In the bank?
The recent bank closures in Greece have made clear a number of essential aspects of money and banking.
Banks and bankers have come in for massive (and justified) criticism, both for the role that their irresponsible behaviour has played in recent financial crises and for the ludicrous salaries and bonuses that bankers receive.
But this takes nothing away from the importance of having a properly functioning banking system, as events in Greece have shown. And banking depends on two intertwined elements: trust and liquidity.
Shocking though it might seem to some people, banks do not hold enough cash to satisfy their depositors should they all wish to withdraw all of the money from their accounts at the same time.
Normally, we are happy to leave most of our money as electronic entries on our accounts. But we are only happy to do this because we believe that when we do want to turn these electronic entries into cash — either at the counter or at an ATM — we will be able to do so.
This requires banks to have enough liquidity to meet the normal day-to-day needs of their customers. If this is not the case, customers are likely to panic and try to convert their accounts into cash, causing a run on the banks.
To prevent this, central banks provide liquidity to banks, normally as short-term loans in exchange for some kind of collateral. In the case of Greece, this role has ultimately been played by the European Central Bank via its scheme of Emergency Liquidity Assistance (ELA).
If things go well, customers will no longer panic and will once again be happy to leave their money on their accounts, trusting that they can get cash when they need it.
In other words, trust and liquidity form a kind of virtuous circle: less liquidity is needed when customers trust that banks have enough liquidity.
Lack of trust and liquidity, on the other hand, creates a vicious circle in which more liquidity is needed to meet customers' demands. Also, as we have seen in Greece, limits may have to be placed on how much bank customers can withdraw from their accounts.
Restoring trust in banks, as in people, can be a long and painful process. Bank customers whose trust has been broken will naturally be wary for quite a while about placing their trust in banks again.
In theory, people who trust each other could live without banks — creating their own money in the form of paper (or other) IOUs. This is what happened during the Irish bank strike of 1970, when cheques circulated as money. But well-functioning banks certainly make life easier.
Creating a stable and solvent banking system is one of the key challenges facing Greece now. The country's banks need a serious injection of capital ("recapitalization") to get them on their feet. Some €25 billion has been allocated for this purpose under the latest proposed rescue plan.
This will no doubt lead to further criticism of "money going to the banks instead of the people". And indeed, strict controls should be placed on how the money is used. But without a functioning banking system, everyone loses out.
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