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Author Topic: How is the current banking system working?  (Read 1433 times)
ploum
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June 27, 2011, 01:28:32 PM
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I'm trying to get more information about how the current banking system is working.

The cash cycle is somewhat easy to figure out. Merchants bring huge quantities of cash to their bank so their are credited on their account. Banks put that cash in their ATM so when you retrieve money, it is charged on your account.

The only remaining question is what if a bank has too much cash and the other not enough. Is there a market for cash? Or is everything regulated by the central bank?

But now about the bank themselves. The money on your account is only a virtual value in some computer. When you pay someone from the same bank, nothing really happens except an addition and a soustraction in an internal database. In theory, if 10 people have an account with 1000€ in a bank, this bank has 10,000€ (we will ignore loans and debts for now).

Now, what does happen when you send money to an account which is not in the same bank?

It looks like an ACH is used. From what I understand, an ACH is mainly a bank for bank. So each bank should have an account to an ACH.

Is that right?

Who is controlling the ACH?

How can a transfer between two ACH happens?

How could it be controlled that the bank have well the money they pretend to have?

I'm a complete n00b in that field and I'm really interested to know the answers.

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hugolp
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June 27, 2011, 01:34:21 PM
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I'm trying to get more information about how the current banking system is working.

The cash cycle is somewhat easy to figure out. Merchants bring huge quantities of cash to their bank so their are credited on their account. Banks put that cash in their ATM so when you retrieve money, it is charged on your account.

The only remaining question is what if a bank has too much cash and the other not enough. Is there a market for cash? Or is everything regulated by the central bank?

Yes, its the federal funds market, and its rates are heavily influenced by the central bank. Only the banks of the Federal Reserve system and certain institutions (like Freddie and Fannie) can access this market.

Right now Bernanke has the federal fund rate at almost zero (between 0 and 0.25%). You can check their daily value here: http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm Short term the central bank uses repos to correct slight deviations of this rates, but if that is not enough it has to raise the rate or do open market operations to inject more money. Right now we are in a special situation because the banks are loaded with money (check the excess reserves) and they have no need for borrowing from the federal fund market for their operations. Right now most of the action comes from the other institutions that lend the banks the money they have around without use overnight to earn some (minimal) interest. Why do the banks borrow this money? Because they can deposit it as excess reserves and earn a 0.25% that the Federal Reserve pays them. So while this situation goes on, the federal fund rate wont go over the excess reserve interest rate that the Fed is paying the banks. Note that this is a way for the Fed to give "free money" to the banks.



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But now about the bank themselves. The money on your account is only a virtual value in some computer. When you pay someone from the same bank, nothing really happens except an addition and a soustraction in an internal database. In theory, if 10 people have an account with 1000€ in a bank, this bank has 10,000€ (we will ignore loans and debts for now).

Now, what does happen when you send money to an account which is not in the same bank?

Different countries work in different ways, but usually the banks settle their balances once a day.

Quote
It looks like an ACH is used. From what I understand, an ACH is mainly a bank for bank. So each bank should have an account to an ACH.

Is that right?

Who is controlling the ACH?

How can a transfer between two ACH happens?

How could it be controlled that the bank have well the money they pretend to have?

I'm a complete n00b in that field and I'm really interested to know the answers.

Sorry, Im not from the USA and I can not give you specifics on how exactly the banking clearing system of the USA works, but there is the wikipedia page that might help you get started: http://en.wikipedia.org/wiki/Automated_Clearing_House (according to the wikipedia is regulated, which is not a surprise at all).

Btw, there were free market clearing houses that restrained member banks from expanding the money supply. See the Suffolk bank in the USA druing the XIX century.
ploum
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June 27, 2011, 01:47:12 PM
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I'm from Europe but it seems that things similar to ACH exist in Europe too.

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hugolp
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June 27, 2011, 02:04:48 PM
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I'm from Europe but it seems that things similar to ACH exist in Europe too.

Let me guess: You are french.
ploum
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June 27, 2011, 03:33:22 PM
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I'm from Europe but it seems that things similar to ACH exist in Europe too.

Let me guess: You are french.

Not far. But missed, I'm from Belgium.

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June 27, 2011, 04:43:13 PM
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Interbank clearing is done by the ACH system in conjunction with the regional Federal Reserve banks.  Each bank has a checking account in the Federal Reserve system, and these accounts are used to transfer money from bank to bank just like we use our checking accounts to transfer money from person to person.

When I deposit a check, my bank tells ACH about it.  ACH attempts to net them out as much as possible, but periodically, it has to balance things out by instructing the local Fed to transfer some dollars from bank A's fed account to bank B's fed account.

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ploum
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June 27, 2011, 04:49:48 PM
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So it means that the money doesn't exist anywhere. It is just a number sent between accounts on the Federal Reserve.

What is still a bit unclear to me is the bootstraping. Imagine a bank that is just created. How is money sent to this bank. Then how could the same bank lend more than they have? Because what they really have is recorded in their central fed account, right?

