{"id":27,"date":"2013-05-20T19:55:30","date_gmt":"2013-05-20T19:55:30","guid":{"rendered":"http:\/\/asadkarim.co.uk\/?p=27"},"modified":"2013-05-20T19:55:30","modified_gmt":"2013-05-20T19:55:30","slug":"the-mechanics-of-the-banking-system","status":"publish","type":"post","link":"https:\/\/www.asadkarim.co.uk\/?p=27","title":{"rendered":"The Mechanics of the Banking System"},"content":{"rendered":"<p><strong>The Mechanics of the Banking System<\/strong><\/p>\n<p>Today marks a turning point in UK banking, with the long awaited report from Independent Commission on Banking, chaired by Sir John Vickers.<br \/>\n[http:\/\/bankingcommission.independent.gov.uk\/]<\/p>\n<p>Effectively this is recommending that the retail banking business is ring fenced from the risking investment banking arm, to avoid a banking collapse, and protect the UK taxpayer from a bailout.<br \/>\nThe banking system on the high street works on a process called The Fractional Reserve Banking. This refers to a banking system which requires the high street banks to keep only portion (a fraction) of the money deposited with them as reserves. The bank pays interest on all deposits made by its customers and uses the deposited money to make new loans. In order to understand how fractional reserve banking works, in this blog let\u2019s look at the following example.<br \/>\n[I read a book on finance by Liaquat Ahamed that gives a worked example]<br \/>\nSomebody (not Asad Karim, he\u2019s not that flush\u2026) deposits \u00a310,000 with HSBC. HSBC is obligated by law to keep 10% of the deposited money as a reserve, that\u2019s why the bank keeps \u00a31000 and lends out \u00a39000. Somewhere down the road the \u00a39000 loan is deposited in another bank account (RBS for example, or it could be with the same bank HSBC but let\u2019s keep things simple). Now RBS (our second bank 83% owned by us, the UK Taxpayer\u2026) also wants to make money by giving out loans, that\u2019s why it keeps the required \u00a3900 and lends \u00a38100. Fast forward to a deposit with a LloydsTSB (fourth bank, 41% owned by us, the UK Taxpayer\u2026) and you\u2019ll get the following:<br \/>\n<strong>Bank\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Deposit\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Reserve\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Loan<\/strong><br \/>\nHSBC\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a310000\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a31000\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a39000<br \/>\nRBS\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a39000\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a3900\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a38100<br \/>\nBarclays\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a38100\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a3810\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a37290<br \/>\nLloydsTSB\u00a0\u00a0\u00a0\u00a0 \u00a37290\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a37290\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a30<br \/>\nTotal\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a334390\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a310000\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a324390<br \/>\nAs you can see from the table above, the banks created \u00a324,390 in loans based on the first \u00a310,000 deposited. Yes, you guessed it a licence to print money. This is sometimes known as the \u2018Money Multiplier\u2019 where money gets re-lent out, some commentators call the banking system a hugh Ponzi Scheme. The fractional reserve banking works for now, because the total amount of withdrawals is offset by deposits made at the same time. While the depositors are confident at the fractional-reserve banking system, a very small part of all deposits is withdrawn at the same time allowing the banks to handle the withdrawals through their minuscule reserves. However when people\u2019s confidence in the banks is shaken, bank runs are possible, (2007 UK Northern Rock) and the entire banking and financial system can collapse.<br \/>\nHowever, what I don\u2019t understand from the Sir John Vickers report, is that even if the report is put into law, and retail deposits are secured, that would not saved HBOS, Northern Rock, Bradford and Bingley, London Scottish Bank, all of which, were Retail banks, with NO risking investment arms, and were brought to their knees, by simply lending too much (from retail deposits) to the property (real estate sector) !!<br \/>\nIn otherwords, poor credit management was to blame.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>The Mechanics of the Banking System Today marks a turning point in UK banking, with the long awaited report from Independent Commission on Banking, chaired by Sir John Vickers. [http:\/\/bankingcommission.independent.gov.uk\/] Effectively this is recommending that the retail banking business is ring fenced from the risking investment banking arm, to avoid a banking collapse, and protect [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-27","post","type-post","status-publish","format-standard","hentry","category-uncategorized"],"_links":{"self":[{"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/posts\/27","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=27"}],"version-history":[{"count":1,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/posts\/27\/revisions"}],"predecessor-version":[{"id":29,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=\/wp\/v2\/posts\/27\/revisions\/29"}],"wp:attachment":[{"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=27"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=27"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.asadkarim.co.uk\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=27"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}