Credit, interest and the bank
Move purchasing power across time, and survive the moment everyone wants it back at once.
Everything for this step
- Field guide
- Institutions: what to found, and how to run them → 32 sections
- Builds
- None yet.
- Reference sheets
- None.
- Sciences it rests on
- Mathematics
- Track
- Money, credit and capital, level 4 of 5 · next: Pooled capital and limited liability
Why this matters
A mill, a furnace, a drainage scheme and a railway all share a shape: large cost now, returns spread over decades. No individual saver holds enough, and no individual saver can wait that long. Banking is the machinery that pools many short claims into one long investment — which is precisely why it is inherently fragile, and why the fragility is not a defect to be engineered away but a permanent property to be managed. Every banking system in history has had runs. The ones that survived had a lender of last resort that would lend freely, against good security, at a penalty rate, during a panic. Knowing that rule in advance is worth more than any amount of prudence during one.
The shape of it
- Lend against productive assets, and write down what happens on default before lending. Enforcement comes from published rule; credit without enforceable contract is charity with paperwork.
- State the interest openly and cap it. Every society that has permitted unlimited rates has produced debt bondage, and then produced a debt cancellation to undo it — the cheaper route is the cap.
- Hold a reserve and publish its size. A reserve nobody can verify does not stop a run, because a run is a crisis of belief before it is a crisis of assets.
- Agree the lender-of-last-resort rule in calm conditions — lend freely, on good security, at a penalty rate. Deciding it during the panic is deciding it too late, and this is the single most valuable paragraph in the money chain.
- Keep maturities visible. Borrowing short to lend long is what banking is; pretending otherwise is what makes the failure sudden instead of manageable.
- Audit from outside. Double entry makes the books checkable; someone unconnected actually has to check them.
- Watch the currency. Financing obligations by issuing more money is the recurring temptation, and it has been run as an experiment enough times that the outcome is not in doubt.
Doing it, step by step
The summary above says what has to happen. This says how, with the numbers that decide whether it works.
1 · Lend against productive assets, with default written first
Credit without enforceable contract is charity with paperwork. Enforcement comes from published rule.
For every loan, in writing, before any money moves: the purpose; the security and its valuation — lend only a fraction of its value, often around half to two-thirds, so a fall in its value does not leave the loan uncovered; the repayment schedule, matched to when the asset produces a return; and exactly what happens on default. No loan is ever secured on a person.
2 · State interest openly, explain compounding, and cap it
Every society that has permitted unlimited rates has produced debt bondage, and then a debt cancellation to undo it — the cheaper route is the cap.
State every rate as a yearly percentage. Teach borrowers compounding: the rule of 72 — 72 divided by the yearly rate gives roughly the years for a debt to double — so a debt at 6% doubles in about 12 years, and at 24% in about 3. Set a legal maximum rate in the published code, and make interest above it unenforceable.
3 · Hold a reserve, and publish its size
A reserve nobody can verify does not stop a run, because a run is a crisis of belief before it is a crisis of assets.
Hold a stated fraction of deposits in cash or the most liquid goods. Publish the reserve and the deposits monthly, and let the outside auditor verify them — see double entry. Set a minimum reserve ratio in the rules, and stop lending when it is reached.
4 · Keep the maturity gap visible
Borrowing short to lend long is what banking is; pretending otherwise is what makes the failure sudden instead of manageable.
Keep a maturity table, updated monthly: how much depositors could withdraw within a week, a month, a year — against how much loans repay in the same periods. Publish the gap. Set a limit on how large it may grow, and act before it does.
5 · Agree the lender-of-last-resort rule in calm conditions
Every banking system in history has had runs. The ones that survived had a rule, stated by Walter Bagehot in 1873: in a panic, lend freely, to solvent institutions, against good security, at a penalty rate.
- Freely — enough to meet every withdrawal, visibly.
- Against good security — so solvent banks are saved and insolvent ones are not.
- At a penalty rate — so nobody borrows this way in calm times.
Write it down, name who holds the role and what reserve backs it, now. Deciding it during the panic is deciding it too late.
6 · Audit from outside every year and publish the result
Double entry makes the books checkable; someone unconnected actually has to check them. Once a year an outside auditor traces a sample of loans and deposits to their documents, values the security held against loans, counts the reserve, and reports publicly.
Losses are recognised when they happen, not rolled over. A loan that will not be repaid is written down in the year that becomes clear.
7 · Do not finance public spending by issuing money
Financing obligations by issuing more money is the recurring temptation, and it has ended the same way every time it has been tried: prices rise, savings and fixed incomes are destroyed, and trust in the unit collapses — taking the whole record of debts with it.
Write the rule into the code: public spending is financed by taxation or by openly recorded borrowing at stated rates, never by issue. Publish the quantity of money in circulation.