Fractional-reserve banking: Difference between revisions
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Although fractional-reserve banking is near universal, it is not without criticism. The primary criticisms relate to the financial risk note holders and depositors bear, and the impact bank notes and demand deposits have on the stock of money, and potentially its value (that is, the effect on inflation and the exchange rate). One proposed alternative to fractional reserve banking is [[full-reserve banking]]. This is advocated by some [[monetary |
Although fractional-reserve banking is near universal, it is not without criticism. The primary criticisms relate to the financial risk note holders and depositors bear, and the impact bank notes and demand deposits have on the stock of money, and potentially its value (that is, the effect on inflation and the exchange rate). One proposed alternative to fractional reserve banking is [[full-reserve banking]]. This is advocated by some [[monetary reform]]ers in concert with the introduction of debt-free government issued [[fiat currency]] from the [[Treasury]].<ref>[http://www.monetary.org/lostscienceofmoney.html Stephen A. Zarlenga, ''The Lost Science of Money'' AMI (2002)]</ref><ref>[http://news.goldseek.com/GoldSeek/1192819378.php The Forgotten War]</ref> |
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===Business cycle=== |
===Business cycle=== |
Revision as of 06:55, 8 May 2008
Fractional-reserve banking is a banking practice in which banks are required to keep only a fraction of their deposits in reserve with the choice of lending out the remainder while maintaining the obligation to redeem all deposits upon demand. This practice is prevalent worldwide and is considered to be the customary form of banking system.[1][2]
History
[3] At one time, people deposited gold coins and silver coins at goldsmiths, receiving in turn a note for their deposit. Once these notes became a trusted medium of exchange an early form of paper money was born, in the form of the goldsmiths' notes.
As the notes were used directly in trade, the goldsmiths noted that people would never redeem all their notes at the same time, and saw the opportunity to invest coin reserves in interest-bearing loans and bills. This left the goldsmiths with more notes on issue than reserves to pay them with. This generated income—a process that altered their role from passive guardians of bullion charging fees for safe storage, to interest-paying and earning banks. Fractional-reserve banking was born. When creditors (note holders) lost faith in the ability of the bank to redeem (pay) their notes, many would try to redeem their notes at the same time, forcing the bank to call in loans or sell bills. This was called a bank run and many early banks either went into insolvency or defaulted on their notes.
Purpose and function
The Federal Reserve gives a summary of why fractional reserve banking is used and what its effects are:
- The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to “create” money.[4]
How it works
A demand deposit at a bank (e.g. checking account) or banknote issued by a bank (bank-issued paper currency) is essentially a loan to the bank, repayable on demand, which the bank uses to finance its investments in loans and interest bearing securities. The nature of fractional-reserve banking is that there is only a fraction of cash reserves available at the bank needed to repay all of the demand deposits and banknotes issued. The reason people deposit funds at a bank or hold banknotes issued by a bank is to store savings in the form of a demand claim on the bank. One important aspect of fractional-reserve banking is that the note holders and depositors still have a claim to repayment of their funds on demand even though the funds are already largely invested by the bank in interest bearing loans and securities.
For instance, you could ask to withdraw all of the money in your checking account at any time. If all of the depositors of a bank did that at the same time (a bank run), the bank could be in trouble, but this rarely happens.
Fractional-reserve banking works because:
- Over any typical period of time, redemption demands are largely or wholly offset by new deposits or issues of notes. The bank thus needs only to satisfy the excess amount of redemptions.
- Only a minority of people will actually choose to withdraw their demand deposits or present their notes for payment at any given time.
- People usually keep their funds in the bank for a prolonged period of time.
- There are usually enough cash reserves in the bank to handle net redemptions.
If the net redemption demands are unusually large, the bank will run low on reserves and will be forced to raise new funds from additional borrowings (e.g. by borrowing from the money market or using lines of credit held with other banks), and/or sell assets, to avoid running out of reserves and defaulting on its obligations. If creditors are afraid that the bank is running out of cash, they have an incentive to redeem their deposits as soon as possible, triggering a bank run.
