How Banking Works

Let's suppose you agree to lend me £10. For some reason you trust me not to spend it on hookers and crack cocaine, at least not in your absence. I promise that if you lend me the money for a year, I'll give you an extra £5 back at the end of it. I'll make this extra money by carefully investing the money you lent me.

Now let's suppose that Bill, Fred and Jim each want to borrow £10 to finance some potentially-profitable venture. If I agree to guarantee them £10, they each promise me £20 back at the end of it. I only have your £10 at the time so, picking randomly, I make a private arrangement with Fred to lend him the £10, which I do by writing him a cheque promising to pay it to him if he needs it.

Once this works out, I'll get the £10 back with an extra £10 profit. I'll give you back your £10 plus the £5 I promised you, and I'll get £5 for arranging everything.

Pay attention; here comes the clever bit:

"But wait!", I think to myself. "Only Fred knows that I committed the £10 to him. I could make money three times as quickly if I simply pretend that I still have that money, and write a £10 cheque for Bill and Jim, too. So long as two of them don't actually need the actual cash at the same time, I can always pay out the money if I ever need to!"

Plus, if I don't mention this brilliant scheme to you, I can keep the £10 profit from each venture all to myself, thus enabling me to acquire greater quantities of hookers, crack cocaine, &c.

So now I'll make three times as much money by pretending that I have a lot more money than I actually do... and because I got lucky the first few times and the ventures didn't fail, everyone trusts me! Ha ha ha ha, now I'm filthy rich and can look down my nose at all of you! Ha ha ha ha!

Oh, except if several things do go wrong at the same time... oh I don't know, let's suppose that Bill, Fred and Jim each decide to lend their money on to, hmm, some not particularly rich people to, hmm, let's say, buy huge houses that they can't really afford, and then [sarcasm] entirely unpredictably [/sarcasm] all those people default on their loans at the same time, and then I have to pay out the actual money to Bill, Fred and Jim at the same time.

Then I'd be pretty fucked, wouldn't I?

As, indeed, would you, if you wanted your tenner back.

And that, children, is how banking works. Or, rather, doesn't.