Basics of the Banking System

Document Sample
Basics of the Banking System Powered By Docstoc
					Introduction to the Banking
  System and its General
         Problems

     Bob Welham, PhD
     Bromsgrove 2009
              Money
    The Ultimate Numbers Racket?
• Money is now mostly electronic numbers
  in the banks’ computers.
• How do these money-numbers come into
  being, and by whose hand?
• Why do we have to pay the banks so
  handsomely for the existence and use of
  these money-numbers?
• Can we use our own money-numbers?
   A Way to Understand Banking

• Look at each basic banking operation,
  each type of event, each transaction, and
  examine its effect upon the banks’
  balance sheets, the record of their assets
  and liabilities.
• See how the money-numbers change for
  each basic operation/event/transaction.
• Emergent properties of the whole system
  are revealed as chronic problems.
         Assets and Liabilities
• An asset is something of value to you, e.g.
  money, property, or other people’s
  obligations to repay to you money that
  you have lent to them.
• A liability is something that will cost you,
  e.g. your debt obligation to someone
  who has lent money to you.
• So, if I borrow from you, the debt is my
  liability (I am obliged to repay it) but your
  asset (something of value to you).
    Banks’ Assets and Liabilities
• The same logic applies between banks
  and their customers.

• My debt (e.g. my mortgage) to the bank is
  the bank’s asset but my liability.

• My “money in the bank” is my asset but
  the bank’s liability, since the bank is
  obliged to repay on demand my money to
  me. This money in my bank account is
  being lent by me to the bank.
      Basic Operation 1, New Loan

• Debt (bank asset) and money (bank liability) are
  brought into being in equal measure when a new
  loan is made. They are birth twins.
      Basic Operation 1, New Loan

• Debt (bank asset) and money (bank liability) are
  brought into being in equal measure when a new
  loan is made. They are birth twins.

• The two sides of the bank’s balance sheet are
  expanded in unison simply by the bank making
  equal and opposite accounting entries of debt-
  numbers and money-numbers.
       Basic Operation 1, New Loan

• Debt (bank asset) and money (bank liability) are
  brought into being in equal measure when a new
  loan is made. They are birth twins.

• The two sides of the bank’s balance sheet are
  expanded in unison simply by the bank making
  equal and opposite accounting entries of debt-
  numbers and money-numbers.

• New, perfectly spendable money-numbers are
  thus introduced into circulation (as bank credit) and
  the money supply is expanded.
 New £1000 Loan Taken Out

        £1000                      £1000
new loan account, what the   into the bank account of
borrower owes to the bank           the borrower




      bank’s                       bank’s
      assets                     liabilities
  Basic Operation 2, Loan Repaid

• Debt and money decrease in equal
  measure when a loan is repaid, the
  reverse of when a loan is made.
  Basic Operation 2, Loan Repaid

• Debt and money decrease in equal
  measure when a loan is repaid, the
  reverse of when a loan is made.
• The two sides of the bank’s balance sheet,
  assets and liabilities, contract in unison.
  Basic Operation 2, Loan Repaid

• Debt and money decrease in equal
  measure when a loan is repaid, the
  reverse of when a loan is made.
• The two sides of the bank’s balance sheet,
  assets and liabilities, contract in unison.
• There is then less spendable money (as
  bank credit) in circulation, the general
  money supply contracts.
        £1000 Loan Repaid

      £1000                      £1000
loan account disappears   goes from current account




     bank’s                      bank’s
     assets                    liabilities
 Bank’s Balance Sheet, General
           assets                            liabilities



                                             deposits
         loans

                                         bills to pay, etc.
       (vault) cash
                               external liabilities, owed to creditors
financial assets, e.g. Gilts   internal liabilities, owed to shareholders

other stuff, e.g. buildings         shareholders’ capital
                                             or
money in the bank’s BoE             the bank’s “reserves”
       account
       Basic Operation 3, Interest
• Interest is added to loans.
• Less interest is added to deposits.
       Basic Operation 3, Interest
• Interest is added to loans.
• Less interest is added to deposits.
• This difference or “spread” in interest rates
  gives the bank its gross profit.
Interest Rate Spread                   Gross Profit
            assets                    liabilities


                               the difference is the gross
                                    profit of the bank
   interest charged on loans

                               interest paid to depositors




          loans                  deposits
    the bank’s “loan book”     initially equal to loans
       Basic Operation 3, Interest
• Interest is added to loans.
• Less interest is added to deposits.
• This difference or “spread” in interest rates
  gives the bank its gross profit.
• The bank has operating costs (salaries,
  bonuses, etc.), leaving a net profit.
       Basic Operation 3, Interest
• Interest is added to loans.
• Less interest is added to deposits.
• This difference or “spread” in interest rates
  gives the bank its gross profit.
• The bank has operating costs (salaries,
  bonuses, etc.), leaving a net profit.
• Some of this net profit is distributed to the
  shareholders as dividends, some is retained.
       Basic Operation 3, Interest
• Interest is added to loans.
• Less interest is added to deposits.
• This difference or “spread” in interest rates
  gives the bank its gross profit.
• The bank has operating costs (salaries,
  bonuses, etc.), leaving a net profit.
• Some of this net profit is distributed to the
  shareholders as dividends, some is retained.
• Over time the bank accumulates value for its
  shareholders by retention of profits.
    Basic Event 4, Loan Default