Cumulative effect
The process of fractional-reserve banking leads to a cumulative effect of money creation by banks[4]. In short, there are two types of money in a fractional-reserve banking system[5][6]:
When a loan is supplied with central bank money, new commercial bank money is created. As a loan is paid back, the commercial bank money disappears from existence.
A pre-requisite for making a loan is that banks have fractional-reserve rate of less than 100%. If the fractional-reserve rate were 100%, then from an inital deposit of $100, nothing could be lent. If the fractional-reserve rate is 90%, then $10 can be lent, and so on.
The table below displays how loans are funded and how the money supply is affected. It also shows how central bank money is used to create commercial bank money. An initial deposit of $100 of central bank money is lent out 10 times with a fractional-reserve rate of 20%. This means that of the initial $100, 20 percent of it, or $20, is set aside as reserves while the remaining 80 percent, or $80, is loaned out. The recipient of the $80 then spends that money. The receiver of that $80 then deposits it into a bank. The bank then sets aside 20 percent of that $80, or $16, as reserves and lends out the remaining $64. As the process continues, more commercial bank money is created. To simplify the table, a different bank is used for each deposit. In the real world, the money a bank lends may end up in the same bank so it then has more money to lend out.
Table:[8] Fractional-Reserve Lending Cycled 10 times with a 20 percent reserve rate (sources: The Principle of Multiple Deposit Creation[9], Federal Reserve Bank of New York[10], Bank for International Settlements[5]) | ||||
---|---|---|---|---|
individual bank | amount deposited | amount lent out | reserves | |
A | 100 | 80 | 20 | |
B | 80 | 64 | 16 | |
C | 64 | 51.20 | 12.80 | |
D | 51.20 | 40.96 | 10.24 | |
E | 40.96 | 32.77 | 8.19 | |
F | 32.77 | 26.21 | 6.55 | |
G | 26.21 | 20.97 | 5.24 | |
H | 20.97 | 16.78 | 4.19 | |
I | 16.78 | 13.42 | 3.36 | |
J | 13.42 | 10.74 | 2.68 | |
K | 10.74 | |||
total reserves: | ||||
89.26 | ||||
total amount deposited: | total amount lent out: | total reserves + last amount deposited: | ||
457.05 | 357.05 | 100 | ||
commercial bank money created + central bank money: | commercial bank money created: | central bank money: | ||
457.05 | 357.05 | 100 |
Although no new money was physically created in addition to the initial $100 deposit, new commercial bank money is created through loans. The 2 boxes marked in red show the location of the original $100 deposit throughout the entire process. The total reserves plus the last deposit (or last loan, whichever is last) will always equal the original amount, which in this case is $100. As this process continues, more commercial bank money is created. The amounts in each step decrease towards a limit. If a graph is made showing the accumulation of deposits, one can see that the graph is curved and approaches a limit. This limit is the maximum amount of money that can be created with a given reserve rate. When the reserve rate is 20%, as in the example above, the maximum amount of total deposits that can be created is $500 and the maximum amount of commercial bank money that can be created is $400.
For an individual bank, the deposit is considered a liability whereas the loan it gives out and the reserves are considered assets. The deposit will always be equal to the loan plus the reserve, since the loan and reserve are created from the deposit. This is the basis for a bank's balance sheet.
The creation and destruction of commercial bank money occurs through this process. Whether it is created or destroyed depends on what direction the process moves. When loans are given out, the process moves from the top down and money is created. When loans are paid back, the process moves from the bottom to the top and commercial bank money is canceled out, effectively erasing it from existence.
The reserves are not allowed to be used to fund any more loans. The reserves cannot be spent until the loan they back up is paid back. If someone defaults on a loan, the reserves have to remain as reserves until the bank can come up with money to cancel the commercial bank money created by the loan.[citation needed]
This table gives an outline of the makeup of money supplies worldwide. Most of the money in any given money supply consists of commercial bank money[5]. The value of commercial bank money comes from the fact that it can be exchanged at a bank for central bank money[5][6].
