Why do we need private banks at all? | 133 comments (133 topical, editorial, 0 hidden)

Re: Why do we need private banks at all? (none / 0)

Why in the world would anyone go into such a business?

Well, for one I am not certain that I did get more in interest last year then they nicked in fees, but anyhow there are a couple of possible reasons:

That the government demands it for access to the lucrative borrow from central bank and lend to customers business.
That borrowing from customers is cheaper then borrowing form the central bank when it comes to liquidity demands of the government.
That it brings customers in.

On the third, I do have an account with the bank of my local supermarket chain that did pay interest and have no fees. But then again once I have put money in that bank I am probably more likely to shop at their stores anyway. And with a banking license they can fund their own loans from their own bank, even though they do not appear to lend to anyone else.

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by A swedish kind of death on Wed Feb 29th, 2012 at 04:14:45 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

1. and 3. are correct. 2. is correct under normal circumstances, but since the Global Financial Clusterfuck there are plenty of deposits being advertised by banks which pay more than the central bank demands for its lending.

The difference is that central bank lending to banks is collateralised quite stringently, whereas customer deposits are not collateralised. In fact, they are guaranteed by the government and the cost to banks of taking part in deposit insurance schemes is rather low.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 06:00:47 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

2. <- is the issue under discussion.

by rootless2 on Wed Feb 29th, 2012 at 08:15:45 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

You need to view this in terms of opportunity costs.

If the bank lends you money, the opportunity cost of that money is the Fed funds rate. This, along with legal limits on how much lending it may pile on top of its equity, is the operational constraint on bank lending. This is irrespective of the rate it pays on deposits, or the volume of deposits.

Yes, it can use deposits to defray that expense, if it can obtain them at less than the Fed funds rate. But if it can obtain deposits at less than the Fed funds rate, it could also just place them in the interbank market or at the discount window to make the Fed funds rate on them. If the bank made no loans at all, it would still be trying to attract those deposits. And if the bank had no depositors, it would not alter one whit the quantity or interest rate of its lending.

OK, in Goldman's case this is not true. Goldman doesn't take deposits because of a business case for taking deposits. Goldman takes deposits so it can hold them hostage if the federal government decides that Goldman needs to go away. But Goldman is special.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 09:14:17 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

Discuss: Government bids to bring halt to banks' deposit war (13 April 2011)

Much to the displeasure of the Bank of Spain, the sector has been engaging in a deposit war now for several months in order to improve liquidity after the debt crisis in the euro zone cut off traditional wholesale funding sources for many lenders.
Some banks are offering annual deposit rates of 4 percent, thereby, narrowing their margins and restricting their ability to lend. The practice also ends up increasing the borrowing costs of households and companies.
The decree move follows repeated calls by the central bank to put an end to what it feels is a self-defeating practice.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:24:50 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

So why do they need "liquidity" if they can just create money as needed?

What does the bank get out of having that cash there?

by rootless2 on Wed Feb 29th, 2012 at 10:42:21 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

Only the central bank can create money as needed.

The other banks can only create the money they lend. When they have to make an actual payment to another bank, they need actual money (i.e., liquidity).

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 10:47:49 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

But previously, you said that what the bank does with my deposit is

"It holds it as custodian and pays interest on it."

So now it is used for interbank payments too?

by rootless2 on Wed Feb 29th, 2012 at 11:13:16 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

The other banks can only create the money they lend. .

Not so, they create money when they spend as well, except that this spent money becomes the object of an (undated) demand deposit in the recipient's current account.

What happens with the (dated) loan is that the money is created, deposited and then instantaneously lent via what is essentially a repo of virtual (fiat 'look-alike') cash.

I find it useful to distinguish between dated and undated deposits.

Banks must always balance - in aggregate - dated (term-even overnight) deposits and dated (loan) assets.

Undated demand deposits (reserves) which are held by banks at the Central Bank are reflected in the balance sheet by:

(a) the (undated) ownership claim of the banks equity capital; and

(b) the (undated) claim of demand depositors in respect of their current account balances.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Feb 29th, 2012 at 11:59:58 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

The central bank pays them interest on the pile of cash. Or the Treasury does, if the CB enforces its target rate by open market operations. Comes to the same thing, though, unless your central bank believes that Treasury notes have cooties, like the ECB does.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 10:53:34 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

So your theory is that they borrow from depositors at 4% and lend to the reserve bank at 1% (actually less).