• Loans can default and be “written off”.
    Basic Event 4, Loan Default

• Loans can default and be “written off”.
• The bank then loses an asset, but its
  external liabilities are unaffected.
    Basic Event 4, Loan Default

• Loans can default and be “written off”.
• The bank then loses an asset, but its
  external liabilities are unaffected.
• The bank loses net worth, it pays the
  price for making a bad loan.
    Basic Event 4, Loan Default

• Loans can default and be “written off”.
• The bank then loses an asset, but its
  external liabilities are unaffected.
• The bank loses net worth, it pays the
  price for making a bad loan.
• Internal liabilities to the bank’s
  shareholders (the bank’s reserves)
  decrease - they lose wealth/money.
    Loan Default - Balance Sheet
      before                                    after
 loan                   balance sheet
default                 shrinks


              L         external
                        liabilities (e.g.
                        deposits) are
                        unchanged
  A                                         A           L
          lost share-
            holders’
             capital
          remaining                                remaining
          s/h capital                              s/h capital
  Recap of Basic Operations 1 to 4
   (how the money-numbers change)
• Money and Debt are brought into being in
  equal measure when a loan is made.
• Money and Debt go out of being in equal
  measure when a loan is repaid.
• Interest is added to loans, assets increase.
• Less interest is added to deposits, liabilities
  increase less than assets, hence profit.
• Loans can default and be written off – the
  bank’s shareholders lose wealth/money.
Banking System – Basic Structure
                       customers interface with
                       competing commercial
                       banks


Bank A        Bank B                              Bank Z


e.g. Lloyds    HSBC                               Barclays
                       each commercial bank
                       has its own “operational
                       account” at the BoE



Bank of England – The Central Bank
       Basic Operation 5, Transfer
• Money is transferred, for example, from an
  account in Lloyds to another account in HSBC.
• Millions of such transfers between banks
  happen every day.
       Basic Operation 5, Transfer
• Money is transferred, for example, from an
  account in Lloyds to another account in HSBC.
• Millions of such transfers between banks
  happen every day.
• They are reconciled at the end of each business
  day by the APACS (now UK Payments
  Administration Ltd., UKPAL) clearing system.
       Basic Operation 5, Transfer
• Money is transferred, for example, from an
  account in Lloyds to another account in HSBC.
• Millions of such transfers between banks
  happen every day.
• They are reconciled at the end of each business
  day by the UKPAL clearing system.
• This reconciliation is done by moving money
  between the banks’ operational BoE accounts.
• And/or by the banks borrowing from each other,
  charging interest at LIBOR (London Inter-Bank
  Offered Rate).
  Money Transfer, e.g. Lloyds to HSBC

                           customer’s bank
                           money (liability)
Lloyds                     is transferred         A
balance
            A              e.g. BACS,
                                                               HSBC
                                                               balance
sheet                      CHAPS, cheque                       sheet
contracts           L                                    L     expands




            reconciliation (schematic) by inter-bank money
            transfer of equal amount (asset) from Lloyds BoE
            account to HSBC BoE account
   Reconciliation by Inter-Bank Lending

Lloyds
                            customer’s bank                         HSBC
balance
                            money (liability)                       balance
sheet
                            is transferred          A               sheet
stays the    A              e.g. BACS,                              expands:
same
                            CHAPS, cheque                           new
size, one           L
liability                                                   L       liability
                                                                    plus equal
replaces
                                                                    new asset
another



        reconciliation (schematic): HSBC lends an equal amount of
        inter-bank money to Lloyds (at LIBOR) via BoE accounts

        creates a new asset for HSBC, a new liability for Lloyds
  Loan from Lloyds Deposited at HSBC

               new                                          new
Lloyds         loan                                        deposit
                             customer borrows                        HSBC
balance
                             from Lloyds but                         balance
sheet
                             deposits at HSBC        A               sheet also
expands,              L                                              expands,
new loan
                                                                     new deposit
asset,         A
equal new                                                    L       liability,
                                                                     equal new
liability to
                                                                     loan asset
HSBC
                                                                     to Lloyds


        reconciliation (schematic): HSBC lends an equal amount of
        inter-bank money back to Lloyds (at LIBOR) via BoE accounts

        creates a new asset for HSBC, a new liability for Lloyds
       The Role of (Physical) Cash
•Issued debt-free by the BoE, a publicly owned institution.

•Issued on demand to the commercial banks who pay for it at
par with electronic money, one asset swapped for another.

•This money (seigniorage) then goes to the public purse (HM
Treasury), to be spent back into the economy by the State.