This is a general outline of how it works. The actual increase in the money supply through this process may be lower, as (at each step) banks may choose to hold reserves in excess of the statutory minimum, borrowers may let some funds sit idle, and some borrowers may choose to hold cash, and there may be delays or frictions in the process.[11] It may also be higher if the reserve requirement is lower or if there are no reserve requirements[12]. Government regulations may also be used to limit the money creation process by preventing banks from giving out loans even though the reserve requirements have been fulfilled[13].
Money multiplier
![](http://upload.wikimedia.org/wikipedia/commons/thumb/4/42/Fractional_reserve_lending_varyingrates_100base.jpg/360px-Fractional_reserve_lending_varyingrates_100base.jpg)
The most common mechanism used to measure this increase in the money supply is typically called the money multiplier. It calculates the maximum amount of money that an initial deposit can be expanded to with a given reserve ratio.
Formula
The money multiplier, m, is the inverse of the reserve requirement, R[14]:
Example
For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as a fraction:
So then the money multiplier, m, will be calculated as:
This number is multiplied by the initial deposit to show the maximum amount of money it can be expanded to.
Reserve requirements
The reserve requirements are intended to prevent banks from:
- generating too much money by making too many loans against the narrow money deposit base;
- having a shortage of cash when large deposits are withdrawn (although the reserve is a legal minimum, it is understood that in a crisis or bank run, reserves may be made available on a temporary basis).
The money creation process is affected by the currency drain ratio (the propensity of the public to hold banknotes rather than deposit them with a commercial bank), and the safety reserve ratio (excess reserves beyond the legal requirement that commercial banks voluntarily hold—usually a small amount). Data for "excess" reserves and vault cash are published regularly by the Federal Reserve in the United States.[15] In practice, the actual money multiplier varies over time, and may be substantially lower than the theoretical maximum.[16]
Financial ratios
In addition to reserve requirements, there are other financial ratios affect how many loans a bank can fund. The capital ratio is one type of ratio. It is also important to note that the term 'reserves' in the reserve ratio generally does not include all liquid assets.[citation needed]
Money supplies around the world
Fractional-reserve banking forms the basis for several money supplies around the world such as the U.S. dollar money supply and the euro supply of the European Union. The amount of central bank money (currency) in the official money supply statistics is much lower than the total money supply because these are fractional-reserve banking systems. Most of the money in these systems is commercial bank money.
![](http://upload.wikimedia.org/wikipedia/commons/thumb/9/95/Components_of_the_United_States_money_supply2.svg/350px-Components_of_the_United_States_money_supply2.svg.png)
![](http://upload.wikimedia.org/wikipedia/commons/thumb/d/d0/Euro_money_supply_Sept_1998_-_Oct_2007.jpg/360px-Euro_money_supply_Sept_1998_-_Oct_2007.jpg)
Limitations for loan creation
The amount of loans that can be given out and thus the amount of commercial bank money that can be created depends on what the bank is permitted to do. In a free banking system, the demand for loans is contingent on the interest rates which are fixed by the lenders who compete against each other. In regulated systems, governments have created central banks that influence interest rates and thus the money supply through the monetary transmission mechanism.
Free banking
Free banking is a theory of banking in which commercial banks and market forces control the provision of banking services. Under free banking, government central banks and currency boards do not exist, and banking-specific government regulations are either non-existent or not as strict. This system is based on the belief that free markets will properly determine how many loans will be given out. Banks are not bailed out or backed by the government and deposits are not insured by the government. It is believed that this will motivate both the depositors and the bankers to be careful about where money is loaned.
