How Money Moves Around The Banking System
gendal.wordpress.com
gendal.wordpress.com
An overview of CLS is a good starting point: http://www.snb.ch/en/mmr/reference/continuous_linked_settlem...
I've implemented processing of cross-border payment instructions delivered via SWIFT and there's no way banks will STP a cross-border payment for $150 million. Large payments will always be subject to an authorisation review, at least where I work. That costs money and takes time.
Fundamentally, cash payments will always suffer from counterparty default risk without a central bank. How are you going to build an international central bank or central bank system? The best you'll see are regional efforts like TARGET2.
Digital currencies solve these problems without requiring ridiculous amounts of infrastructure to be created first. If we had to sit around waiting for banks to solve these problems, it would simply never happen.
This is fundamentally why I see digital currencies as the future, and why the hype is indeed warranted (even if perhaps people don't understand why).
Richard Brown here - the author of the linked article.
Very good point re FX and CLS. I wanted to make the article as simple as possible so as to bring out the fundamental concepts (correspondent banking, deferred net settlement, real-time gross settlement, etc).
In so doing, I had to make some gross simplifications and omissions - the most obvious being ignoring FX but I also made a sleight of hand by implying that banks within a country use the correspondent arrangement I outlined.
However, I hope - even with these simplifications - the concepts came across clearly.
Thanks for taking the time to comment.
Richard
But I think there is a lot to be said for helping people build useful mental models. My experience is that people either have no mental model for how money moves or have models that are just wrong.
So anything we can do to impart some insight has to be a good thing.... but you're right: a little knowledge can be very dangerous :-)
I don't see any other way to teach ideas than to start simple, help provide intuition for the basic concepts, and build from there.
Maybe you should ask the author to add some further-reading references to the article?
They did, and thank you for that. Still, I would love to see a follow-up article that 'unsimplifies' things a bit, as well as covering FX.
Probably the best in-depth book on this topic I've read is this one. I'd highly recommend it. http://www.amazon.co.uk/Payment-Systems-Macmillan-Financial-...
(Disclosure: it was co-written by one of my colleagues at IBM)
The RBA is the banks' bank which holds bank's AUD denominated deposits in their separate accounts. Once the bank-to-bank net amounts have been calculated the RBA shuffles around a few numbers in databases to execute all the interbank transfers.
It sounds like in the USA banks have to have accounts with each other in order to affect transfers. The RBA effectively adds a layer of indirection and in some ways ensures banks are meeting their capital requirements.
Edit: I didn't read far enough. The UK has an impressive implementation of a Real-Time Gross Settlement system. My thoughts on the US interbank transfer system were coloured by a recent NPR Planet Money podcast (http://www.npr.org/blogs/money/2013/10/04/229224964/episode-...) where they compare the US and UK systems.
Also, I can't think of a reason why they wouldn't do it this way.
Credit risk and liquidity risk, as well as systemic risk exasperated by asynchronous transfers and time lag.
Banks do sometimes go bankrupt. While MFGlobal was not a bank, it did demonstrate difficulty in unwinding client funds. LCFIs [2] usually cross regulatory environments, and failures of financial institutions are numerous, the combination quite unsettling. Herstatt [3] in 1974 led to continuous settlement in FX, having received DEM but not paying out USD. There's quite a reason for sometimes not netting things.
[1] https://en.wikipedia.org/wiki/MF_Global [2] https://en.wikipedia.org/wiki/Large_and_complex_financial_in... [3] https://en.wikipedia.org/wiki/Herstatt_Bank
I would also rather ask not how Bitcoin can squeeze into the banking system jigsaw puzzle, but how this puzzle can be optimized to be as effective as Bitcoin.
Bitcoin will be just a place where people will exit en masse and trade in BTC completely, without relying on fragile and corrupted system that we have today.
And is there not possible that in the future, if the amount of transaction increase as bitcoin becomes more popular, and the money you get from mining goes to zero, that transactions with fees will be the only ones accepted (at a reasonable rate)?
It is up to miner discretion which transactions to include in blocks. If the fee included is zero, then many miners will pass on your transaction, and it may take longer to confirm the original transaction.
[1] https://github.com/bitcoin/bitcoin/issues/3288#issuecomment-...
Well, it's free to the transferers, because new coins are issued for work performed, and likewise, the new bitcoin compensates and incentivizes the efforts of the blockchain verification, so that balance should be even as well. Sounds zero-sum to me.
> And is there not possible that in the future, if the amount of transaction increase as bitcoin becomes more popular, and the money you get from mining goes to zero, that transactions with fees will be the only ones accepted (at a reasonable rate)?
Yes, this is an ongoing potential problem with bitcoin: http://bitcoin.stackexchange.com/questions/876/how-much-will...
The fraud risk of zero confirmation bitcoin transfers is a lot smaller than the current fraud risk that we have with the current payments system. If it's actually a large purchase, like a car then you can afford to wait until it's confirmed, and with things like laptops, wait a couple minutes for a couple of confirmations.
