Fractional reserve banking is a practice in which a bank accepts deposits, makes loans or investments, but is required to hold the same reserve with only a small fraction of its deposit obligations. Reserves are held as currency in the bank, or as a balance in a bank account at the central bank. Fractional reserve banking is a form of banking currently practiced in most countries of the world.
Fractional reserve banking allows banks to act as financial intermediaries between borrowers and savers, and to provide long-term borrowing to borrowers while providing direct liquidity to depositors (providing the function of maturity transformation). However, the bank may experience the bank running if the depositor wants to attract more funds than the reserves held by the bank. To mitigate the risk of bank runs and systemic crises (when the problem is extreme and widespread), governments in most countries regulate and oversee commercial banks, provide deposit insurance and act as lenders of last resort for commercial banks.
Because banks hold reserves in smaller amounts than the amount of their deposit obligations, and since deposit liabilities are considered money in their own right, the fractional reserve banking allows the money supply to grow beyond the underlying base money originally created by the central bank. In most countries, the central bank (or other monetary authority) regulates the creation of bank credit, imposing reserve requirements and capital adequacy ratio. This can slow down the money creation process taking place in commercial banking systems, and help ensure that banks have solvents and have enough funds to meet withdrawal requests. However, rather than directly controlling the money supply, the central bank usually pursues interest rate targets to adjust the inflation rate and the issuance of bank credit.
Video Fractional-reserve banking
Histori
The fractional reserve banking precedes the existence of the government's monetary authority and derived centuries ago in the realization of bankers that in general not all depositors demand payment at the same time.
In the past, savers who wanted to keep their coins and valuables in storage kept gold and silver in goldsmiths, received in exchange for records for their deposits ( see Bank of Amsterdam ). These records gain acceptance as a medium of exchange for commercial transactions and thus become the earliest form of banknotes in circulation. Because records are used directly in the trade, goldsmiths observe that people will not normally redeem all their records at the same time, and they see an opportunity to invest their coin reserves in loans and interest charges. This generates revenue for goldsmiths but leaves them with more notes on issues than the reserves that can be used to pay them. A process begins that changes the role of goldsmiths from passive guardians of bullion, charging for safe storage, to banks that pay interest and interest. Thus the fractional reserve banking was born.
If creditors (holders of originally registered gold records) lose confidence in the ability of banks to pay their records, however, many will try to redeem their records at the same time. If, in response, the bank can not raise sufficient funds by calling for a loan or selling a bill, the bank will enter into bankruptcy or default on its record. This kind of situation is called the bank run and caused the death of many early banks.
Riksbank Sweden was the world's first central bank, formed in 1668. Many countries followed in the late 1600s to establish a law-enforced central bank to set reserve requirements, and to determine the form in which the asset (called the monetary base) must be held. To mitigate the impact of bank failures and financial crises, the central bank is also authorized to centralize the bank's precious metal reserves, thereby facilitating the transfer of gold in terms of bank runs, to regulating commercial banks, imposing reserve requirements, and acting as lender-of-last- resort if any bank faces bank runs. The emergence of central banks reduces the risk of bank runs attached to bank deposits, and it allows the practice to continue as it does today.
During the 20th century, the role of the central bank grew including influencing or managing various macroeconomic policy variables, including measures of inflation, unemployment, and international balance of payments. In the process of enacting the policy, the central bank from time to time seeks to manage interest rates, reserve requirements, and various measures of money supply and monetary base.
Maps Fractional-reserve banking
The regulatory framework
In most legal systems, bank deposits are not a guarantee. In other words, the funds deposited no longer belong to the customer. The funds belong to the bank, and the customer in turn receives an asset called a deposit account (check or savings account). The deposit account is the obligation of in the bank balance. Each bank is legally authorized to issue credits up to a certain multiple of its reserves, so that the available reserves to fulfill the payment of the deposit obligation are less than the total amount required to be paid by the bank in the demand deposit satisfaction.