Government regulated systems
Fractional-reserve banking is the basis for many financial systems throughout the world. Because the nature of fractional-reserve banking involves the possibility of bank runs, central banks have been created throughout the world to address these problems.[17][3]
Central banks
Government controls and bank regulations related to fractional-reserve banking have generally been to impose restrictive requirements on note issue and deposit taking on the one hand, and to provide relief from bankruptcy and creditor claims, and/or protect creditors with government funds, when banks defaulted on the other hand. Such measures have included:
- Minimum required reserve ratios (RRRs)
- Minimum capital ratios
- Government bond deposit requirements for note issue
- 100% Marginal Reserve requirements for note issue, such as the Peels Act 1844 (UK)
- Sanction on bank defaults and protection from creditors for many months or even years, and
- Central bank support for distressed banks, and government guarantee funds for notes and deposits, both to counteract bank runs and to protect bank creditors.
Use of money multiplier
The use of the money multiplier as a tool of monetary policy is declining, as the money multiplier has changed over time and can usually not be directly influenced by central banks: privately owned banks may have different target levels of liquidity and may not be able to control directly the level of deposits attracted or feasible lending opportunities.[18]
Liquidity and capital management for a bank
To avoid defaulting on its obligations, the bank must maintain a minimal reserve ratio that it fixes in accordance with, notably, regulations and its liabilities. In practice this means that the bank sets a reserve ratio target and responds when the actual ratio falls below the target. Such response can be, for instance:
- Selling or redeeming other assets, or securitization of illiquid assets,
- Restricting investment in new loans,
- Borrowing funds (whether repayable on demand or at a fixed maturity),
- Issuing additional capital instruments, or
- Reducing dividends.
Because different funding options have different costs, and differ in reliability, banks maintain a stock of low cost and reliable sources of liquidity such as:
- Demand deposits with other banks
- High quality marketable debt securities
- Committed lines of credit with other banks
As with reserves, other sources of liquidity are managed with targets.
The ability of the bank to borrow money reliably and economically is crucial, which is why confidence in the bank's creditworthiness is important to its liquidity. This means that the bank needs to maintain adequate capitalisation and to effectively control its exposures to risk in order to continue its operations. If creditors doubt the bank's assets are worth more than its liabilities, all demand creditors have an incentive to demand payment immediately, a situation known as a run on the bank.
Contemporary bank management methods for liquidity are based on maturity analysis of all the bank's assets and liabilities (off balance sheet exposures may also be included). Assets and liabilities are put into residual contractual maturity buckets such as 'on demand', 'less than 1 month', '2-3 months' etc. These residual contractual maturities may be adjusted to account for expected counter party behaviour such as early loan repayments due to borrowers refinancing and expected renewals of term deposits to give forecast cash flows. This analysis highlights any large future net outflows of cash and enables the bank to respond before they occur. Scenario analysis may also be conducted, depicting scenarios including stress scenarios such as a bank-specific crisis.
Example of a bank balance sheet and financial ratios
An example of fractional reserve banking, and the calculation of the reserve ratio is shown in the balance sheet below:
Example 2: ANZ National Bank Limited Balance Sheet as at 30 September 2007[citation needed] | |||
---|---|---|---|
ASSETS | NZ$m | LIABILITIES | NZ$m |
Cash | 201 | Demand Deposits | 25482 |
Balance with Central Bank | 2809 | Term Deposits and other borrowings | 35231 |
Other Liquid Assets | 1797 | Due to Other Financial Institutions | 3170 |
Due from other Financial Institutions | 3563 | Derivative financial instruments | 4924 |
Trading Securities | 1887 | Payables and other liabilities | 1351 |
Derivative financial instruments | 4771 | Provisions | 165 |
Available for sale assets | 48 | Bonds and Notes | 14607 |
Net loans and advances | 87878 | Related Party Funding | 2775 |
Shares in controlled entities | 206 | [subordinated] Loan Capital | 2062 |
Current Tax Assets | 112 | Total Liabilities | 99084 |
Other assets | 1045 | Share Capital | 5943 |
Deferred Tax Assets | 11 | [revaluation] Reserves | 83 |
Premises and Equipment | 232 | Retained profits | 2667 |
Goodwill and other intangibles | 3297 | Total Equity | 8703 |
Total Assets | 107787 | Total Liabilities plus Net Worth | 107787 |
In this example the (legal tender) cash held by the bank is $201m and the demand liabilities of the bank are $25482m, for a (legal tender) cash reserve ratio of 0.79%.
