How We Got The Banking System We Have
Most people never think about how banks work until one of them gets into trouble. You swipe a card, money moves, and that’s the end of it. But the system behind that swipe wasn’t designed in one go. It got built in layers, and almost every layer was a reaction to some earlier mess. Start with how it works now. Banks take deposits and make loans. A lot of us picture banks lending out whatever savers hand over, but the Bank of England says it mostly runs the other way. When a bank approves a loan, it credits the borrower’s account, and that new deposit is new money. Above the banks sits a central bank, which in the US is the Federal Reserve. It sets interest rates and acts as the backstop when things go wrong. Regulators and deposit insurance cover the rest. The dollar itself isn’t backed by gold or anything physical. It works because everybody trusts everybody else to accept it.
The roots go back a long way. Early bankers noticed that depositors never all asked for their money on the same day, so some of it could be lent out at interest. That was a good business, and also a fragile one, since a rumor could send everyone to the door at once. Governments got involved too. They needed money for wars, and banks were happy to provide it in exchange for special privileges. The Bank of England, founded in 1694, is the classic example. In 1873, the British writer Walter Bagehot argued that in a panic a central bank should lend freely to solvent banks, but at a high rate. Central bankers still follow that advice.
America took a rougher road. For decades after the Civil War it had a patchwork of banks and no central bank, and panics kept coming. The one that finally pushed things forward was 1907. It started with a failed attempt to corner a copper company’s stock and spread to New York’s trust companies, which were lightly regulated and sat outside the Clearing House. Depositors ran on Knickerbocker Trust. The panic convinced enough people that the country needed a central bank, and the Federal Reserve was created in 1913.
The Great Depression was worse. More than 4,000 banks shut down between 1929 and 1933, and many families lost their savings. Congress answered with the Banking Act of 1933, usually called Glass-Steagall. It separated commercial banking from investment banking and created the FDIC, which at first insured deposits up to $2,500. The Fed’s own history still calls deposit insurance a great success, while noting that moral hazard turned up again in the bank failures of the 1980s.
The next big change was about the money itself. Under the Bretton Woods system set up in 1944, other currencies were tied to the dollar, and the dollar was convertible to gold at $35 an ounce. By 1971, with inflation rising and a run on US gold looming, President Nixon ended that convertibility. Since then the dollar has been backed by nothing but confidence in the government that issues it. Over the next few decades the rules loosened. In 1999 Congress passed Gramm-Leach-Bliley, which repealed the parts of the 1933 act that kept banks and securities firms apart. Then came 2008, which looked a lot like 1907. The trouble was centered on investment banks, which had no direct access to the Fed, just as the trust companies had been outside the Clearing House. Congress responded with the Dodd-Frank Act in 2010, and regulators pushed banks to hold more capital.
If there’s a pattern, it’s that every fix leaves something behind. Lending created runs, runs created central banks, insurance created moral hazard, and moral hazard created more rules. Today’s system is less a clean design than a pile of repairs, each aimed at the last crisis. That probably means the next one will come from somewhere the current rules aren’t looking.
Where could this next crisis potentially come from?
My best guess is that the next crisis starts in a leveraged, opaque corner of non-bank finance, most likely private credit, and then spreads. Private credit funds promise investors periodic liquidity against loans that can't be sold quickly, and that structure is already under strain, with heavy redemption requests since early 2026, worries about software-sector loans, and defaults like First Brands and Tricolor last fall. The Treasury market is the likely amplifier. Hedge fund basis trades are near double their 2020 peak, and that trade helped turn March 2020 into a Treasury market scare. Stablecoins are a slower-burning risk, since a run on them could force Treasury bill sales. The trigger will probably come from outside finance, such as the Iran war and oil shock the Fed flagged, an AI-related selloff, or a bout of persistent inflation. The shock would find the weak spots rather than create them. This is an informed read of where the vulnerabilities sit, not a forecast or investment advice, and the real trigger is usually something nobody has on their watchlist.
Works Cited
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Cera, Katharina, et al. “Stress in Global Private Credit Markets and Its Implications for Euro Area Financial Stability.” Financial Stability Review, European Central Bank, May 2026, www.ecb.europa.eu/press/financial-stability-publications/fsr/special/html/ecb.fsrart202605_04~3f2135af91.en.html. Accessed 2 Nov. 2026.
Citizens. Stablecoins: Impact on U.S. Treasury Market. July 2026, www.citizensbank.com/dam/562618a4-5cc5-47bf-aa50-b46400d801ca/citizens-allium-stablecoin-white-paper-original-file.pdf. Accessed 2 Nov. 2026.
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Maues, Julia. “Banking Act of 1933 (Glass-Steagall).” Federal Reserve History, Federal Reserve Bank of St. Louis, 22 Nov. 2013, www.federalreservehistory.org/essays/glass-steagall-act. Accessed 2 Nov. 2026.
McLeay, Michael, Amar Radia, and Ryland Thomas. “Money Creation in the Modern Economy.” Bank of England Quarterly Bulletin, 2014 Q1, 14 Mar. 2014, www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy. Accessed 2 Nov. 2026.
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