Sunday, November 27, 2011

savings bank making loans


(New thoughts below. We were distracted by "fractional reserve banking" concept, which doesn't apply to Thomas, OrangeUnion or KS. For a real example, I actually deposited $1600 in Citibank but I know I can't take out $5000.)

Suppose Thomas is a small venture fund with $2 million of real cash. Thomas likes a start-up called Prism so he invests $2m in Prism. Now Thomas has $0 balance. Thomas likes another start-up CakeHealth, so he invests $1m in CakeHealth.  Both cases, Thomas gives a check from his CapitalOne corporate account. Both start-ups have bank accounts in Chase. When CakeHealth cashes in the $1m check, it bounces.

In theory, CapitalOne may implicitly give Thomas a credit line of $1m when CakeHealth cashes the CapitalOne check drawn against Thomas's depleted account. Question is how much credit. In fact, since there's no collateral, I doubt CapitalOne will give the $1m unsecured loan. If CapitalOne were so generous, then many Thomas's would queue up to take advantage of it -- deposit $100k and take out $200k to buy gold. Bank would soon collapse. I know that in reality a commercial bank like CapitalOne looks at each application when handing out loans -- not implicitly or automatically approved.

That's story 1. Now Story 2. Orange bank is a tiny private (unregulated) savings union not registered with Fed or FDIC. It can't even print checks. OrangeUnion takes deposits from local residents totalling $20m. Depositors mostly use CD's. Then a McDonald's franchise shows up to borrow $20m so OrangeUnion lent her. Then KFC wants to borrow $10m and OrangeUnion lent him. Both loans mature in a month and get repaid. Then McDonald's borrows $22m and KFC $11m, but for 10 years. Now OrangeUnion must be careful because it can't get the money back quickly. 

But let's analyze the first OrangeUnion 2 loans. Suppose the $20m deposit is maintained in a Citibank account owned by OrangeUnion. McDonald's gets the loan amount in a $20m Citibank check. McDonald's owner deposits that in her corporate account in Citibank (Citi just transfers the $20m from one account into the other.) Then she writes a check of $20m to pay her supplier. No problem. Orange's Citibank account and McDonald's bank account both become $0. Now KFC gets the $10m loan from OrangeUnion in a Citibank check and tries to deposit it into KFC's account with Wachovia. Check Bounce? In that case, this OrangeUnion has absolutely no leverage as a lender. It can only lend out $20m if it has $20m deposit.
I now think OrangeUnion (or Thomas) has no leverage.

Story3 is a regular savings bank -- say AppleBank. Somehow AppleBank does have leverage. If it has $20b deposit, it CAN lend out more than that. What's the real difference between AppleBank and OrangeUnion? I guess answer is the regulation. The central bank gives AppleBank its leverage and central bank has some kind of control over its lending practice.

Story 4 is an investment bank KS. No Fed no FDIC. KS __borrows__ $3b from short term money market, but how can it lend $2b to Shell and then $4b to BP in investment banking deals? Say KS checks are issued from BofA, when both Oil companies take money out of the checks, they will more than deplete the $3b cash KS puts into its account with BofA! The BP check will bounce?

Note KS has to _borrow_ from money market because it can't freely borrow from central bank -- no fractional reserve banking for KS.

No comments:

Total Pageviews

my favorite topics (labels)

_fuxi (302) _misLabel (13) _orig? (3) _rm (2) _vague (2) clarified (58) cpp (39) cpp_const (22) cpp_real (76) cpp/java/c# (101) cppBig4 (54) cppSmartPtr (35) cppSTL (33) cppSTL_itr (27) cppSTL_real (26) cppTemplate (28) creditMkt (14) db (65) db_sybase (43) deepUnder (31) dotnet (20) ECN (27) econ/bank` (36) fin/sys_misc (43) finGreek (34) finReal (45) finRisk (30) finTechDesign (46) finTechMisc (32) finVol (66) FixedIncom (28) fMath (7) fMathOption (33) fMathStoch (67) forex (39) gr8IV_Q (46) GTD_skill (15) GUI_event (30) inMemDB (42) intuit_math (41) intuitFinance (57) javaMisc (68) javaServerSide (13) lambda/delegate (22) marketData (28) math (10) mathStat (55) memIssue (8) memMgmt (66) metaProgram` (6) OO_Design (84) original_content (749) polymorphic/vptr (40) productive (21) ptr/ref (48) py (28) reflect (8) script`/unix (82) socket/stream (39) subquery/join (30) subvert (13) swing/wpf (9) sysProgram` (16) thread (164) thread_CAS (15) thread_cpp (28) Thread* (22) timeSaver (80) transactional (23) tune (24) tuneDB (40) tuneLatency (30) z_ajax (9) z_algoDataStruct (41) z_arch (26) z_arch_job (27) z_automateTest (17) z_autoTrad` (19) z_bestPractice (39) z_bold (83) z_bondMath (35) z_book (18) z_boost (19) z_byRef^Val (32) z_c#GUI (43) z_c#misc (80) z_cast/convert (28) z_container (67) z_cStr/arr (39) z_Favorite* (8) z_FIX (15) z_forex (48) z_fwd_Deal (18) z_gz=job (33) z_gzBig20 (13) z_gzMgr (13) z_gzPain (20) z_gzThreat (19) z_hib (19) z_IDE (52) z_ikm (5) z_IR_misc (36) z_IRS (26) z_javaWeb (28) z_jdbc (10) z_jobFinTech (46) z_jobHunt (20) z_jobRealXp (10) z_jobStrength (15) z_jobUS^asia (27) z_letter (42) z_linq (10) z_memberHid` (11) z_MOM (54) z_nestedClass (5) z_oq (24) z_PCP (12) z_pearl (1) z_php (20) z_prodSupport (7) z_py (31) z_quant (14) z_regex (8) z_rv (38) z_skillist (48) z_slic`Problem (6) z_SOA (14) z_spring (25) z_src_code (8) z_swingMisc (50) z_swingTable (26) z_unpublish (2) z_VBA/Excel (8) z_windoz (17) z_wpfCommand (9)

About Me

New York (Time Square), NY, United States