It is a common misconception that banks loan money. They don’t and never have. What banks do is create non-existent money in the form of credit and loan it out, charging interest on it.

Banks operate on the principal of Fractional Reserve Lending, sometimes more accurately described as fictional reserve lending.
The way this worked historically was that for every tenner in real money the banks had on reserve, they could lend out €100, which is ten times that amount.
But that was in the good old days. Since the 1990’s, the ratio has grown to a staggering 20 to 1 and in some – more extreme – cases as high as 70 to 1. The six Irish owned banks are far from being the most exposed: they have €407 billion out on loan yet their core capital stands at €23.3 billions which represents a ratio of 17½ to 1.
To the average man or woman on the street who needs €250,000 to buy a house, it doesn’t matter how the money came into being. Or so people tend to assume.
Unfortunately it does. Because, the way the system works, it will eventually cost them €400,000 to pay back the €250,000 mortgage thanks to interest charges. Appropriately enough, the word mort gage which is Latin in origin literally means death grip.
It would be possible to create interest-free money (more of which later) – but Governments long ago abrogated this right and handed it over to private banks instead, who out of virtually nothing, created over 90% percent of the money which is now in circulation. Or to be more precise, the digital money that exists on a computer screen.
In Ireland’s case, €450 billion was created out of thin air during the ’90s and onwards, and loaned to people.
Initially, the new borrowed money created a credit-fuelled boom, with money filtering down from developers through the builders and the well-paid workmen, who in turn spent it in coffee shops (and on breakfast rolls) and so forth.

PYRAMID SCHEME
However, we are now in the phase where the whole process has gone into reverse, with all the borrowed money plus interest being slowly sucked out of the economy by the banks.
Think of a million people paying a thousand euro a month on their mortgages and suddenly you realize why all the bars are empty and half the staff have been let go. It’s no mystery really. No one has any spare cash.
To complete the circle, when a loan is paid back, the bank cancels out of existence the original money it created and is only allowed to keep for itself the interest.
Thus, in order to maintain the status quo and avoid an economic downturn, banks have traditionally had to encourage ever-larger numbers of people to borrow in order to inject new money into the economy.
It is a classic pyramid scheme with only one possible outcome: the mathematical certainty that the whole economy will spectacularly collapse if the banks run out of fresh customers.
Governments are only too well aware of this paradox, which is why they are so obsessed with economic growth.
By bringing new money into the country via the multinational factories and so forth, they can keep one step ahead of the debt. So far so good – until the economy hits an economic tempest and stops growing. Which is what has been happening these past few months.
Unfortunately Ireland’s €450 billion debt has a life of its own, and thanks to interest, continues to grow larger by the day like a malignant tumour.
It’s hard to over-play the depth of the crisis: paying off Ireland’s €450 billion debt would require something of the magnitude of almost a trillion euros. Unfortunately there isn’t enough money in existence in the economy to pay off the debt.
With little or no new money coming into the country, and with the banks extracting their pound of flesh every month, the existing pool of money soon starts to dwindle.
With less money in circulation, the economy slowly grinds to a halt and large numbers of people end up losing their jobs – a situation which inevitably leads to people defaulting on their loans.
In theory banks should be able to walk away from the economic crash, cashed up to the hilt whilst their indebted customers make do with frugal austerity measures. Not so.
Due to a peculiarity of the Fractional Reserve Lending model, the mechanism that allowed banks to conjure-up huge loans out of relatively little cash also works in reverse – with dire consequences for the banks if enough people start defaulting on their loans.

ALTERNATIVE MODEL
How? If someone defaults, the phantom €250,000 house loan rises up and wipes out €250,000 worth of the bank’s real cash reserves.
Due to the fact that most banks’ cash reserves are quite low, if only a small percentage of their customers can’t pay their loans back, then the bank is potentially in serious trouble.
Normally, banks make allowances for a small percentage of bad debts. However, when the unforeseen occurs – an event such as huge job losses - then all bets are off and banks start to collapse.
That’s what happened with Lehman Brothers, as a result of which bankers all over the world have been demanding corporate dole from the Government to give them the liquidity (cash) to continue spinning new money out of straw.
Curiously, the problem with banking isn’t so much the creation of endless credit out of thin air, but rather, the interest levied on it, which completely undermines the economic benefits of the new money. Think of a €3.49 tube of lipstick bought on a credit card which a year later ends up costing €5.
Presently, governments around the world are pouring hundreds of billions into a crumbling banking system in a vain attempt at preserving the status quo.
However, rather than viewing the situation as an economic Armageddon, perhaps the collapse of faith based banking presents the world with a once-in-a-century opportunity to literally scrap the entire usury (interest) based system, and start again from scratch.
There is an alternative model: a financial system based on interest-free credit. A bank offering interest-free credit would operate like any normal financial institution, in as much as they could loan out ten times more money than they actually possess.
There’s one key difference, though. Instead of profiting on the interest normally charged on loans, the bank would instead – upon repayment of the loan – keep for itself a small portion of the new money created, and cancel out of existence the remainder.
A great benefit of this alternative system is that anyone who borrowed say €200,000 to buy a house would only ever have to pay back €200,000.
A downside is that depositors would no longer receive interest on their savings. So much so that the cash reserve to create each new loan would have to come from the borrower, who would lodge with the bank a 10% percent cash deposit, which would be returned when the loan was paid off.
Historically, Arthur Griffith and Michael Collins had in mind a system of this type, and planned for the newly independent Ireland to issue its own interest-free money rather than allowing the banks to control this function, and charge interest on the result.
Unfortunately, both died in the Civil War – and the idea died with them.