Posted: Apr 02, 2013 3:59 pm
Panderos wrote:
Yes, that's what I was saying, which means my question is unanswered. In what way is doing this not preferable to taking deposits from customers if the base rate is only 0.5% (and deposit interest rates are higher)? If I were a bank I'd not bother will all the effort and cost of attracting customers and running their accounts and paying for bank branches. Just borrow from the central bank at next to nothing.
Because the central bank provides short term funding to allow banks to settle overnight imbalances in their transaction flows, not to fund a bank's long term liabilities. If a bank continued to borrow very large sums of money indefinitely, then the bank supervisors would step in to investigate why the bank needed to borrow continuously from the central bank.
Panderos wrote:
The purpose of my questions is to try to understand what prevents them from doing this.
Well in the UK, one thing that prevents them is the central bank. Commercial banks accounts with each other are actually held with the central bank (sorry I should have explained this better previously) and the central bank would certainly notice a sudden massive rise in interbank balances that didn't seem to match with any other transfer in or out of the two colluding banks.
Panderos wrote:Why not? What stops me from doing that deal I said above, then making a transfer from my account at the co-conspirator bank into another bank? The other bank will ask the co-conspirator if I have the money, and they will say yes. Hmm wait I think I just figure that out... is it because in that second transaction, the third bank would reduce the value of the account of the co-conspirator bank at the third bank, so that the co-conspirator bank still has a massive liability?
Correct.
Panderos wrote:
Right but that is not the same as transferring money into my account with the central bank. That is transferring money to the central bank itself, right? Otherwise I am having my cake and eating it.
Apologies. I misunderstood your question. OK, if a bank wants to transfer money to its own account held at the central bank, that can come in two ways. It can come from another bank. This is what happens for example when you write a cheque and give it to someone who deposits at a different bank to yours. The two banks effect the transfer of money between themselves by adjusting their accounts with the central bank. The other way to transfer money to an account with a central bank is to sell securities back to the central bank, which will then add the proceeds to the selling bank's account held with it. The latter is simply converting financial assets into money whereas the former is moving existing money.
Panderos wrote:Ok but what if there is no cash involved? The system today uses less and less cash compared to electronic money. People have already begun to talk about cashless economies. That way there can be no asset that people want to withdraw that causes a bank to crash.
It doesn't have to be cash. The definition of money is wider than notes and coins. A deposit at a bank can be withdrawn without notice and spent. That falls within the definition of money. The spending mechanism can be cash, cards, cheque. It doesn't matter. For this purpose they are interchangeable. If you use a debit card in a store, you are making a demand on your bank to pay the store's bank. If your bank doesn't have funds available or assets that it can readily liquidate and turn into funds, it will fail to honour your transaction and is technically bankrupt.
Panderos wrote:Also, even if there is cash, could a bank not theoretically pay its employees ridiculous money, and then just go bankrupt? I mean if you are running a bank and looking to get rich but don't care about the future of the institution? I'm not saying that's happened..although my belief if that if there is a cheap way of getting rich, somebody will try it at some point.
Yes a bank could do that. However deliberately running an institution into bankruptcy would expose its directors and senior management to potential criminal charges. The point you are making isn't so crazy though. In the last ten years many banks took on all kinds of assets which turned out to be virtually worthless. This was fundamentally what caused the banking crisis. I would call that reckless negligence on a monumental scale. But that's another topic.