•Cash is now a very small component of the money supply,
down from around 46% after WW2 to less than 3% today.

•Interchangeable with electronic bank money (via ATMs etc.)

•No profit for the banks in our use of cash, except charges!
    Overall Picture, Dual Money System
             Money-numbers come into and out of circulation as bank loans are
             made and repaid. Ambiguity - are they “money” or just “credit” ?

             These temporary money-numbers constitute (almost all of) our
customers’   means of exchange. In that sense they are certainly our money.
bank
deposit      They circulate with great complexity between millions of bank
accounts     accounts across many banks as business is conducted 24/7.
and loans
             This myriad of money transfers is reconciled daily by (net) transfers
             and/or by inter-bank lending between the banks’ BoE accounts.
    Overall Picture, Dual Money System
              Money-numbers come into and out of circulation as bank loans are
              made and repaid. Ambiguity - are they “money” or just “credit” ?

              These temporary money-numbers constitute (almost all of) our
customers’    means of exchange. In that sense they are certainly our money.
bank
deposit       They circulate with great complexity between millions of bank
accounts      accounts across many banks as business is conducted 24/7.
and loans
              This myriad of money transfers is reconciled daily by (net) transfers
              and/or by inter-bank lending between the banks’ BoE accounts.


              These BoE account money-numbers are referred to as “base”
banks’ BoE    money & regarded by the banks as the “real” money in the system.
operational
              They are far smaller in total than the circulating “credit” money-
accounts      numbers above.

              They are internal to the banking system.
    Overall Picture, Dual Money System
              Money-numbers come into and out of circulation as bank loans are
the game?     made and repaid. Ambiguity - are they “money” or just “credit” ?

              These temporary money-numbers constitute (almost all of) our
customers’    means of exchange. In that sense they are certainly our money.
bank
deposit       They circulate with great complexity between millions of bank
accounts      accounts across many banks as business is conducted 24/7.
and loans
              This myriad of money transfers is reconciled daily by (net) transfers
              and/or by inter-bank lending between the banks’ BoE accounts.


              These BoE account money-numbers are referred to as “base”
banks’ BoE    money & regarded by the banks as the “real” money in the system.
operational
              They are far smaller in total than the circulating “credit” money-
accounts      numbers above.
                                                                           the score?
              They are internal to the banking system.
     Chronic Problem 1: Rent-a-Currency
       an emergent property of the money system

Other than physical cash, our entire means of exchange must be
borrowed into existence, at interest, from commercial banks.

Unless some people, somewhere borrow from the banks, we have
a totally inadequate means of exchange and so no economy.
     Chronic Problem 1: Rent-a-Currency
       an emergent property of the money system

Other than physical cash, our entire means of exchange must be
borrowed into existence, at interest, from commercial banks.

Unless some people, somewhere borrow from the banks, we have
a totally inadequate means of exchange and so no economy.


Unnecessarily, we have a   rent-a-currency system.
     Chronic Problem 1: Rent-a-Currency
        an emergent property of the money system

Other than physical cash, our entire means of exchange must be
borrowed into existence, at interest, from commercial banks.

Unless some people, somewhere borrow from the banks, we have
a totally inadequate means of exchange and so no economy.


Unnecessarily, we have a   rent-a-currency system.
Rough calculation: the gross profit on the £2T (approx.) in
circulation (BoE stats) gives a figure of £20,000,000,000 p.a. per
percentage point of the average interest rate differential.

Not a bad return for the provision of electronic numbers!
   Chronic Problem 2: Perpetual Net Debt
Money and Debt come into and go out of being in equal measure.

Because of the interest rate differential, total Money in
circulation grows more slowly than total Debt owed to the banks.
   Chronic Problem 2: Perpetual Net Debt
Money and Debt come into and go out of being in equal measure.

Because of the interest rate differential, total Money in
circulation grows more slowly than total Debt owed to the banks.

So, from the point of view of the non-banking sector (an
important condition) and assuming limited debt default and at
least some profit retention (i.e. a solvent banking system):

    total money supply < total bank debt
   So, an unavoidable emergent property of the system is that
   collectively we must remain forever in debt to the banks.
           Some Other Problems 1
•Because the State is not itself the main money issuer, it
must borrow commercially issued money to enable
spending over and above taxation. Politicians are all too
willing to do this to please (bribe?) the electorate.

•The result is an ever growing and more onerous
National Debt, an unnecessary and increasing burden
passed down the generations.

•Instability, volatility, booms, bubbles and busts are
regular occurrences as the borrowed, over-elastic
money supply expands and contracts for speculations
way beyond the needs of productive enterprise.
           Some Other Problems 2

• Many very talented people are attracted to the highly
lucrative world of banking. Much of this precious talent
is wasted in ferocious but essentially unproductive
competition to develop ever more sophisticated ways to
exploit both each other and the general population.

• The money “industry” has developed into an enormous
global parasite upon productive enterprise.

• The tail is wagging the dog, maybe shaking it to
death.

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:55
posted:2/15/2010
language:English
pages:44