Understanding Finance from scratch

Chapter 14 Who is in charge of handling our "money" - learn something about financial institutions every day (1)
Central Banks: Lenders of Last Resort

Remember the story about the bank on the island that I told earlier?The story can continue to be told: after the emergence of the bank, it can ensure that the exchange activities are carried out more continuously. Everyone is desperately producing, and there are more and more things on the island. The bank keeps printing banknotes according to the production quantity of the products. In order to ensure that the exchange can be carried out more deeply.

Later, people's exchange activities became more frequent, and there were too few banks, so many banks appeared, and there must be someone in charge of the bank, so a banknote was designated to manage other banks, and banknotes could only be printed by this bank, and then passed through Other banks lent money to those who needed it, and the central bank appeared in this way.

We can see from the story that the central bank is a bank that manages general commercial banks. So, what does a country's central bank do?How did it come about?What is the role of central banks?Why does it have so much power?

Whenever the interest rate of commercial banks changes, we always hear reports that the central bank announces when and how much to cut or raise interest rates, or at some point to increase the statutory deposit reserve ratio, etc. From here we can see The central bank exists to ensure the stability of a country's currency and the security of its financial system, and it does not aim at profit.

Handling "deposit, release, and remittance" is still the main business content of the central bank, but please note that the business objects of the central bank are not ordinary enterprises and individuals, but commercial banks and other financial institutions.As a financial management institution, this function is embodied in three aspects: centralized deposit reserve, final lender, and organization of national liquidation.

Let's take a look at how central banks are described in economics textbooks:
The central bank is the "bank that issues currency" and plays an important role in regulating the money supply and stabilizing the currency value.

The central bank is the "bank of banks" that centralizes the reserves of banks and makes loans to them, acting as a "lender of last resort".

The central bank is the "bank of the country". It is the maker and executor of the country's monetary policy and a tool for the government to intervene in the economy; at the same time, it provides financial services for the country, acts as an agent for the treasury, issues government bonds, and raises funds for the government; represents the government Participate in international financial organizations and various international financial activities.

The main businesses of the central bank include: currency issuance, centralized deposit reserves, loans, rediscounts, securities, gold and foreign exchange funds, transfer and liquidation of funds and transfer of funds for commercial banks and other financial institutions.

The central bank is the bank of the country.This function is mainly manifested in the following aspects: Acting treasury; issuing state bonds; providing credit support to the state; keeping foreign exchange and gold reserves; formulating and supervising entertainment related financial management regulations.In addition, the central bank also represents the government to participate in international financial organizations, attend various international conferences, engage in international financial activities and sign international financial agreements on behalf of the government; in domestic and foreign economic and financial activities, it acts as a consultant to the government, providing economic and financial intelligence and decision-making suggestion.

As a bank of banks, it only accepts deposits from banks and only makes loans to banks.Commercial banks can borrow from the central bank when they need funds.We call this role of the central bank "lender of last resort".In other words, when there is a crisis of shortage of funds, the central bank is the last resort.Since the central bank does not deal directly with the public or companies, you will hardly see its branches.

But one role of the central bank that cannot be ignored is to protect you and me as depositors while maintaining the safety of the financial system.Then let me ask again, how can the central bank prevent this phenomenon from happening and protect the interests of depositors?

The first is to strengthen the supervision of commercial banks.As the higher authority, the central bank can inspect the operation of commercial banks at any time.If commercial banks break the law seriously, the central bank can revoke their business licenses.

The second is to provide insurance for depositors' deposits.For example, in the United States, the Federal Reserve, which exists as the central bank, stipulates that deposit insurance for depositors is 10 US dollars. In 2008, the financial crisis occurred in the United States. In order to prevent a large number of bank failures due to bank runs, the Federal Reserve temporarily increased the insurance amount to 25 US dollars.

Finally, it is to set a statutory deposit reserve ratio for commercial banks.The so-called statutory deposit reserve ratio means that the central bank stipulates that the bank cannot lend out all depositors' deposits, but must use a proportion of them as reserves and deposit them in the central bank forcibly, so that when depositors come to withdraw money, the bank has money Pay him, we call the money that is mandatory deposited in the central bank according to this example the statutory deposit reserve.What is this ratio?Central banks can adjust at any time.

Central Bank: Issuer of Currency

Take out any RMB from your wallet, and you can find the words "People's Bank of China" on it, which is the issuing bank.Of course, if you have foreign currency, you can also see "European Central Bank" printed on the euro banknote, and "Bank of Japan" printed on the Japanese yen.Banknotes are printed and issued exclusively by the central bank, which is true in many countries, but why is it so?
In China, there are laws and regulations: no unit or individual may print or sell token coupons to replace RMB circulation.This means that no matter banknotes or coins, no matter main currency or auxiliary currency, they are all issued by the People's Bank of China in a centralized manner, and the People's Bank of China has the monopoly right to issue currency.In addition, the Ministry of Finance, other financial institutions, and any other unit or individual have no right to issue currency and substitute currency.In other words, the central bank enjoys complete currency issuance power.