Other financial ratios
The key financial ratio used to analyse fractional-reserve banks is the cash reserve ratio, which is the ratio of cash reserves to demand deposits and notes. However, other important financial ratios are also used to analyse the bank's liquidity, financial strength, profitability etc.
For example the ANZ National Bank Limited balance sheet above gives the following financial ratios:
- The (legal tender) cash reserve ratio is $201m/$25482m, i.e. 0.79%.
- The central bank notes/balances reserve ratio is $3010m/$25482m, i.e. 11.81%.
- The liquid assets reserve ratio is ($201m+$2809m+$1797m)/$25482m, i.e. 18.86%.
- The equity capital ratio is $8703m/107787m, i.e. 8.07%.
- The tangible equity ratio is ($8703m-$3227m)/10787m, i.e. 5.08%
- The total capital ratio is ($8703m+$2062m)/$10787m, i.e. 9.98%.
Clearly, then, it is very important how the term 'reserves' is defined for calculating the reserve ratio, and different definitions give different results. Other important financial ratios may require analysis of disclosures in other parts of the bank's financial statements. In particular, for liquidity risk, disclosures are incorporated into a note to the financial statements that provides maturity analysis of the bank's assets and liabilities and an explanation of how the bank manages its liquidity.
How the example bank manages its liquidity
The ANZ National Bank Limited explains its methods as:[citation needed]
Liquidity risk is the risk that the Banking Group will encounter difficulties in meeting commitments associated with its financial liabilities, e.g. overnight deposits, current accounts, and maturing deposits; and future commitments e.g. loan draw-downs and guarantees. The Banking Group manages its exposure to liquidity risk by maintaining sufficient liquid funds to meet its commitments based on historical and forecast cash flow requirements.
The following maturity analysis of assets and liabilities has been prepared on the basis of the remaining period to contractual maturity as at the balance date. The majority of longer term loans and advances are housing loans, which are likely to be repaid earlier than their contractual terms. Deposits include substantial customer deposits that are repayable on demand. However, historical experience has shown such balances provide a stable source of long term funding for the Banking Group. When managing liquidity risks, the Banking Group adjusts this contractual profile for expected customer behaviour.
Example 2: ANZ National Bank Limited Maturity Analysis of Assets and Liabilities as at 30 September 2007[citation needed] | ||||||
---|---|---|---|---|---|---|
Total carrying value | Less than 3 months | 3-12 months | 1-5 years | Beyond 5 years | No Specified Maturity | |
Assets | ||||||
Liquid Assets | 4807 | 4807 | ||||
Due from other financial institutions | 3563 | 2650 | 440 | 187 | 286 | |
Derivative Financial Instruments | 4711 | 4711 | ||||
Assets available for sale | 48 | 33 | 1 | 13 | 1 | |
Net loans and advances | 87878 | 9276 | 9906 | 24142 | 44905 | |
Other Assets | 4903 | 970 | 179 | 3754 | ||
Total Assets | 107787 | 18394 | 10922 | 25013 | 45343 | 8115 |
Liabilities | ||||||
Due to other financial institutions | 3170 | 2356 | 405 | 32 | 377 | |
Deposits and other borrowings | 70030 | 53059 | 14726 | 2245 | ||
Derivative financial instruments | 4932 | 4932 | ||||
Other liabilities | 1516 | 1315 | 96 | 32 | 60 | 13 |
Bonds and notes | 14607 | 672 | 4341 | 9594 | ||
Related party funding | 2275 | 2275 | ||||
Loan capital | 2062 | 100 | 1653 | 309 | ||
Total liabilities | 99084 | 60177 | 19668 | 13556 | 746 | 4937 |
Net liquidity gap | 8703 | (41783) | (8746) | 11457 | 44597 | 3178 |
Net liquidity gap - cumulative | 8703 | (41783) | (50529) | (39072) | 5525 | 8703 |
Criticism
Although fractional-reserve banking is near universal, it is not without criticism. The primary criticisms relate to the financial risk note holders and depositors bear, and the impact bank notes and demand deposits have on the stock of money, and potentially its value (that is, the effect on inflation and the exchange rate). One proposed alternative to fractional reserve banking is full-reserve banking. This is advocated by some monetary reformers in concert with the introduction of debt-free government issued fiat currency from the Treasury.[19][20]
Business cycle
