Lesson preview · Money and banks
Money and banks
~7 min · Free to read
During the Second World War, R. A. Radford was a prisoner of war. In 1945 he described trade in the camps. Prisoners all got the same Red Cross parcels of food and cigarettes, and swapped what they didn’t want.
Within a month, nobody priced tinned beef in sugar. Prisoners quoted prices in cigarettes: “cheese for seven”. Even non-smokers sold things for cigarettes, because they could spend them later. Nobody planned it, but the cigarette had become money.
Key Term
The three jobs money does
Money is anything people widely accept as payment. It does three jobs:
- Medium of exchange: you swap it for goods, so you needn’t find someone who wants exactly what you have.
- Unit of account: prices are written in it, so you can compare things at a glance.
- Store of value: it holds buying power over time, so you can sell today and spend next week. Rising prices eat into it.
Cigarettes did all three, though not perfectly: prisoners smoked their money.
Some courses add a fourth job, a standard of deferred payment: debts are written in money.
Key Term
Cash and deposits
Cash means notes and coins. A deposit is money in a bank account: the bank owes it to you and pays it out when you ask. You can spend it by card or phone, so it’s money too.
Countries count money in wider and wider circles, with names such as M1, M2 or M4. Narrow money is cash, or cash plus everyday deposits. Broad money is cash plus most bank deposits.
Cash is only a sliver: 100 units out of 1,000, or 10%. Real economies are similar. In the United States at the end of 2025, notes and coins were about 10% of broad money. Many of those dollar notes are held abroad, so cash use at home is even lower. In the UK, cash was just 3% of broad money at the end of 2013, and under 4% at the end of 2025. Most money isn’t printed. It’s numbers in bank accounts.
Where do all those deposits come from? In the simple picture, a bank takes deposits from savers and lends to borrowers, such as a family buying a home. It charges borrowers more interest than it pays savers.
The bank keeps a buffer of cash and reserves to pay out withdrawals. Reserves are money the bank keeps at the central bank, the public body that looks after a country’s money and acts as the banks’ bank. Most days, few customers withdraw, so the buffer is enough.
Say the bank lends Mia 10,000 dollars for a car. It doesn’t hand her other customers’ notes. It adds 10,000 dollars to her account. Nobody else’s balance falls, so that deposit is new money. When Mia repays the loan, the money disappears again. Banks create most of an economy’s money this way, with no printing press.
Banks can’t do this without limit. A bank lends only when it expects to be repaid at a profit, and the rules below cap the risk it can take.
A bank’s buffer is enough only while people trust the bank. Customers can withdraw deposits today, but borrowers repay loans over months or years. If a rumour spreads and everyone asks for their money at once, even a well-run bank can’t pay them all. That rush is a bank run. Each person who joins the queue makes failure more likely, so the fear feeds itself.
Key Term
Why banks are regulated and deposits insured
Governments protect savers in two main ways.
- Regulation: banks must have enough capital, their owners’ stake, which takes the first losses on bad loans. Big banks must also hold enough easy-to-sell investments to keep paying out for a few weeks of heavy withdrawals.
- Deposit insurance: a government-backed scheme repays each customer’s deposits, up to a limit, if their bank fails. In 2026, Australia and the United States both set the basic limit at 250,000 of their own dollars per customer at each bank.
Insured savers have no reason to queue, so a rumour is less likely to start a run.
Trap · Common Misconception
"The bank keeps my money in its vault"
It’s natural to picture a bank as a safe full of everyone’s cash. If it were, it couldn’t lend, and runs couldn’t happen. Your deposit is really a promise: the bank owes you the money. Most of what it holds in return is loans and other investments.
Tip
Money, income and wealth
A farmer can own valuable land yet have little money to spend. Wealth is everything you own minus everything you owe, at one moment. Money is the part of your wealth you can spend straight away. Income is the money you receive over a period, such as pay of 300 dollars a week.
Check yourself · no marks
A rumour says your bank has made some bad loans. You think the rumour is false. Why might you still rush to take your money out? How does deposit insurance change your answer?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Check yourself · no marks
Sam earns 400 dollars a week. He has 1,500 dollars in a bank account, owns a bike worth 600 dollars and owes nothing. What are his income, his wealth and his money?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 6
A café’s menu lists a sandwich at 6 dollars and a juice at 3 dollars. You can see at once that the sandwich costs twice as much. Which job of money is the menu using?
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