Fractional bank deposits usually work smoothly. Relatively few depositors are asking for payment at a certain time, and banks maintain a reserve buffer to cover the withdrawal of depositors' money and other requests for funds. However, as long as the bank runs or general financial crisis, the demand for withdrawal may exceed the bank's fund buffer, and the bank will be forced to raise additional reserves to avoid default on its obligations. The bank can raise funds from additional loans (for example, by borrowing on the interbank loan market or from the central bank), by selling assets, or by calling in short-term loans. If creditors are afraid of banks running out of reserves or going bankrupt, they have an incentive to redeem their deposits as soon as possible before other depositors access the remaining reserves. So, the fear of the bank could really trigger a crisis.
Many contemporary banking and central banking regulatory practices, including centralized clearing payments, central bank lending to member banks, regulatory audits, and government-managed savings, are designed to prevent such bank operations from occurring.
Economic function
Banking fractional reserves allow banks to create credit in the form of bank deposits, which represent direct liquidity to depositors. The banks also provide long-term loans to the borrower, and act as financial intermediaries for the fund. Less liquid forms of deposit (such as time deposits) or risky classes of financial assets (such as long-term equity or bonds) can lock in depositors' assets for a period of time, making them unavailable for on-demand use. The "short-term borrowing, long-term borrowing" loan function, or the maturity of this fractional reserve banking is a role many economists regard as an important function of the commercial banking system.
In addition, according to macroeconomic theory, a well-regulated fractional reserve bank system is also beneficial to the economy by providing regulators with powerful tools to influence the money supply and interest rates. Many economists believe that this should be tailored by the government to promote macroeconomic stability.
The reserve-splinter process of banking expands the money supply from the economy but also increases the risk that banks can not meet the withdrawal of depositors. The modern central bank allows banks to practice bank deposits with interbank business transactions with reduced bankrupt risk.
Money type
There are two types of money in a reserve-fractional banking system that operates with the central bank:
- Central bank money: money made or adopted by the central bank irrespective of the form - precious metals, commodity certificates, banknotes, coins, electronic money lent to commercial banks, or what even other central banks choose as a form of money.
- Commercial bank money: Current accounts in the commercial banking system; also referred to as "money checkbooks", "sight deposits" or simply "credits".
When deposits of central bank money are made in commercial banks, central bank money is removed from circulation and added to commercial bank reserves (no longer counted as part of M1 money supply). At the same time, the same amount of commercial bank money is made in the form of bank deposits.
Money-making process
At least one textbook states that when a loan is made by a commercial bank, the bank holds only a fraction of the central bank's money as a reserve and the money supply increases with the size of the loan. This process is called "multiplication of deposit". However, as described below, bank loans are rarely made this way.
The results of most bank loans are not in the form of currency. Banks typically make loans by receiving promissory notes in exchange for the credit they make to the borrower's deposit account. Deposits made in this way are sometimes called derivative deposits and are part of the process of creating money by commercial banks. Issuing loan proceeds in paper and coin form is currently regarded as a weakness in internal control.
The process of creating money is also influenced by the ratio of currency drainage (the tendency of people to hold paper money rather than to store it in commercial banks), and the ratio of safety reserves (excess reserves beyond the legal requirements that are voluntarily held by commercial banks - usually a small fraction). Data for "excessive" reserves and cash domes are published regularly by the Federal Reserve in the United States.
Money multiplier
The money multiplier is a heuristic used to denote the maximum amount of money that a commercial bank can make for a certain fixed sum of base money and reserve ratio. This theoretical maximum is never reached, as some qualified reserves are held as cash outside the bank. Instead of holding a fixed base amount of money, the central bank has recently pursued an interest rate target to control the issuance of bank credit indirectly so that the ceiling implied by money multipliers does not impose a limit on the creation of money in practice.
Formula
Pengganda uang, m , adalah kebalikan dari persyaratan cadangan, R :
- Contoh
Misalnya, dengan rasio cadangan 20 persen, rasio cadangan ini, R , juga dapat dinyatakan sebagai pecahan:
Jadi, pengganda uang, m , akan dihitung sebagai:
Persediaan uang di seluruh dunia
In countries where banking fractional reserves are prevalent, commercial bank money usually forms the bulk of the money supply. The acceptance and monetary value of commercial banks is based on the fact that it can be exchanged freely in commercial banks for central bank money.