Fractional-reserve banking, by expanding the money supply, implies that interest rates will be different than what they would be in a full-reserve system. Austrian School economists point to the role of the interest rate as the price of investment capital, guiding investment decisions. In their view, the "natural" (free of government influence) interest rate reflects the actual time preference of lenders and borrowers. Government control of the money supply through central banks and regulations allowing fractional-reserve banking disturbs this equilibrium such that the interest rate no longer reflects the real supply of and demand for investment capital. Austrian School economists conclude that, if the interest rate is artificially low, then the demand for loans will be higher than the actual supply of willing lenders, and if the interest rate is artificially high, the opposite situation will occur. This misinformation leads investors to misallocate capital, borrowing and investing either too much or too little in long-term projects. Periodic recessions, then, are seen as necessary "corrections" following periods of fiat credit expansion, when unprofitable investments are liquidated, freeing capital for new investment. One of the proponents of aspects of the business cycle theory, Friedrich von Hayek, was awarded the Nobel Prize in Economics[1], but the theory is not universally accepted; at least one mainstream economist, Paul Krugman, considered it unworthy of serious study.[21] A few Austrian School economists, such as Pascal Salin, also suggest that a full-reserve banking system should not be enforced and rather simply root for free banking.
Risk
In a fractional-reserve banking system, in the event of a bank run, the demand depositors and note holders would attempt to withdraw more money than the bank has in reserves, causing the bank to suffer a liquidity crisis and, ultimately, to perhaps default. In the event of a default, the bank would need to liquidate assets and the creditors of the bank would suffer a loss if the proceeds were insufficient to pay its liabilities. Since public deposits are payable on-demand, liquidation may require selling assets quickly and potentially in large enough quantities to affect the price of those assets. An otherwise solvent bank (whose assets are worth more than its liabilities) may be made insolvent by a bank run. This problem potentially exists for any corporation with debt or liabilities, but is more critical for banks as they rely upon public deposits (which may be redeemable upon demand).
Although an initial analysis of a bank run and default points to the bank's inability to liquidate or sell assets (i.e. because the fraction of assets not held in the form of liquid reserves are held in less liquid investments such as loans), a more full analysis indicates that depositors will cause a bank run only when they have a genuine fear of loss of capital, and that banks with a strong risk adjusted capital ratio should be able to liquidate assets and obtain other sources of finance to avoid default. For this reason, fractional-reserve banks have every reason to maintain their liquidity, even at the cost of selling assets at heavy discounts and obtaining finance at high cost, during a bank run (to avoid a total loss for the contributors of the bank's capital, the shareholders).
Many governments have enforced or established deposit insurance systems in order to protect depositors from the event of bank defaults and to help maintain public confidence in the fractional-reserve system.
Responses to the problem of financial risk described above include:
- Proponents of prudential regulation, such as minimum capital ratios, minimum reserve ratios, central bank or other regulatory supervision, and compulsory note and deposit insurance, (see Controls on Fractional-Reserve Banking below);
- Proponents of free banking, who believe that banking should be open to free entry and competition, and that the self-interest of debtors, creditors and shareholders should result in effective risk management; and,
- Withdrawal restrictions: some bank accounts may place a limit on daily cash withdrawals and may require a notice period for very large withdrawals. Banking laws in some countries may allow restrictions to be placed on withdrawals under certain circumstances, although these restrictions may rarely, if ever, be used;
- Opponents of fractional reserve banking who insist that notes and demand deposits be 100% reserved.
