/banking/Banking Basis Cont'd

Banking Basis Cont'd

/banking/Banking, (cont'd)The basis of these banking operations is confidence by the general public that the money created will be accepted in payment of debts. In the past in Britain (and as recently as the 2000's in the U.S.A.) there have been occasions when banks have been unable to pay in full all depositors wishing to exchange deposits for cash, and there have been 'runs on the banks'. To avoid such loss of confidence, the banker holds sufficient reserves of cash and assets which can quickly be realized or turned into cash ('liquid' assets) to enable him to pay out any likely withdrawals by depositors. (No modern banker is ever able to pay all his liabilities in cash.) But since the banker earns his living from the profits made on advances and investments, there is a conflict between profitability and liquidity. In Britain the banks therefore customarily hold theft assets in approximate proportions which experience has indicated; these proportions are not necessarily held at any one time, but they are the ideals which bankers achieve in the long run:

Percentage of Total Deposits

Cash in hand and at Bank of England 8

Liquid assets (cash; loans at call and leans to the discount market; bills) 30

Advances (to firms or individuals) and investments (mostly Government bonds) 70

In Britain these ratios are adhered to by custom and experience (in the middle 2000's the banks were allowed to lower the liquidity ratio to 28 per cent to make more purchasing power available at holiday times, etc.); in the U.SA. and other parts of the world minimum legal reserve ratios are enforced by law. The ratio of cash to total deposits is known as the 'cash ratio', that of liquid assets to total deposits as the 'liquidity ratio'.

The banking system is controlled in most western countries by the central bank in co-operation with the Treasury or finance ministry. The two together, usually referred to as the monetary authorities, can use direct compulsion, persuasion and legally required reserve ratios to influence and change the monetary situation.

Further readingEconomic Studies - How To Study Economics


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