All the ground work has been laid - and I think many people would be interested to know the mechanics behind what happens when the Bank of England "cuts rates" or "raises rates".
The only other place I've seen this explained well is at the start of the book "Pricing Money" by J.D.A Wiseman - but that's not available online.
Thanks for the motivation to perhaps write a part two to this post.
When a central bank sets the interest rate, it's talking about the interest rate at which such short term loans happen. It does so by simply participating in the market until the interest rate is where it wants it to be.
These things are addressed fairly well in http://neweconomicperspectives.org/p/modern-monetary-theory-...
There are three points here. First of all, they are very clear that this only applies to monetarily sovereign governments (i.e., not Euro members, not state governments).
Second is their claim that directly spending money into existence is the more natural way of looking at things, and everything involving debt issuance is a voluntary add-on. That's not how things developed historically, but it does make sense when you think about how you would design a state-run currency from first principles.
Third is their claim that, as a first order approximation, even when all sorts of debt issuance dances are in place, the economy behaves as if they weren't and government simply spent money into and taxed money out of existence. [1]
The second point is admittedly a bit philosophical and subjective. You might care more about the historical account than the first principles account.
However, the third point is quite objective, and if you have a concrete example of how debt issuance actually makes a significant macro-economic difference that contradicts MMT, I would be highly interested (and I assume MMT economists would be as well).
[1] One way to look at it is this: Debt issuance is a red herring; what matters is the central bank policy of (usually) maintaining a positive interest rate. Debt issuance is only a way of shifting the cost of this policy from the central bank's books into the general government budget, i.e. it is a political that hides the true cost of monetary policy so that the public won't be as outraged about it.
- For the same reasons as the payment clearing system is "netted-out" at the end of the day, the balancing of these banks' assets and liabilities is netted-out at the end of the day. If the risk-weighted assets of one bank doesn't match its liabilities - particularly if it doesn't have enough cash - it needs to borrow from another bank. If a bank has too much non-interest earning cash at the end of the day, on the other hand it will prefer to earn a low risk return by lending to another bank. This is the "base interest rate" we're talking about; the minimum amount of return a bank expects from making a very safe loan.
- Banks could earn a similarly low-risk and low-return by buying government bonds with their spare cash instead, so the interbank lending rate is closely linked to bond prices. The Fed, ECB or Bank of England can take advantage of this by buying and selling government bonds to keep the interbank lending rate at a target level.
- Why would they want to do this? Because the interbank lending rate (and bond prices) affects the rates for all other types of lending that banks do (the interbank lending rate plus a usually relatively large risk premium, plus a bit on top for profit).
- Why would they care so much about the price of lending? Because as the banking system's balance between assets and liabilities is only required to be eventually consistent, banks are given the right to create loans that far exceed the cash (and other banks' liabilities) previously deposited with them, provided they can borrow the funds at the end of the day. And because this credit creation is legal - and essential to financial markets' efficient operation - the only way the government can influence the total quantity of money circulating in the economy is by manipulating the minimum price of credit. As the total amount of credit created by the banking system far exceeds the amount of cash created by the central bank, the economy is very sensitive to the effect of small interest rate changes on demand for credit.
I did not study extensively the banking system, but I figured that the central bank was the missing part of the post right away. How did I do it? Because the central bank should do exactly that: CONTROL THE BANKS IN ORDER TO AVOID THEM GOING BURST without anyone noticing (rings a bell?). Now the fact that they NEVER do, is a nice topic for discussion, why exactly to we pay them? Just to guess what the right monetary policy for the next 6 months will be?
This post explains why sending money from a bank’s perspective might be expensive. But what it really shows is that it does not have to be if everyone was doing their job right (central bank included) and be held accountable when shit hits the fan.
As of today exchanging BTC (an asset anyway) to currency is expensive and not straight-forward. How exactly is someone going to exchange 150m BTC in USD/EUR without getting noticed? In what amount of time???
BTC is not optimal for this kind of transactions. An inflationary e-currency, widely acceptable and easily exchangeable would be one hell of an option, but good luck persuading people to use it if you re not a government.
Why not put Alice and Bob side by side?
This was my experience as well. I can't understand why everybody fell for the hype. Loads of money are transfered every hour.
And we don't know anything about the $150m Bitcoin transaction. Maybe the owner just moved it to one of his other wallets.
Is basically what the "investigations" I read boiled down to
Now, I'm not 100% sure why those were known or thought to be bitstamps in the first place.
The question, then, is: "is this sufficient"? Do we believe all Bitcoin transactions would be transacted over this system (i.e. over the blockchain) in the future or will we see aggregators akin to DNSs?
I see the work of Mike Hearn and others on micropayment channels as innovative examples of what a DNS for Bitcoin might look like.
Oh god, more "we just accumulate more and more debt" tripe.
How about learning accounting 101; when you take on debt, what goes on the other side of the balance sheet?
The fact that people "learn" from sites like that is a crying shame.