Effects of an increased money supply
Fractional reserve banking involves the issue of commercial bank money. According to the quantity theory of money, the expansion of the money supply leads to more money with the same amount of goods, which leads to inflation. Some monetarists believe that the exchange rate or purchasing power of the monetary unit is governed by the quantity of money, including demand deposits and notes, and therefore view fractional reserve banking as a potential cause of inflation. Most schools of economics recognize the link between money supply and inflation; many economists, however, consider the issue of money through the banking system as a mechanism of monetary transmission, which a central bank can influence indirectly by raising or lowering interest rates (although banking regulations may also be adjusted to influence the money supply, depending on the circumstances).
Quantity theorists may either be hostile to fractional reserve banking or supportive of minimum reserve ratios and other government controls on the quantity of money created by commercial banks. The process with which commercial banks practice fractional-reserve banking is explained at deposit creation multiplier.
Inadequate government regulation
Critics of current bank regulations argue that:
- Minimum reserve ratios put reserves beyond reach in a time of need;
- Minimum capital ratios are poor regulators of financial risk, as they ignore other portfolio risk drivers such as scale and diversification and come at a heavy compliance cost;
- Central bank support and government protection of creditors creates moral hazard and socializes credit risk.
See also
- Bimetallism
- Bretton Woods system
- Credit money
- Debt-based monetary system
- Digital gold currency
- Fiat currency
- Full-reserve banking
- Gold standard
- Islamic banking
- Money supply
- Money creation
- Monetary reform
- Seignorage
- Usury
- List of economics topics
- List of finance topics
- List of business ethics, political economy, and philosophy of business topics
References
- ^ The Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors by Jonathan Golin. Publisher: John Wiley & Sons (August 10, 2001). ISBN-10: 0471842176 ISBN-13: 978-0471842170
- ^ http://www.bankintroductions.com/definition.html
- ^ a b Reserve Bank of India - Functional Evolution of Central Banking: http://rbidocs.rbi.org.in/rbiadmin/Scripts/PublicationReportDetails.aspx?UrlPage=ReportonCurrencyandFinance&ID=454
- The monopoly power to issue currency is delegated to a central bank in full or sometimes in part. The practice regarding the currency issue is governed more by convention than by any particular theory. It is well known that the basic concept of currency evolved in order to facilitate exchange. The primitive currency note was in reality a promissory note to pay back to its bearer the original precious metals. With greater acceptability of these promissory notes, these began to move across the country and the banks that issued the promissory notes soon learnt that they could issue more receipts than the gold reserves held by them. This led to the evolution of the fractional reserve system. It also led to repeated bank failures and brought forth the need to have an independent authority to act as lender-of-the-last-resort. Even after the emergence of central banks, the concerned governments continued to decide asset backing for issue of coins and notes. The asset backing took various forms including gold coins, bullion, foreign exchange reserves and foreign securities. With the emergence of a fractional reserve system, this reserve backing (gold, currency assets, etc.) came down to a fraction of total currency put in circulation.
- ^ a b Page 57 of 'The FED today', a publication released by the united states federal reserve education website designed to educate people on the history and purpose of the united states federal reserve system. http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf
- ^ a b c d Bank for International Settlements - The Role of Central Bank Money in Payment Systems. See page 9, titled, "The coexistence of central and commercial bank monies: multiple issuers, one currency": http://www.bis.org/publ/cpss55.pdf
A quick quote in reference to the 2 different types of money is listed on page 3. It is the first sentence of the document:
- "Contemporary monetary systems are based on the mutually reinforcing roles of central bank money and commercial bank monies."
