Tuesday, March 26, 2013

Banking Example #1.2: Loan & Deposit Transfer (w/ Colors!)

Example of a loan and deposit transfer. Coloring of cells inspired by commenter Geoff at pragcap.com (an attempt to make it more clear, by matching assets with their related liabilities across balance sheets). Otherwise this is exactly the same as Example #1. Each color represents a financial entity: loan, deposit, etc. Cells with the same color represent two views of the same entity, one from the creditor's viewpoint (left hand column) and one from the debtor's viewpoint (right hand column). Example #10 demonstrates how these different financial entities are interrelated but have a degree of independence from one another.

Setup: one central bank (CB), two commercial banks A and B, and one person x. No reserve requirements or capital requirements and everyone's balance sheet initially clear (empty).


Initial balance sheets (for CB, A, B, and x):

CB, A, B, x
Assets Liabilities
$0 $0


Balance sheets after x takes a $100 loan from A:

Bank A
Assets Liabilities
$100 loan to x $100 deposit for x

Person x
Assets Liabilities
$100 deposit at A $100 borrowing from A


Balance sheets after x transfers deposit from Bank A to Bank B:

Central Bank
Assets Liabilities
$100 reserve overdraft for A $100 reserve deposit for B

Bank A
Assets Liabilities
$100 loan to x $100 overdraft at CB

Bank B
Assets Liabilities
$100 reserves $100 deposit for x

Person x
Assets Liabilities
$100 deposit at B $100 borrowing from A


Balance sheet after Bank A borrows $100 of reserves from Bank B and repays CB the overdraft amount by the end of the day (note: Bank A could have borrowed from any other bank, the money markets, the Central Bank's discount window or by attracting transfer deposits, but I've chosen to show the case where it borrows from Bank B):

Central Bank
Assets Liabilities
$0 $0

Bank A
Assets Liabilities
$100 loan to x $100 reserve borrowings from B

Bank B
Assets Liabilities
$100 loan of reserves to A $100 deposit for x

Person x
Assets Liabilities
$100 deposit at B $100 borrowing from A


Note that at the end, the central bank's balance sheet is again clear, yet there are $100 of reserves on loan to A from B. To see a similar case where the deposit transfer is accomplished with a purchase instead, see Example 1.1.

I recommend this writeup on the monetary system by Cullen Roche for more information. Also, I must credit this article. Also, this site animates balance sheets, and has an especially good macro page with consolidated balance sheets.  Look at this to see this same example with reserve requirements, and here to see it with both reserve and capital requirements.

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