No wonder they are in trouble.

by rootless2 on Wed Feb 29th, 2012 at 11:01:20 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

No, they borrow (uncollateralised) from depositors at 4% and borrow (collateralised) from the central bank at 1%.

They lend to each other, and to customers, at whatever the respective markets will bear.

And it's not my theory. It is a fact Competition for deposits in 2010-11 got insane and they were offering up to 4% for demand deposits (not time deposits!) which did squeeze margins as they were not increasing what they were charging for their lending in a commensurate way. And so the Central Bank got worried, especially as competition for deposits is a zero-sum game among banks and does not improve the overall health of the banking system.

However, what deposits (as liabilities) do is allow banks to book cash as assets. At a minimum they can park this cash as central bank reserves making a measly 0.25%. And, as assets, central bank reserves and cash don't count as risk weighted assets and therefore don't count in capital adequacy requirements (i.e., they don't imply regulatory or market needs for additional equity) whereas a loan which may collect 7% or upwards as interest income is a risky asset which does count as risk-weighted assets for capital adequacy purposes and does lead to additional equity requirements.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:12:16 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

I must be dumb indeed, because here's what I understand Jake to be saying:

the banks borrow from customers at 4%
the banks deposit that money in the central bank at nearly zero interest.

That would make no sense.

At a minimum they can park this cash as central bank reserves making a measly 0.25%. And, as assets, central bank reserves and cash don't count as risk weighted assets and therefore don't count in capital adequacy requirements

So they put some of it in the central bank, which increases their cash asset base which allows them to lend and buy more profitable assets - in theory. But suddenly, the deposit taking doesn't seem like a service business, it seems like a vital part of bank capital management. In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!

To me you are taking a true observation: that with access to central bank reserves and fancy accounting, bank lending is not constrained to be a fraction of deposits, and then extending it over the cliff as an argument that deposits don't have any effect on bank lending capability - something you contradict in the quoted sentence above.

by rootless2 on Wed Feb 29th, 2012 at 11:21:06 AM EST
[ Parent ]

Re: Why do we need private banks at all? (4.00 / 2)

Look, before the Global Financial Clusterfuck it was a perfectly viable banking model to fund your lending by borrowing in the interbank market instead of and in preference to deposit-taking.

Then the interbank maket seized and it took with it Northern Rock and Lehman Brothers.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:25:34 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

I agree with that, sort of, before the crisis one would read all sorts of snotty comments about the business of retail banking which was so passe and boring. BUT before the boom deposits were the prized and since the bust, suddenly all those juicy deposits look valuable again. They are NOT a service business but a much sought after source of cash which banks obtain at a low rate because of the government subsidy in form of the guarantee. My argument is that there is little public gain in the resulting complex system and guaranteed deposits could simply be provided for by a postal bank or flexible treasury bond system.

by rootless2 on Wed Feb 29th, 2012 at 11:43:48 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

Your conclusion - that the depository function could be handled by a postal bank, or direct participation by the CB - is true.

Everything leading up to it is false, and it won't have the effect on the financial system you think it will. But it's still a good idea for other reasons.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:05:17 PM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

I think the reason deposits are wanted now - and even more so a year or so ago - is that we are living through a continous financial crisis.

US embassy cables: Mervyn King says in March 2008 bailout fund needed | Business | guardian.co.uk

The problem is now not liquidity in the system but rather a question of systemic solvency, Bank of England (BOE) Governor Mervyn King said at a lunch meeting with Treasury Deputy Secretary Robert Kimmitt and Ambassador Tuttle. King said there are two imperatives. First to find ways for banks to avoid the stigma of selling unwanted paper at distressed prices or going to a central bank for assistance.

I understand this to mean that banking as a whole since 2008 is in permanent crisis. This causing stuff like temporarily panics for deposits to short-term meet requirements that would otherwise send them into receivership or to government help centrals.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Feb 29th, 2012 at 02:17:37 PM EST
[ Parent ]

Re: Why do we need private banks at all? (4.00 / 2)

I think the reason deposits are wanted now - and even more so a year or so ago - is that we are living through a continous financial crisis.

