Home / Banking / Christian Economics in One Lesson, II: 8: Legitimate and Illegitimate Banking
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Christian Economics in One Lesson, II: 8: Legitimate and Illegitimate Banking

Written by Gary North on May 21, 2016

Wherefore then gavest not thou my money into the bank, that at my coming I might have required mine own with usury? (Luke 19:28).

The Greek word for bank is the word for table or stool. It was the same word used to identify the tables used by the moneychangers in the temple (Matt. 21:12). The banker was a money-changer, a specialist in the currency business. The legitimacy of banking is affirmed in this passage. The capitalist who entrusted his money to his three stewards expected a positive rate of return on his investment. The lowest rate of return acceptable to him was the rate of interest offered by a money-changer.

Risk Allocation

The fearful steward buried the coin entrusted to him. What kind of stewardship was that? The owner could have done the same thing with less risk. After all, he had to trust the steward with his coin. He could hardly be expected to trust his steward as much as he trusted himself. The owner of an asset generally takes better care of his assets than his agent will. The owner has more to lose than his agent does.

There are exceptions, of course. Some owners know that they are unreliable managers of their own wealth and seek trustees to act as their agents. But there is always risk involved in such a delegation of authority. The question is one of comparative risk. The owner must decide who is the more reliable money manager. It is his responsibility to make this decision.

The steward refused to hand back the coin in the first place. He accepted the responsibility of money management and then attempted to escape it by burying the coin. But there is no escape from risk. The devil tempted Jesus by quoting Psalm 91:12: “If thou be the Son of God, cast thyself down: for it is written, He shall give his angels charge concerning thee: and in their hands they shall bear thee up, lest at any time thou clash thy foot against a stone: (Matt. 4:6). Yet Jesus’ life was not risk-free. “Jesus said unto him, it is written again, Thou shalt not tempt the Lord thy God” (v. 7).

The owner told the steward that the steward should have entrusted the money to a banker. There was inescapable risk in the arrangement for the steward: risk of losing the coin, or selecting the wrong banker, or not gaining a positive rate of return for the owner. The owner gave him good retroactive advice: put the money with the banker. Let the banker guarantee him a rate of return and then let the banker find the debtor or group of debtors who would repay the loan with interest. A banker specializes in portfolio risk allocation: the sharing of risk. He places himself in between depositors–lenders to the bank–and debtors. The debtors repay the bank; the bank repays the depositors. The banker makes it on the interest rate spread: the difference between what the debtors pay him and what he pays his creditors, i.e., the depositors.

There is always risk. The depositor thinks that he can reduce his risk and increase his rate of return by handing over his money to the banker. The banker thinks he can assure himself a reward by using other people’s money. The banker reaps a management fee from the borrowers. He is a middleman in the transaction: allocating risk and reaping a fee.

There can be additional stages of risk management. The borrower thinks he can make a higher rate of return than the bank loan’s rate of interest. Let us consider an example. I know a man who borrowed a million dollars from a bank in order to lend money to mobile home buyers at 18% to buy new mobile homes. He pays the bank 9%. He owns the mobile home park where these people live, so they cannot easily drive off his park with his collateral for these loans. The bank, on the other hand, would find it risky to make loans to dozens of mobile home buyers in dozens of different parks. It would cost too much to monitor the bank’s collateral. The bank is not in the mobile home park business. My friend makes $180,000 a year in interest on the money he has loaned out. He pays $90,000 in interest a year to the bank. He pockets $90,000 a year because he knows how to find fairly reliable debtors who will pay 18% to buy a mobile home.

It is all a matter of risk allocation. The mobile home buyers are paying a market rate of interest to my friend, given the risks involved to lenders in lending to mobile home buyers. My friend is paying a market rate of return to the bank, given two decades of having never missed a payment. The banker looks at my friend and imputes one degree of risk; he would impute a much higher degree of risk for a mobile home buyer. Because of the difference in portfolio risk allocation, the transaction becomes profitable for all concerned. Everyone gets what he wants at a price he can afford: the mobile home buyer, my friend, the bank, and the bank’s depositors.

(For the rest of my article, click the link.)

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