Finance / Banking Qs

It's all electronic. Remember, banking today is sophisticated enough that institutions (can) make money on the balances left in accounts overnight. For the most part it's just numbers changing in computers somewhere.

it's basically the matrix.

it's on some now you see me now you don't shit

TS on the subject of finance: peter soros v. method man.

"It's all electronic" is not an answer at all. Even if debts are settled electronically, there must be something that's transferred over and above the electrons, which as yet have no direct equivalence in dollars. I can imagine how banks might transfer loans electronically, for instance: I'm sure it's possible to execute a legal exchange of loans over the wire, since banks can electronically sign the necessary documents, etc. Loans aren't very fluid, however; I would suppose that an instrument as fluid as cash is needed for the smooth operation of this process. Cash obviously cannot be transferred electronically, and a bank may not even have enough cash on-hand to settle debts.

So what other asset might a bank have that's as fluid as cash yet amenable as loans to electronic transfer? Perhaps banks use some kind of "electronic cash" created just for this purpose. If so, then a raft of questions arise: Who issues these funds? Who regulates them? It can't be any "normal" bank, as this would put said bank in a particularly privileged position. Are these instruments, if they exist, Federal Reserve e-notes?

These are questions. I want answers.

Check the stuff about the US payments system in the Federal Reserve article: http://en.wikipedia.org/wiki/Federal_Reserve_System and the link to the Fedwire system. That might cover what you're looking for. International stuff generally uses bank-to-bank wire funds transfers, but I'm not sure how the physical transfer of assets is handled.

I have a question, too. I'm working on a financial translation from Dutch (Flemish, actually). I can't find the term "quotiteit". When used in reference to mortgages, it seems to be the ratio of downpayment to asking price. Here it is used in reference to shares.

Loans aren't very fluid

lol credit crisis. banks and other fis use fedwire for large interbank transfers. from the frs site:

The Fedwire Funds Service provides a real-time gross settlement system in which more than 9,500 participants initiate funds transfers that are immediate, final, and irrevocable when processed. Participants that maintain a reserve or clearing account with a Federal Reserve Bank may use Fedwire to send payments to, or receive payments from, other account holders directly. Participants use Fedwire to handle large-value, time-critical payments, such as payments for the settlement of interbank purchases and sales of federal funds; the purchase, sale, and financing of securities transactions; the disbursement or repayment of loans; and the settlement of real estate transactions.

This is all very interesting information. I'm still trying to sort thru it.

One suggestion made by a friend is that banks go into debt with each other and agree to adjust that debt according to the transactions made between them. This answer is somewhat unsatisfactory to me, since if funds tend to flow from bank A into bank B, then bank A is going to incur interest on that debt -- surely, no banks would make interest-free loans to each other -- which it would surely prefer to avoid. Of course, if there were a trusted third party, such as the Fed, that'd settle matters in terms of the institutions' fractional holdings there, it'd make more sense. However, what about financial institutions that have no Fed holdings? Are they required to settle their transactions through a third-party bank that is part of the Fed system? Do they have to settle in cash each month, say?

However, what about financial institutions that have no Fed holdings? Are they required to settle their transactions through a third-party bank that is part of the Fed system? Do they have to settle in cash each month, say?

You mean like state banks?

http://en.wikipedia.org/wiki/Syndicated_loan

If yr interested in interbank lending and credit markets I'd stop thinking in terms of actual physical assets. I dk if what yr interested in is how currency reserves physically adjust? I dk much about that tbh. When I was first hired as an analyst I got a like, ten minute talk on how the retail side works and then promptly forgot all about it.

Interbank loans vary in structure depending on the length of the loan e.g. fi w/reserve accounts will settle transactions through the fed and, at the end of the night those who have funds in excess of the minimum required can lend that money to other banks that are short of funds, hence the "overnight rate". Term loans are generally done through the Fed funds market or other interbank markets the actual transactions, again, handled electronically.

I have a feeling I'm not really addressing yr qn are you interested in how transactions are processed or who transactions are structred or both?

*how not who. Also Maria the author is probably referring to a minimum number of shares that must be traded cf. quotity

Let me say this once and for all, to clear it up: I'm not thinking solely in terms of physical assets except insofar as they enter into the process of settling bank debts, if they do at all. I'm interested in a high-level, abstract description of how interbank transactions work. I'm perfectly happy to conceive of this in terms of entities that have no simple, physical tangible existence with well-delimited boundaries.

The answer may or may not involve loans, credit, or what have you, but that's not what I'm after, of necessity. For instance, the exchange-of-debt-obligation = settlement scenario described above is sound in terms of the entities it describes: A debt, after all, is a legal contract, which may be verified (or disputed) like any other legal contract. In terms of plausibility, this explanation is weak, I feel, since the interest on such loans might well be quite a disadvantage to a bank, even though a bank might have other, quite legitimate reasons to borrow funds from another financial institution. The explanation I proposed involving "e-dollars" or the like would be sound if such entities could be verified to exist, but I have no evidence that they do, and if they did, further explanations would be required regarding their issuance & regulation.