We're in a liquidity crisis and banks want to be in an all-cash asset position.

This is what the ECB's LTRO is about: allowing banks to get into an all-cash position for up to 3 years to weather the coming storm. Draghi to banks: winter is coming and it's going to last at least a year.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 04:59:09 PM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

I must be dumb indeed, because here's what I understand Jake to be saying:

the banks borrow from customers at 4%

the banks deposit that money in the central bank at nearly zero interest.

That would make no sense.

If you can find a bank that'll pay you 4 % on a demand deposit, you should run away very fast because they're most likely desperately papering over their insolvency.

But suddenly, the deposit taking doesn't seem like a service business, it seems like a vital part of bank capital management.

"Large" != "vital."

In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!

Not so.

Having extended a loan, they must obtain some cash reserves. They can always do this (so long as they are solvent and the central bank defends a policy rate) by rediscounting the loan with the central bank.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:29:53 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!
Not so.
Having extended a loan, they must obtain some cash reserves. They can always do this (so long as they are solvent and the central bank defends a policy rate) by rediscounting the loan with the central bank.

ECB: 8 December 2011 - ECB announces measures to support bank lending and money market activity

The NCBs are allowed, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use. Details of the criteria for the use of credit claims will be announced in due course.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:32:08 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

It's very easy to find a bank offering 4% on short fixed term deposits - I simply look up the article migeru linked to 3 comments above.

by rootless2 on Wed Feb 29th, 2012 at 11:46:24 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

No, not any more. But it was possible a year ago.

And, again, your point is?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:47:30 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 1)

That would make no sense.

I have called it insane. The Spanish Central Bank called it self-defeating and after a year of asking pretty please it issued a directive banning the practice.

So, your point is?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:36:27 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

So what was the bank motivation? Just crazy?

by rootless2 on Wed Feb 29th, 2012 at 11:52:31 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

Interbank lending dried up and borrowing from the Central Bank carried a stigma. So the banks started a price war. You are familiar with the concept of a price war, and why it's not necessarily a good thing for firms to engage in it, are you not?

In the short term, price wars are good for consumers, who can take advantage of lower prices. Often they are not good for the companies involved. The lower prices reduce profit margins and can threaten their survival.
In the medium to long term, they can be good for the dominant firms in the industry. Typically, the smaller, more marginal, firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:56:26 AM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

This is what you claimed banks did with deposits

"It holds it as custodian and pays interest on it."

So the motivation for this price war is somewhat elusive. The prestige of being a custodian and paying interest?

I'm more used to looking businesses that try make profits or at least revenue. This concept of borrowing money from depositors as a beneficent service has me befuddled.

by rootless2 on Wed Feb 29th, 2012 at 12:26:03 PM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

Having a customer's deposits means the bank becomes involved in all the payments activity of that customer and collects all kinds of service provider fees from it.

Also it brings the customer in the door so they can be sold loans.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Carrie (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 12:28:19 PM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

Yes.¹

But more importantly, depositors don't ask for collateral. The discount window does. So when your balance sheet is full of shit, you are willing to pay your depositors for the privilege of not being asked questions.

If your balance sheet is not full of shit, however, there is no particular reason to prefer creditors who do not ask questions over ones who do.

- Jake

¹A lot of bankers (and, unfortunately, regulators) are witch doctors who target cutesy rules of thumb like "lending/deposit ratio," Taylor rules or "even banks around the rediscount rate." Most of these rules of thumb are bullshit, but pass for plausible under ordinary conditions, because they basically amount to "do the same thing you did yesterday."

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:00:16 PM EST
[ Parent ]

Re: Why do we need private banks at all? (none / 0)

If you can find a bank that'll pay 4 % on a demand deposit anywhere in the world today, I wanna know where it is, so I can run as fast as possible in some other direction.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:30:25 AM EST
[ Parent ]

Why do we need private banks at all? | 133 comments (133 topical, 0 editorial, 0 hidden)

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