Of course, those who have rights also have obligations. The obligation of the central bank is to manage money on behalf of the government and maintain the stability of the currency value.A citizen of a country holds its own currency, and he will demand that the money in his hand be able to buy things of sufficient value.The task of ensuring the full value and stability of the currency falls to the central bank.

The central bank issues a country's currency, and the stability of the currency value is an important indicator of the health of a country's economy.If a country's currency is appreciating, it means that the country's economy is doing well.If everyone recognizes you and comes to ask for your currency, your currency will appreciate; if everyone doesn’t believe you and they all sell your currency, of course your currency will depreciate.Therefore, currency marks the economic strength of a country, and it is a symbol of confidence. People are willing to want this currency because of its full value and stability.If there are too many currencies in the market, prices will naturally rise.For example, in Zimbabwe, an African country, during the years when Robert Mugabe was president, the central bank continued to print banknotes, and more than 50% of the government’s income came from minting revenue from issuing banknotes.The result was skyrocketing prices—prices doubling every hour.

So how to prevent the central bank from issuing banknotes indiscriminately?Currency issuance systems in various countries vary in content due to different national conditions. The core is the difference in the principle of setting up issuance reserves.Issuance reserves are generally divided into two types: one is cash reserves, including gold and silver bars, gold and silver coins with full monetary value, and foreign exchange balances that can be directly used for currency settlement abroad.The other is guarantee reserve (also known as credit guarantee), which uses government bonds, fiscal short-term treasury bills, short-term commercial bills and other assets with high liquidity as guarantees for issuance.Historically, there have been five basic types of currency issuance reserve systems:

The full cash reserve system is also called the simple reserve system, that is, the issued exchange certificates and bank notes must have full cash reserves, and the face value of the issued paper currency must be equivalent to the value of cash such as gold and silver. In fact, this paper currency is only A direct substitute for metal money, only for the convenience of circulation.This system is only applicable in the age of metal currency.

The partial reserve system is also known as the partial credit issuance system, the direct limitation system of the issuance amount, and the maximum guarantee reserve system.The partial reserve system first appeared in the United Kingdom. Its main point is that the state stipulates the maximum amount of credit issuance of bank notes, and the excess part must have [-]% cash reserve.With the concentration of distribution rights, this limit can be increased within certain limits.

The indirect restriction system on the amount of issuance includes: the securities depository system, that is, the issuance of national securities as a guarantee. The system, that is, the credit issuance limit stipulated by the state, and a certain issuance tax must be paid for excess issuance approved by the government. This system was adopted in Germany in 1863; the proportional reserve system, that is, it is stipulated that a certain proportion of cash reserves must be provided for the issuance of banknotes, such as in 1875. The Federal Reserve Act of the United States.

The maximum issuance system is also called the statutory maximum issuance system, that is, the maximum issuance amount of bank notes is stipulated or adjusted by law, and the actual issuance amount and cash reserve ratio are controlled by the central bank.France has adopted this system since 1870.

Commodity full value guarantee system means that a large number of commodities put into circulation at the planned price are used as the guarantee for the issuance of banknotes.In China, it is expressed as "a hundred things standard system". Before the end of the 20s, most of the Soviet Union and Eastern European countries had adopted this system.

The implementation of the above issuance reserve system can ensure to the greatest extent that the central bank cannot issue banknotes indiscriminately, thereby maintaining the stability of the currency value.

And managing money for the government is actually acting as an agent for the treasury.The most important source of funding for government spending is taxation.Taxation is managed by the Ministry of Finance, but the Ministry of Finance cannot put the money in the office building of the Ministry of Finance, but also deposits it in the bank.Which bank does the Ministry of Finance deposit the money in?The Treasury can only deposit money in the Central Bank.The revenue and expenditure of the Ministry of Finance are carried out through various accounts it opens with the Central Bank.

Finally, let's talk about the procedures for setting the total limit of currency issuance in RMB issuance.The total limit of currency issuance is the maximum limit of currency occurrence within the planning period (usually one year). It is proposed by the People's Bank of China through the preparation of the national credit plan and cash plan according to the actual needs of the country's economic development. After submission to the State Planning Commission in the The annual national economic plan is approved on the basis of comprehensive balance, and is implemented after being reported to the State Council for approval.The total quota of currency issuance is a mandatory national economic plan indicator, which must be strictly observed and effectively implemented.This is the most critical procedure of currency issuance.

Central Bank Independence: A Delicate Tradeoff

We often hear economists calling for central bank independence.What does it mean?It means that the central bank cannot take orders from the head of the government casually, and must be relatively independent of the government.For example, in the United States, the Federal Reserve cannot just obey the president of the United States; in the UK, the Bank of England cannot just obey the British Prime Minister.If the central bank were completely at the mercy of the executive branch, the consequences would be severe.

