At the end of each day, commercial banks will either be ‘short’ of central bank reserves and need to borrow more or they will be ‘long’ on central bank reserves and have ‘excess’ liquidity. As in Figure 13, we can imagine banks’ reserves with the central bank as buckets with different volumes of liquid. Some banks will have too much and others too little, so they will trade with each other to balance this out in preparation for the following day’s trading. To adjust its reserves, a bank can either borrow funds directly from the central bank or, more usually, it will engage in overnight trading with other banks on the interbank money market. Banks that have excess reserves will typically lend them to banks in need of reserves in return for highly liquid interest-bearing assets, usually gilts (government securities) (see Chapter 3, Box 3 on bond issuance). The rates of interest on loans between banks will typically be better than banks could attain when borrowing directly from the central bank. If central bank reserves are withdrawn from one account, they must go up in some other account. What this means is that the 46 banks within the clearing system know that there should always be enough money in aggregate to meet all the necessary payments. There may not be enough reserves to meet liquidity requirements, if the central bank imposes such a rule (we examine liquidity regulation in Section 5.2). This means that if a bank finds itself with too few reserves to make a payment, it can borrow central bank reserves from another bank within the loop, which, by definition, will have excess reserves. And the opposite also applies – if a bank has excess reserves, it can lend these to a bank in need of more reserves. The one vital caveat, as we discuss later, is that banks have enough confidence in one another to be happy to lend to each other. These transfers are made on the interbank money market (Box 4) at the interbank market rate of interest, known as LIBOR (Box 7). We explore how the Bank of England attempts to influence this rate in Chapter 5.
Andrew Jackson - Where Does Money Come From - Positive Money pdf from epub