The US Payments system Jaq mentioned might be what I'm after, but the details aren't specific enough on the Wikipedia page to tell. The Fedwire system might be part of the answer too, but again, the details are short, and it doesn't seem like a full explanation in any case.

sounds like you need a book dude--or to talk to an actual banker, not an ilxor

does commercial paper play any part of the answer that you ARE looking for, libcrypt?!?

wikipedia on commercial paper

For a moment, I thought you were linking the print version of Wikipedia, Eisbaer. I dunno about CP, but I don't think it's the missing puzzle piece.

Maybe I should read a book, yea, but this seems like such a simple, fundamental part of our economy, that surely knowledge of how it works can't be that uncommon.

um, i work in a bank (although not in the back office). Despite your insistence that you're not interested in physical assets, you don't seem willing to take anything else as an answer. Broadly speaking, settlement occurs either on a wholesale level (see Fedwire ref above, better description here: http://www.federalreserve.gov/paymentsystems/fedwire/default.htm; up one level for broader discussion of payment systems, also read about CHIPS) or on a "retail" level, which are handled through "Automated Clearing Houses" (start here: http://en.wikipedia.org/wiki/Automated_clearing_house).

Payments can be made on a gross basis (e.g. Citi owes HSBC $1mn and "sends" them that $1mn) or net (e.g. Citi unit A owes HSBC Unit A $3mn; Citi Unit B owes HSBC unit B $2mn; at the end of the day Citi "sends" $1mn).

The "sending" above is, as I said initially, all electronic. Citi sends an email message saying "here's your $1mn." HSBC sends back "thanks got it" and they both make adjustments to their ledgers.

Obviously a simplified discussion, but that's how it works, sorry. Movement of cash for the most part only happens around the margins, either to satisfy the needs of physical customers and/or regulatory requirements.

The same basic idea holds for securities nowadays, although (again simplifying) imagine that the physical stock/bond certificate is held in a neutral third location (a depository, although it's all electronic). The depository just changes the entry of who owns the stock, which they note by the bank/broker. In turn that bank/broker breaks down "its" holdings of Google shares into individual account holders.

okay i've made a total hash of explaining things. i'm only going to try to clarify wholesale transactions and not retail or OTC markets. going back to the original qn transactions between banks are settled by the transfer of balances on the books of either their central bank account or, less frequently, on commercial bank accounts.

in the U.S. transactions are processed via either fedwire (gov't) or CHIPS (private) although CHIPS accounts are funded indirectly via fedwire funds so i'm not going to really go over that. bank a has an outstanding debt to bank b of 10 dollars. using fedwire bank a debits their reserve bank account for 10 and B's account is credited 10 dollars. FIs w/reserve bank accounts have a daylight overdraft enabling them to maintain liquidity up to a certain cap. if a FI needs to extend the cap they can pledge collateral. fedwire transactions are processed in real-time as gross settlements as mitya describes above so a FI's position is always being adjusted during the day.

so say bank a closes at -5 dollars they can borrow that money in the federal funds market at the overnight rate, typically from banks that have excess funds in their reserve accounts. in the morning the position will be closed via settlement processes described above. longer-term contracts can be negotiated on the funds market as well, as can continuing overnight contracts.

interbank lending and trading on things like FOREX, securities &c. is all settled essentially the same way. obv the interbank lending market has been simplified and we can talk about a bunch of related things like credit and systemic risk, gross vs. net settlement processes, how loans are securitized and tracked but this post is tl;dr already so... i hope this was at least clearer.

OK, then. I have something of a question for you, then, mitya. It's kind of theoretical, but bear with me, since it cuts to the heart of my queries. It relies on physical cash, I will admit, but that's a mere convenience, since I could easily substitute CDOs or commercial paper or stocks or what have you for cash.

Suppose I open a bank with 0 assets. It doesn't really have to be a bank, but any kind of institution capable of receiving electronic transfers of funds. Furthermore, it doesn't have to be on 0 assets, since I could adjust the other numbers to make the example "work", but let's just go with 0 for now. Suppose I gain 10 customers, and each opens an account with the minimum. Say that minimum is $1. So I now have ten dollar bills. The day after my customers create their accounts, each customer gets a paycheck drawn on HSBC for $100. They all deposit them in my bank that same day. Later that day, HSBC settles things with me by sending me 10 "email messages", or whatever, telling me that I have $100 for each customer. I adjust my ledgers accordingly, and now they indicate that my bank has $1010.

With me so far?