The increase in the money supply actually through this process may be lower, because (at every step) the bank may choose to hold reserves beyond the minimum threshold, the borrower may leave some funds idle, and some community members may choose to withhold cash, and there may also be a delay or friction in the lending process. Government regulations can also be used to restrict the process of creating money by preventing banks from lending even though reserve requirements have been met.
Rule
Due to the nature of fractional reserve banking involving the possibility of bank runs, the central bank has been created around the world to address this issue.
Central banks
Government controls and bank regulations related to fractional reserve banking have generally been used to enforce restrictive requirements on record and deposit-taking issues on the one hand, and to provide assistance from bankruptcy and creditor claims, and/or protect creditors with government funds, when the bank failed on the other. These steps include:
- The minimum mandatory reserve rate (RRR)
- Minimum capital ratio
- Government bonds deposit requirement for note issues
- 100% Marginal Reserve requirements for record issues, such as the Charter Bank Act 1844 (UK)
- Sanctions against bank defaults and protection from creditors for months or even years, and
- Support the central bank for the depressed banks, and government guarantee funds for records and deposits, both to ward off bank runs and to protect bank creditors.
Backup requirements
The prevailing view of current reserve requirements is that they are intended to prevent banks from:
- make too much money by making too many loans against a narrow deposit base;
- has a cash shortage when a large deposit is withdrawn (although reserves are considered legal minimum, it can be understood that in a crisis or bank runs, reserves may be provided temporarily).
In some jurisdictions, (such as the United States and the European Union), the central bank does not require reserves to be held during the day. The reserve requirement is intended to ensure that the bank has a sufficient supply of highly liquid assets, so the system operates regularly and maintains public confidence.
In addition to reserve requirements, there are other necessary financial ratios that affect the amount of loans that can be financed by the bank. The capital requirement ratio is probably the most important of these other required ratios. When there is no mandatory reserve requirement, which is considered by some economists to limit lending, the ratio of capital requirements acts to prevent unlimited bank lending amounts.
Liquidity and capital management for banks
To avoid default on its obligations, the bank must maintain a minimum reserve ratio fixed in accordance with, in particular, its rules and obligations. In practice this means that the bank sets the reserve ratio target and responds when the actual ratio falls below the target. The response can be, for example:
- Sell or redeem other assets, or securitize any illiquid assets,
- Limit your investment in new loans,
- Borrow funds (either paid on demand or on fixed due dates),
- Issuing additional capital instruments, or
- Reduce dividends.
Because different financing options have different costs, and differ in reliability, banks have a low-cost and reliable source of liquidity such as:
- Saving request with another bank
- High-quality debt securities
- Line of credit is committed to another bank
As with reserves, other sources of liquidity are managed on target.
The bank's ability to borrow money reliably and economically is very important, which is why trust in bank credit worthiness is important for its liquidity. This means that the bank needs to maintain adequate capitalization and effectively control its exposure to risk to continue its operations. If the creditor doubts the bank's assets is worth more than its liabilities, all creditors demand an incentive to demand immediate payments, leading to the occurrence of a bank.
The method of contemporary bank management for liquidity is based on the maturity analysis of all bank assets and liabilities (off balance sheet exposure may also be included). Assets and liabilities are included in the remainder of the contract as 'on demand', 'less than 1 month', '2-3 months' etc. These residual contractual periods can be adjusted to account for expected oppositional behavior such as early repayment loans due to refinancing borrowers and expected renewals of time deposits to provide cash flow forecasts. This analysis highlights future large net cash outflows and allows banks to respond before they occur. Scenario analysis can also be done, which illustrates scenarios including stress scenarios such as bank-specific crises.