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June 27, 2011, 04:56:27 PM
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is this a joke

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June 27, 2011, 04:57:52 PM
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So it means that the money doesn't exist anywhere. It is just a number sent between accounts on the Federal Reserve.

What is still a bit unclear to me is the bootstraping. Imagine a bank that is just created. How is money sent to this bank. Then how could the same bank lend more than they have? Because what they really have is recorded in their central fed account, right?

I believe that is where fractional reserve lending comes into play. You need only retain a fraction of your promises in lending in the central fed account, which limits the amount of promises you can make in loans (but still is multiples more than you actually have, I believe in the US you can lend 10x the amount of deposit you have?). Rarely in a loan does the bank actually give anyone cold hard cash, they merely agree to put a credit blip in the account of the borrower to put towards whatever their debt obligation is to.

The rest simply works like you described before, intrabank or interbank, most of the money doesn't exist anywhere, just credits and debits on a balance sheet.
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June 27, 2011, 05:03:19 PM
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How is money sent to this bank.

i believe the basic idea is to start with a money fond + a board of people responsible. reality might be different.
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June 27, 2011, 05:17:17 PM
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So it means that the money doesn't exist anywhere. It is just a number sent between accounts on the Federal Reserve.

Correct.

What is still a bit unclear to me is the bootstraping. Imagine a bank that is just created. How is money sent to this bank. Then how could the same bank lend more than they have? Because what they really have is recorded in their central fed account, right?

To open a chartered bank in the US principals/investors are required to put a minimum of ~$5M USD into their Fed account. The amount they have on deposit with the Fed determines how much they can loan out but it is not the exact amount they have on deposit, they can loan out 10 - 50 times more than their reserve required deposit. They cannot loan out customer saving/checking deposits.

When money is moved around through the system it is done via ACH and ledger entries, they are not moving physical cash/coins.
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June 27, 2011, 05:33:38 PM
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Oh, and physical cash and coins are purchased by the bank from the regional reserve, and I think they pay a slight premium for it, so they try to recycle as much as possible.

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marcus_of_augustus
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June 28, 2011, 01:25:03 AM
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Well basically, it doesn't work ... so the question is kind of moot.

ploum
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June 28, 2011, 07:51:06 AM
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Well basically, it doesn't work ... so the question is kind of moot.

It does a great job of making people believe that it works and allowing a few to gain lot of money.

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June 28, 2011, 08:34:28 AM
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Well basically, it doesn't work ... so the question is kind of moot.

It does a great job of making people believe that it works and allowing a few to gain lot of money.
Until recently......and it's still the safe conservative choice, If I'm responsible for a company and the jobs of the people there, I'd still have to go with it.....

But, it's now a matter of who's going to be standing in a few years and what confidence remains, and even then we have thousands of years of historical practice to break with. I'd love a deposit bank like bitcoin tho, P2P, Self regulating by design, Solid security, truly international without borders.

There may well be an opportunity there, use bitcoin as a design model, started by one centralized group that decentralizes by franchising globally, backed by physical commodities to protect the depositors store of wealth. I realize this wouldn't suit some here in their world outlook, but then again what we're looking for is mass adoption and an option where people can store their wealth with more trust then can be realized with the current banking system.
ploum
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June 28, 2011, 08:59:51 AM
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But, it's now a matter of who's going to be standing in a few years and what confidence remains, and even then we have thousands of years of historical practice to break with. I'd love a deposit bank like bitcoin tho, P2P, Self regulating by design, Solid security, truly international without borders.

There may well be an opportunity there, use bitcoin as a design model, started by one centralized group that decentralizes by franchising globally, backed by physical commodities to protect the depositors store of wealth. I realize this wouldn't suit some here in their world outlook, but then again what we're looking for is mass adoption and an option where people can store their wealth with more trust then can be realized with the current banking system.

I've finished a 10 pages paper describing exactly that. If someone wants to invest (a lot of) money in the creation of a bitcoin bank, the plan is already there :-)

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YoYa
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June 28, 2011, 11:30:10 AM
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But, it's now a matter of who's going to be standing in a few years and what confidence remains, and even then we have thousands of years of historical practice to break with. I'd love a deposit bank like bitcoin tho, P2P, Self regulating by design, Solid security, truly international without borders.

There may well be an opportunity there, use bitcoin as a design model, started by one centralized group that decentralizes by franchising globally, backed by physical commodities to protect the depositors store of wealth. I realize this wouldn't suit some here in their world outlook, but then again what we're looking for is mass adoption and an option where people can store their wealth with more trust then can be realized with the current banking system.

I've finished a 10 pages paper describing exactly that. If someone wants to invest (a lot of) money in the creation of a bitcoin bank, the plan is already there :-)
Do share Smiley
ploum
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June 29, 2011, 09:07:29 AM
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Do share Smiley

Here you are: http://forum.bitcoin.org/index.php?topic=24256

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