evaluate these projects.
- And maybe these projects,
- they don't require just part of the savings of one person,
- they require the savings of 1,000 people because it's a large project.
- It's also hard for these people
- to evaluate who has a good project.
- It's hard for these people to evaluate who has savings.
- In fact, if I have savings,
- if I've buried a bunch of stuff in my backyard or in my mattress,
- I don't want to advertise it.
- That's just going to make people come and rob me.
- So I'm a third entrepreneur and I see an opportunity for business
- and I call that business a bank.
- And so what is a bank going to do?
- What is my bank going to do?
- Let's just talk about it from the bare bones.
- How am I going to start my business?
- I'm actually one of these entrepreneurs.
- Let's say I have some savings,
- just to make it simple so I don't have to go into this pool.
- So let's say I have a million gold coins of savings--
- let's say it's a million dollars.
- Let me draw my balance sheet.
- And balance sheets, as you see,
- they were useful even in primitive cultures.
- So that's my balance sheet.
- Let's say my initial balance sheet is--
- I put in a million dollars of my gold coins.
- I'll say a million dollars
- just because we're used to that.
- You could say a gold coin is worth a dollar,
- so it's a million gold coins.
- We know that that's not true anymore.
- And I use that essentially to build this big structure of solid stone
- that looks really safe and really secure.
- So I use it essentially just to build a big vault, right?
- So this is my equity, right, and I use it to build a vault--
- a big, nice, fancy looking building.
- So I'll actually draw the building.
- It has pillars in the front.
- It looks like an old Greek or Roman temple.
- I think that's not an accidental appearance.
- So I build this nice looking building
- that people would feel comfortable keeping their money in--
- and that could actually be safe for safekeeping.
- And I tell everyone, look, I have this nice big building.
- Instead of having your money insecure in your backyard or your bed,
- why don't you put your savings in this building
- and if you ever need it, you can come and get it?
- And on top of that,
- I'm going to pay you to keep your money with me.
- So everyone says, that's a good deal and Sal's trustworthy
- and, more than Sal, that building looks even more trustworthy
- because it looks like a Greek temple.
- So everyone puts their savings with me.
- And let's say that is
- that is $10 million of savings in my village.
- I have a fairly wealthy village.
- So that's $10 million of deposits.
- This is a liability for me, right?
- Why is it a liability?
- Because I owe that to other people.
- They're giving it to me for safekeeping.
- So this is my liabilities.
- This is my equity.
- If it wasn't just me, if there was 10 shareholders,
- each of us would have 1/10 of this.
- But this is a sole proprietorship
- so this is my equity.
- This is my building.
- I'm running a business here, right?
- I'm not doing this
- as some type of nonprofit or charity work.
- So what am I going to do with this $10 million of deposits?
- Well, I told people
- that they can take the money out any time.
- I'm taking their money as safekeeping.
- If they put it in and then one day they can't get their money back,
- they're going to be very suspicious of me.
- So I have to keep some of the money set aside.
- This could be amongst 3,000 or 4,000 people.
- So at any given day,
- not everyone-- hopefully not everyone's--
- going to pull their money out or put their money in.
- But I need to keep some cash reserves
- in case people want their money back.
- So I need to keep some of that $10 million in cash.
- So let me do that in magenta.
- Let me say I want to keep 10% of it in cash.
- So I'm going to keep $1 million in cash
- and then I have $9 million left
- that I can hopefully put to productive use.
- And what I'd do with that $9 million is
- I loan it out to people who have really good projects or investments.
- So $9 million in loans.
- That's an asset, right?
- I give that money to someone else.
- They owe me $9 million.
- I'm essentially borrowing $10 million,
- keeping $1 million aside, and paying out $9 million in loans.
- There could be a bunch of different projects.
- There could be 100.
- I'm not just giving $9 million to one person.
- I'm diversifying a bunch
- across a bunch of different projects.
- So the natural question is, how am I making money?
- Well, these loans-- I'm hopefully putting them
- to build irrigation ditches or build factories or do whatever,
- something that actually is an investment,
- that creates more value than it needed to start up.
- So I can actually charge interest
- and that interest should be a cut of that value that's being created.
- So let's say that I charge 10% on this money.
- And just for the sake of it,
- let's say I invest really well and no one defaults.
- I'm the first bank so I get all of the best investments.
- So I'm getting 10%.
- And for their money, these people,
- not only do they get to keep their money in this nice, safe deposit,
- but I'm also paying them 5%.
- So how much money do I make in a year?
- Well, I'm making 10% on this $9 million.
- So what is that?
- That's $900,000 a year I'm bringing in.
- And how much am I paying out every year?
- Well, 5% of $10 million--I'm paying out $500,000.
- So interest income-- $900,000.
- Interest expense-- $500,000.
- That nets me $400,000.
- And let's say I pay another $100,000
- for salaries and for security guards and all of that.
- So essentially, I'm netting $300,000.
- So I'm netting $300,000.
- I'll do it in a little more detail in the next video.
- But if you look at it big picture,
- I put a million dollars in and every year,
- I'm making $300,000 by providing this service--
- by matching up the savings with good investments.
- And everyone benefits.
- The pie's getting bigger because these are real investments
- that are going to benefit my village.
- And of course, these people benefit
- because they get safekeeping for their accounts
- and their money is actually growing.
- They're actually participating in this capital investment.
- Anyway, see you in the next video.
Be specific, and indicate a time in the video:
At 5:31, how is the moon large enough to block the sun? Isn't the sun way larger?
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