OK, then. Customer number one, say his name is Joe, comes by the bank. Joe wants to withdraw $50 in cash from my bank. One problem, though: I only have $10 in cash and 10 "email messages" from HSBC. Joe, however, is a patient man. He'll wait however long it takes me to get the cash he wants for his withdrawal. Fine, I say. I'll just call up my pals at HSBC and get it from them! I do, and explain my situation, and that Joe needs to get his cash from his cheque that cleared yesterday. HSBC, however, say that I have already settled, and I have everything HSBC owes me: I got my "message" from them and adjusted my ledgers accordingly upward, so what's the problem?

I could end this example right here, since it illustrates what I'm trying to get at, but I won't, for the purpose of illustrating several potential scenarios I've outlined above.

Ending 1: I say to HSBC, "whoa there, pardner. That transfer was in fact a LOAN, and I am now demanding that you make good on it. Pay up to the tune of $1000." HSBC counters that it was no such thing and that they don't borrow in that manner, since I, being not a chump, am unwilling to lend money to HSBC without demanding interest. HSBC reiterates that my messages should suit me just fine and to stop buggin' 'em.

Ending 2: HSBC says to me, "ah, those messages? Those are actually negotiable e-funds. They are as good as cash. You can send a 'message', an irrevocable agreement, as it were, to exchange these e-funds messages we sent to you to any reputable banking institution, and they will be happy to exchange them for their face value in physical cash dollars." I say, "that's good to know, indeed. Now can you tell me more about these e-funds? Who issues these e-funds, and how are they regulated?"

Which is the right ending, mitya, or is there a third I haven't thought of?

(xpost)

That's the best explanation so far, Lamp. Still thinking about it.

The existence of a neutral third-party bank in this matter simplifies things tremendously, so I'm gonna go out on a limb and say that our current inter-bank system is built upon the notion of a central bank.

Questions floating around my head now:

How do institutions that do not participate directly in the central banking system receive electronic funds transfers? Do they contract with a bank that does to perform this service?

How do international funds transfers work? Is there an international analog to the Fed?

option two is correct, sort of. your e-funds are currency dude they exist as money supply it is really dollaz so leaving aside the fact that you can't open a bank w/no assets in your example you would, like many banks, have a cheque-clearing window of 3 business days or whatever allowing you both time to purchase currency and to make money on the float.

xpost in order to take deposits you must have a reserve account. part of the central bank's manadate here in the u.s. is to guarantee liquidity and mitigate risk so yes, interbank lending is predicated on a federal settlement system. wholesale international transactions in dollars are often done through CHIPS but other countries have their own systems but the settlement process is the same. intn'l analog is BIS in swizterland it's the bank to central banks.

I thought that participating in the reserve system was optional for banks, but I sit corrected. I know that FDIC insurance is optional, since Bank of the West isn't FDIC insured, but that's apparently independent of the reserve system to some extent.

Something I am trying to understand (for work rather than personal investment reasons):

Scenario A: I invest 10,000. At the end of a year I have 10,700 -- my principal plus 7% interest.
Scenario B: I invest 10,000. At the end of the year I have earned 7% interest, or $700, but my principal is still tied up (e.g. because it's a bond with a five-year term or something).

How do you describe the difference between these two scenarios? Do they both technically have the same return? Scenario A seems much better than Scenario B but how do you describe or quantify it? Is there a term of art for it?

Far from expert but I guess you might just call scenario A liquid and scenario B illiquid? I don’t see it being accurate to say A has a higher return than B simply bc of its liquidity

It depends on if your interest rate of return is fixed, annual, what would you do with the money that isn't tied up in the meantime. There are a lot of variables.

The word "invest" is extremely opaque in those scenarios, but silby is correct to identify liquidity/illiquidity as the only difference that can be teased out of those descriptions.

Maybe this is too advanced a question for here but is there some way to "value" the liquidity vs illiquidity? Maybe comparing the returns you get on liquid vs illiquid and subtracting the difference as a kind of "premium"?

Any valuation on liquidity over illiquidity would be need to be based on assumptions about the future, which usually would be about the safety of the primary investment vehicle and the direction of interest rates. Markets regularly make bets about the future, but markets are made up of individual investors, each of whom has different ideas about that future, so the usual mechanism for placing a valuation would be to look at whatever premium investors in that market are currently willing to pay in return for greater liquidity. This will fluctuate.

In the absence of a well-developed market setting such valuations, setting that liquidity premium would be down to direct negotiation between the parties to the transaction.

I'd add that I value liquidity on a personal level, what might I need the money for, what else is going on, what % of my total resources I'm devoting to something locked-in

Which is what is at play when you compare the interest on a regular savings account and a Certificate of Deposit, where the vast majority of the people in those markets are small-timers, like you and me. We need liquidity, mainly because what we 'invest' may be needed to meet immediate expenses, like medical bills.

When one uses the term illiquid, it generally means there is no buyer or the security is basically worthless. I wouldn't use it here because depending on the bond you could find a buyer, it depends on whether there is a penalty for not holding it to maturity. I have never traded debt, so I don't know the retail market or what the typical penalties are.

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