
How Money Moves Around The Banking System - BitcoinNews_io
http://gendal.wordpress.com/2013/11/24/a-simple-explanation-of-how-money-moves-around-the-banking-system/
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jackgavigan
No mention of cross-currency payments/settlement which, given how Bitcoin is
currently being used, is more relevant than bank transfers within the same
country.

An overview of CLS is a good starting point:
[http://www.snb.ch/en/mmr/reference/continuous_linked_settlem...](http://www.snb.ch/en/mmr/reference/continuous_linked_settlement/source)

~~~
gendal
Hi there,

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

~~~
jackgavigan
I am instinctively against over-simplification of this sort of thing because,
in my experience, the devil is in the detail and a little knowledge is a
dangerous thing.

~~~
gendal
Well, I certainly hope nobody tries to build a system off the back of that
blogpost!

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 :-)

------
brotchie
Interesting how payments work in different countries. For example, in
Australia when dealing in AUD, banks can participate in end-of-day
multilateral netting. That is, all the banks' inflows and outflows to all
other banks are netted and sent to the Reserve Bank of Australia (RBA).

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-...](http://www.npr.org/blogs/money/2013/10/04/229224964/episode-489-the-
invisible-plumbing-of-our-economy)) where they compare the US and UK systems.

~~~
PeterisP
Isn't it the same as the original article description of deferred net
settlement? I believe most country-local-currency systems are (or used to) run
this way.

~~~
josu
> This thought process motivated the creation of deferred net settlement
> systems. In the UK, BACS is such a system and equivalents exist all over the
> world.

Also, I can't think of a reason why they wouldn't do it this way.

~~~
zhte415
> 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](https://en.wikipedia.org/wiki/MF_Global)
[2]
[https://en.wikipedia.org/wiki/Large_and_complex_financial_in...](https://en.wikipedia.org/wiki/Large_and_complex_financial_institutions)
[3]
[https://en.wikipedia.org/wiki/Herstatt_Bank](https://en.wikipedia.org/wiki/Herstatt_Bank)

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romain_g
Interesting ! An excellent introduction is also available as a coursera class
(by Perry Mehrling from Columbia U) at
[https://www.coursera.org/course/money](https://www.coursera.org/course/money)
and
[https://www.coursera.org/course/money2](https://www.coursera.org/course/money2)
!

~~~
polskibus
+1 on the coursera classes, Mr. Mehrling is an amazing teacher and really
knows the subject well. I finished part 1 of his course and am close to
finishing part 2.

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znowi
Bitcoin resembles a lot more a one bank operation where accounts are settled
immediately and at zero cost. Not an interbank, expensive, RTGS system.

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.

~~~
gnyman
But transfering bitcoin is not instant and not free is it? Please correct me
if I'm wrong but as far as I understood you will have to wait for your
transaction to be included in a (few steps of the?) chain, and unless you pay
a fee you might not get included for a while?

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)?

~~~
clarkmoody
The transaction is propagated through the network in a few seconds. The
bitcoin wallet will allow you to spend the funds received, even if they are
not confirmed by the network[1]. You simply add the risk of a double-spend
attack against your balance, if an attacker also sent coins to someone else.

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-...](https://github.com/bitcoin/bitcoin/issues/3288#issuecomment-28923237)

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Patient0
What would also be interesting would be an explanation of how this then ties
in to the "headline" short term interest rate that the Fed, ECB, Bank of
England etc. set.

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.

~~~
notahacker
In summary \- banks' liabilities to you (your deposits) are backed by assets.
One of these is cash, but this doesn't earn the bank any return. Banks
therefore prefer to hold much larger quantities of interest-earning assets
like loans made to other parties, or government bonds (these are assets to a
bank because they are promises by third parties to pay _the bank_ money in the
long term).

\- 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.

~~~
kaonashi
Minor quibble: banks do earn interest on reserve balances since 2008. The rate
maintenance strategy was changed at that time to address cost instead of
quantity.

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atmosx
Using todays technology SWIFT (or any other online messaging system for the
matter) does not have to be expensive.

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.

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mattchamb
Very interesting article. I work in writing some financial software (consumer
facing) and I have never actually read about how the banking system works.
Just the other day I was writing some code to make SWIFT transfers.

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Havoc
To quote Liar's Poker: "How does money move around the world...any which way
it likes".

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optymizer
This was a puzzling diagram:
[http://gendal.files.wordpress.com/2013/11/single-bank-
settle...](http://gendal.files.wordpress.com/2013/11/single-bank-
settlement.png)

Why not put Alice and Bob side by side?

~~~
gendal
You're right - sorry. I drew the whole slide first and then subtracted pieces
to support the flow of the story. It meant some parts were a bit squashed....
and you're right that, in isolation, the early diagrams look a bit confusing.

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amiune
Related course on Coursera
[https://class.coursera.org/money-001/class](https://class.coursera.org/money-001/class)
It changed my vision about the complexity of the banking system.

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ohwp
_" in my expecience, almost nobody actually understands how payment systems
work"_

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.

~~~
laichzeit0
Indications are that it was Bitstamp shuffling money around.

~~~
Maarius
What are the indications?

~~~
shawabawa3
"who has loads of money? Bitstamp? Maybe it was them"

Is basically what the "investigations" I read boiled down to

~~~
jimktrains2
I thought that many of the accounts that funneled into the one big account
were known to be bitstamps?

Now, I'm not 100% sure why those were known or thought to be bitstamps in the
first place.

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shreyas056
I doubt if bitcoin really resembles RTGS; for one thing there is no central
agency involved. Or may be it does if you consider distributed network of
nodes which does "proof of work" for your bitcoin transaction as a Central
Bank

~~~
gendal
Exactly. My contention is that you can perhaps regard the _entire_ Bitcoin
network (of full nodes) as providing RTGS services for the Bitcoin currency.

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.

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ncourage
This was a fantastic read, and very educational. I was most surprised to see
it put as we are lending money to our banks. Thought there might be mention of
FDIC but didn't see any.

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seanhandley
Well worth watching the videos on
[http://www.positivemoney.org](http://www.positivemoney.org)

~~~
davidw
Looks like a site with an Agenda (with a capital A) rather than something more
neutral/academic/created to inform. I'm always wary of those kinds of groups
if I'm trying to learn about something.

~~~
polymatter
I highly recommend Khan academy as a better set of videos to inform on this
topic ([https://www.khanacademy.org/economics-finance-domain/core-
fi...](https://www.khanacademy.org/economics-finance-domain/core-
finance/money-and-banking)).

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guyinblackshirt
no mention of DTC/Gray screen?