In fact, in the early days of the emergence of the central bank, no one paid attention to the issue of independence. During the period from the First World War to the early 20s, the central bank was basically not independent, but only existed as a functional department of the government and a means of regulation.This is mainly due to the need to raise war funds for the government during the war and the need for economic recovery after the war. The government increased its control over the central bank, thereby expanding currency issuance and stimulating economic growth.This has caused inflation and economic crises in many countries.Especially in the 70s, the emergence of the worldwide economic crisis and the popularity of the theory of state intervention in the economy led by Keynes greatly weakened the independence of the central bank.During this period, at the two international economic conferences held in Brussels in 20 and Geneva in 30, the central banks of many countries proposed to reduce government intervention and implement the idea that the central bank should be independent of the government. , German National Bank President Schneider, US Federal Reserve Chairman Storren and others all support this view.This is the first time in the history of the development of central banks that the issue of central bank independence has been raised.

Maintaining the independence of the central bank is a major trend in the world today. Countries with a high degree of central bank independence often have a single regulatory agency, and the central bank is the competent department of the financial industry.In countries with a federal system, such as Germany and the United States, or in countries with less independent central banks, such as Italy, France, Japan, Canada, and Switzerland, regulators of the financial industry are bullish.

From the perspective of legislation, the central bank laws of many western countries clearly endow the central bank with statutory responsibilities, or grant the central bank considerable independence in formulating or implementing monetary policy.As stipulated in the West German Bundesbank Act, "In order to fulfill its mission, the Deutsche Bundesbank must support the general economic policy of the government, implement the powers conferred by this law, and be free from interference by government instructions."The powers of the central bank under the Federal Banking Act are very broad.Rediscount, reserve policy, open market policy, etc., the Commonwealth Bank can independently make decisions.In the Bank of Japan Law, it has been mentioned many times that the Bank of Japan is subject to the supervision of the competent minister (only the Minister of Finance).It also stipulates that "when the competent minister deems that the Bank of Japan is particularly necessary to complete the task, he may order the Bank of Japan to handle necessary business or change the terms or other necessary matters."These regulations are consistent with the affiliation of the aforementioned Bank of Japan.In terms of independence, the Bank of Japan is smaller than the Deutsche Bundesbank.

From the perspective of the capital ownership of the central bank, its development trend tends to be owned by the government.At present, the capital of the central banks of many western countries is owned by the state, mainly the United Kingdom, France (the central banks of the above two countries were nationalized after World War II), the Federal Republic of Germany, Canada, Australia, the Netherlands, Norway , India and other countries.In some countries, the share capital of the central bank is jointly owned by public and private, such as Japan, Belgium, Austria, Mexico and Turkey.In other countries, although the central bank is under the jurisdiction of the government, the capital is still owned by individuals, such as the United States and Italy.Where private holdings of central bank shares are permitted, there are generally some restrictions on private equity.For example, private shareholders of Bank of Japan only receive certain dividends and do not enjoy other rights.Italy only allows certain banks and institutions to hold the shares of Italian banks, and the shares of the Federal Reserve Bank of the United States can only be held by member banks.The gradual nationalization of central bank capital or strict restrictions on private shares is mainly due to the following considerations, that is, the central bank mainly serves the national policy, and private interests cannot be allowed to occupy any special status in the central bank.

Judging from the history and appointment of the central bank's president, the government, as the sole or major shareholder of the central bank, or even when private individuals hold all of the central bank's stocks, the government generally has the power to appoint directors or presidents.As for whether the government has representatives to participate in the central bank council or how much authority the government representatives have, there are great differences among countries.Generally speaking, there are the following situations: ①There are government representatives in the central bank, who have no involvement in the formulation of central bank policies, such as the United Kingdom, the United States, the Netherlands, Austria and other countries; ②The government has representatives in the central bank, These representatives have different rights to speak, vote, veto and suspend execution.In the Bank of Italy, the government representative has more power.In the Bundesbank and the Bank of Japan, government representatives have a voice, not a vote.

But everything must be viewed from both sides. The central banks of various countries should strive to maintain close cooperation with the government, because the country's economic policy and monetary policy are inseparable.If the independence of the central bank is overemphasized, it is easy to get out of coordination with the government.For example, the global financial crisis triggered by the US subprime mortgage crisis has had a great impact on the economies of many countries. In this financial tsunami, comments accusing the Federal Reserve of making mistakes can be seen everywhere.Before this crisis, the Federal Reserve implemented long-term low interest rates, relaxed the control of financial innovation, and various financial derivatives entered the market. However, the entire market was built on the basis of subprime loans, which greatly increased Instability in financial markets, once subprime lenders default, will cause turmoil in the entire market.

The central bank cannot be independent, but it cannot completely lose its independence, otherwise the government will rely too much on the bank and cause excessive fiscal issuance.Therefore, how to maintain the relative independence of the central bank is a very important issue.

Commercial banks: financial network all over the country
There are hundreds of households living on a small island. This small island is isolated from the world, and people rely on exchanging items to make a living, but sometimes what you exchange in your hand is not necessarily what the other party wants. What should you do?So people used gold and silver, which they all liked, as exchange items, so the exchange was convenient.However, gold and silver are subject to wear and tear and are inconvenient to carry. When the exchange activities are frequent, they find that this thing is too cumbersome and limits the exchange activities. So in order to solve this problem, they thought of a way, that is, the administrators of the island issue a Symbol, use it to replace gold and silver, so banknotes appeared.

(End of this chapter)