Hypothetical examples of bank balance sheets and financial ratios
Examples of fractional backup banks, and "reserve ratio" calculations are shown in the balance sheet below:
In this example, the cash reserve held by the bank is NZ $ 3.010m (NZ $ 201m Balance NZ $ 2,809m Balance at the Central Bank) and Giro (liabilities) from the bank is NZ $ 25.482 m, for a cash reserve ratio of 11.81%
Other financial ratios
The main financial ratios used to analyze fractional reserve banks are the cash reserves ratio, which is the ratio of cash reserves to demand deposits. However, other important financial ratios are also used to analyze bank liquidity, financial strength, profitability, etc.
For example, ANZ National Bank Limited's balance sheet above provides the following financial ratios:
- The cash reserve ratio is $ 3.010m/$ 25.482m, which is 11.81%.
- The ratio of liquid asset reserves is ($ 201m $ 2.809m $ 1.797m)/$ 25.482m, ie 18.86%.
- The equity capital ratio is $ 8.703m/107,787m, which is 8.07%.
- The tangible equity ratio is ($ 8.703m - $ 3.297m)/107,787m, ie 5.02%
- The total capital ratio is ($ 8.703m $ 2.062m)/$ 107,787m, ie 9.99%.
It is important how the term 'backup' is defined to calculate the reserve ratio, because different definitions give different results. Other important financial ratios may require disclosure analysis in other parts of the bank's financial statements. Specifically, for liquidity risk, disclosures are included in the notes to the financial statements that provide an analysis of the maturity of bank assets and liabilities and an explanation of how the bank manages its liquidity.
Criticism
Critics of monetary system textbook description
A paper published in the Quarterly Bulletin of the Bank of England states, "Although money multiplier theories can be a useful way to introduce money and banking in economics textbooks, this is not an accurate description of how money is created in reality."
Glenn Stevens, governor of the Reserve Bank of Australia, said of the "money multiplier", "most practitioners consider it a very unsatisfactory description of how the monetary and credit system works."
Lord Adair Turner, formerly head of the UK's financial regulator, said "Banks do not, because too many textbooks still advise, take deposits of existing money from savers and lend it to borrowers: they create credit and money ex nihilo - extend loans to borrowers and simultaneously credit borrower's money account ".
Former Deputy Governor of Bank of Canada William White said "Several decades ago, academic literature would emphasize the importance of reserves provided by the central bank to the banking system, and its implications (through money multipliers) for money and credit growth. no industrialized country does policy in this way under normal circumstances. "
Criticism on the basis of instability
In 1935, economist Irving Fisher proposed a 100% reserve banking system as a means to reverse deflation in the Great Depression. He writes: "100 percent banking... will give the Federal Reserve absolute control over the money supply.Remember that under the current fractional reserve system, the money supply is determined in the short term by such non-policies.variables as currency ratios/public deposits and excess reserve ratio of the depository institutions. "
Criticism on the basis of legitimacy
Austrian School economists such as JesÃÆ'ºs Huerta de Soto and Murray Rothbard also criticized the fractional reserve banking, called for it to be banned and criminalized. According to them, it is not just the creation of money that causes macroeconomic instability (based on Austrian Business Cycle Theory), but this is a form of embezzlement or financial fraud, which is legalized only by the influence of powerful wealthy bankers against corrupt governments around the world. Politician Ron Paul also criticized the fractional reserve banking based on the arguments of the Austrian School.
See also
Note
References
Further reading
- Crick, W.F. (1927), Origin of bank deposits, Economica , vol. 7, 1927, pp 191-202.
- Friedman, Milton (1960), Program for Monetary Stability , New York, Fordham University Press.
- Meigs, A.J. (1962), Free Reserves and Money Supply , Chicago, University of Chicago, 1962.
- Paul, Ron (2009). "2 The Origin and Nature of the Fed". End the Fed . New York: Grand Central Publishing. ISBN: 978-0-446-54919-6.
- Philips, C.A. (1921), Bank Credit , New York, Macmillan, chapters 1-4, 1921,
- Thomson, P. (1956), Variations of themes by Philips, American Economic Review vol 46, December 1956, p. 965-970.
External links
- The creation of money in the modern economy of the Bank of England
- Rule D of the US Federal Reserve Board.
- Bank for International Settlement - The Role of Central Bank Money in the Payment System
Source of the article : Wikipedia
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