Excerpt Taken from:
Blog: Pragmatic Capitalism, Authored by Cullen Roche
Blog: Pragmatic Capitalism, Authored by Cullen Roche
The following is a general overview of the purpose of modern
banks and how they operate in a simplistic sense. This passage is an
excerpt from Cullen Roche’s book “Pragmatic Capitalism: What Every
Investor Needs to Know About Money and Finance”
The monetary
system is designed to cater to the creation of the public’s money
supply, primarily by private banks by establishing a money supply that
is elastic. That is, it can expand and contract as the demand for money
expands and contracts. Most modern money takes the form of bank
deposits, and most market exchanges involving private agents are
transacted in private bank money. As I have discussed, inside money
governs the day-to-day functioning of modern fiat monetary systems. The
role of outside money, which is created by the public sector, is
comparatively minor and plays a mostly facilitating role.
Like
the government, banks are also money issuers but not issuers of private
sector net financial assets. That is, banking transactions always
involve the creation of a private sector asset and a liability. Banks
create loans independent of government constraint (aside from the
regulatory framework). As I will explain, banks make loans independent
of their reserve position with the government, rendering the traditional
money multiplier deeply flawed.
The monetary system in the
developed world is designed specifically around a competitive private
banking system. The banking system is not a public-private partnership
serving public purpose, as the central bank essentially is. The banking
system is a privately owned component of the system run for private
profit. The thinking behind this design was to disperse the power of
money creation away from a centralized government and put it into the
hands of non-government entities. The government’s relationship with the
private banking system is more a support mechanism than anything else.
In this regard I like to think of the government as being a facilitator
in helping to sustain a viable credit-based money system.
It’s
important to understand that banks are not constrained by the government
(outside the regulatory framework) in terms of how they create money.
Business schools teach that banks obtain deposits and then leverage
those deposits ten times or so. This is why we call the modern banking
system a fractional reserve banking system. Banks supposedly lend a
portion of their reserves. There’s just one problem here: banks are
never reserve constrained. Banks are always capital constrained. This
can best be seen in countries such as Canada, which has no reserve
requirements. Reserves are used for two purposes—to settle payments in
the inter-bank market and to meet the Fed’s reserve requirements. Aside
from this, reserves have little impact on the day-to-day lending
operations of banks in the United States. This was recently confirmed in
a paper from the Federal Reserve:
Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.
5 comments:
This has been taken from “Pragmatic Capitalism: Practical Views on Money, Finance & Life.” http://www.pragcap.com/the-basics-of-banking/.
I thought to read a bit more about the same to have a better understanding and thus searched for it.
The author here is trying to give a brief account of the modern banking system that comprise of both private and public banking. Through the post, I got to know that:
Monetary system- A monetary system is the set of institutions by which a government provides money in a country's economy. Modern monetary systems usually consist of mints, central banks and commercial banks.
1.Banks create loans independent of government constraint.
2.The monetary system in the developed world is designed specifically around a competitive private banking system.
3.The thinking behind this design was to diffuse the power of money creation away from a centralized government and put it into the hands of non-government entities, i.e. private banks.
4.Thus, it can be concluded that government supports the private banking and that only is its relation with it (to say). Government, thus, is an architect in helping to sustain a workable credit-based money system.
Problems faced by modern banking system:
1.Some banks will do anything and everything to make a higher profit. And this sometimes involves wide scale fraudulent activity.
2.People rely a lot on these banks which, however, should not be done.
3.Banks are not making enough profit but they however show that the profit to attract customers. Banks and financial institutions still are not making enough return on investment, or the return on equity, that shareholders require.
4.Consumers expect a lot from the banks and many banks are feeling pressure because they are not delivering the level of service that consumers are demanding, especially in regards to technology.
ANANT GAUTAM(16BAL067)
Banks basically have two main functions; Primary and Secondary.
Under Primary they further have two functions
1.)Accepting deposits 2.) Lending loans.
Banks help in bridging the gap between the surplus and the deficit sector.
i.e, the people who have money more than what they require and people with less than what they require.
Banks accepts deposits from the surplus sector and use the same money to render loan services to the deficit sector.
They charge interest on loans and give interest on deposits.
By charging a higher rate of interest from the deficit sector, they pay their part of interest which they owe to the surplus.
The rate of interest on loans is more than the interest given to the depositors. The DIFFERENCE between them is what the banks get as PROFITS.
When a household holds money in his bank locker it does not increase of its own and thus,most modern money takes the form of bank deposits because with the time and at a certain rate of interest it gives some returns than, the amount of money which you deposited.
Now, according to this excerpt: The banking system is not a public-private partnership serving public purpose, as the central bank do.The banking system is a privately owned component of the system run for private profit. But, it is also important that banks are not constrained by the govt. (outside the regulatory framework). Banks lend a portion of their reserves which they obtain from deposits. So, people rely a lot on these banks and it governs the day-to-day functioning of the modern fiat monetary systems.
16BAL069
A bank is an institution whose primary purpose is to accept deposits and make loans, although banks may also offer a multitude of other services. A number of types of bank exists, including commercial banks, consumer banks, investment banks, central banks and international banks. Banking services that may be beneficial to your small business include depository accounts, advisory services, commercial loans and payment services.
Bank Functions
Banks attract depositors by offering to pay interest on funds held on deposit. They then pool the funds of all of their depositors and lend those funds to qualified borrowers at a higher interest rate. The bank earns money on the spread between the rate of interest it pays out and the rate of interest it charges. Bank regulations require banks to maintain a set level of capital to satisfy the needs of demand depositors, i.e., those who have their deposits in accounts that can be readily accessed, such as passbook savings accounts and checking accounts. Occasionally a bank may run low on ready cash and need to borrow short-term funds from a Federal Reserve bank. These loans are made at a low interest rate, commonly referred to as the Federal Reserve discount rate.
Fees
For most of the 20th century, banks made the bulk of their income from the interest rate spread between deposits and loans. Since the mid-1980s, banks have increasingly relied on fee-based services to help bolster their bottom line, according to the Federal Reserve Bank of Chicago. Banks may derive a significant portion of their income from non-interest or fee-based services for either traditional or non-traditional banking services. Fees from traditional services may include late charges on credit card payments, monthly service charges for non-interest bearing checking accounts and returned check charges. Fees for non-traditional services may include fees for insurance services, securities brokerage services and merchant banking services.
Ancillary Services
You bank may offer a variety of ancillary services that can benefit your small business. Your bank may provide merchant services allowing you to offer your customers multiple payment options, such as credit cards. You may be able to set up your payroll on direct deposit through your bank. Your banker may handle your small business retirement program through a 401k or SEPIRA. Your banker may be able to provide or recommend a provider for different types of business insurance. Your bank may offer secure storage for your important business documents in a safe deposit box. The list of small business services that may be available to your through your bank is extensive and varies from bank to bank.
National Bnaking Act of 1863 created a system of dual banking in which banks could have either a state or federal charter. Federally chartered banks issued national currency or national bank notes.It wads uniform in appearance backed by US govt.bonds.
Banks make money by simply moving money around even the services they provide. A bank works by paying people small amounts to lend them money, then lending that money onto others for larger amounts. They manage that whole process, and then keep the difference between the large amount (interest on loans) and small amount (interest from a savings account).
Banks today make a lot of money from fees. One gets pinged when the wrong ATM is used or overdrafting of a check, and so on. Each of these activities only costs the bank a few cents to handle, but it costs few rupees/dollars(at least).
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