- ^ a b European Central Bank - Domestic payments in Euroland: commercial and central bank money:
http://www.ecb.int/press/key/date/2000/html/sp001109_2.en.html One quote from the article referencing the two types of money:
- "At the beginning of the 20th almost the totality of retail payments were made in central bank money. Over time, this monopoly came to be shared with commercial banks, when deposits and their transfer via checks and giros became widely accepted. Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. While transaction costs in commercial bank money were shrinking, cashless payment instruments became increasingly used, at the expense of banknotes"
- ^ Chicago Fed - Our Central Bank: http://www.chicagofed.org/consumer_information/the_fed_our_central_bank.cfm
- the reference is found in the "Money Manager" section:
- "the Fed works to control money at its source by affecting the ability of financial institutions to "create" checkbook money through loans or investments. The control lever that the Fed uses in this process is the "reserves" that banks and thrifts must hold."
- the reference is found in the "Money Manager" section:
- ^ Table created with the OpenOffice.org Calc spreadsheet program using data and information from the references listed.
- ^ Federal Reserve Education - How does the Fed Create Money? http://www.federalreserveeducation.org/fed101_html/policy/money_print.htm
- See the link to "The Principle of Multiple Deposit Creation" pdf document towards bottom of page.
- ^ An explanation of how it works from the New York Regional Reserve Bank of the US Federal Reserve system. Scroll down to the "Reserve Requirements and Money Creation" section. Here is what it says:
- "Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity."
- ^ http://books.google.com/books?id=I-49pxHxMh8C&pg=PA303&dq=deposit+reserves&lr=&sig=hMQtESrWP6IBRYiiaZgKwIoDWVk#PPA295,M1 William MacEachern, Macroeconomics: A Contemporary Introduction, p. 295
- ^ FRB: Monetary Policy, Reserve Requirements
- ^ ebook: The Federal Reserve - Purposes and Functions:http://www.federalreserve.gov/pf/pf.htm
- see pages 13 and 14 of the pdf version for information on government regulations and supervision over banks
- ^ http://www.mhhe.com/economics/mcconnell15e/graphics/mcconnell15eco/common/dothemath/moneymultiplier.html
- ^ http://www.federalreserve.gov/releases/h3/Current/ Federal Reserve Board, "AGGREGATE RESERVES OF DEPOSITORY INSTITUTIONS AND THE MONETARY BASE" (Updated weekly).
- ^ http://books.google.com/books?id=FdrbugYfKNwC&pg=PA169&lpg=PA169&dq=united+states+money+multiplier&source=web&ots=C_Hw1u82xe&sig=m7g0bMz167DijFsOCbn5f4aWAOU#PPA170,M1 Bruce Champ & Scott Freeman, Modeling Monetary Economies, p. 170 (Figure 9.1).
- ^ The Federal Reserve in Plain English - An easy-to-read guide to the structure and functions of the Federal Reserve System. See page 5 of the document for the purposes and functions: http://www.frbsf.org/publications/education/plainenglish/index.html
- ^ http://links.jstor.org/sici?sici=0022-1082(197403)29%3A1%3C57%3AMCATTO%3E2.0.CO%3B2-O Money Creation and the Theory of the Banking Firm, Richard E. Towey, The Journal of Finance, Vol. 29, No. 1 (Mar., 1974), pp. 57-72
- ^ Stephen A. Zarlenga, The Lost Science of Money AMI (2002)
- ^ The Forgotten War
- ^ http://www.slate.com/id/9593 Paul Krugman, "The Hangover Theory", Slate.com, says the Austrian Theory of the business cycle is "about as worthy of serious study as the phlogiston theory of fire".
- Huerta de Soto, J. (2006), Money, Bank Credit and Economic Cycles, Ludwig von Mises Institute
- Meigs, A.J. (1962), Free reserves and the money supply, Chicago, University of Chicago, 1962.
- Crick, W.F. (1927), The genesis of bank deposits, Economica, vol 7, 1927, pp 191-202.
- Philips, C.A. (1921), Bank Credit, New York, Macmillan, chapters 1-4, 1921,
- Thomson, P. (1956), Variations on a theme by Philips, American Economic Review vol 46, December 1956, pp. 965-970.
- Parliament of Tasmania, Monetary System, Report of Select Committee, With Minutes of Proceedings, 1935.