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Banking business and the circulation of money

May 21, 2014 0 Comment

The business relationship between banks and their customers involves depositing, withdrawals, and lending. Deposits are also referred to as bank created money. Therefore, when checking account balance holder deposits cash into his/her account, then it means the customer has sold cash to the bank, which adds the amount of bank reserve, and purchased an additional cash equivalent to the amount sold to the checking account balance. A small portion of the acquired cash (reserve requirement) is usually retained to maintain the increase of the customer’s account balance whereas the remaining large portion (excess reserve) which they lend to borrowing customers as banks’ cash. Excess reserves (banks own money) is what banks use to make loans. Lending is an important business to the bank because it is a profit making process. Lending and withdrawals are two banking services that affect the affects the amount of the total operating reserves. When the lending and withdrawing customers spend the cash acquired from banks reserves in processes are does not require depositing of the cash into banks’ accounts (money circulation), a condition called zero feedback is created. If the portion of the cash is re-deposited into banking accounts, which is normal, a substantial feedback will be the case. Cash in the checking account balance is usually backed with a definite percentage of required reserve of the amount of the deposit. Therefore, when the customer withdraws the cash he will get the cash plus the required reserve backing (feedback ratio) it resulting to a leak. A portion of the money withdrawn or lend (in circulation) can get back into back accounts and is referred to as feedback ratio. The other portions that persist in circulation also result to a leak. A leak is the reduction of banks operating reserve; therefore, reducing the reserve ratio and conditions that favors higher feedback ratio reduces leaks. As a result, the excess reserve will be higher and this will allow more lending, hence, banks will be making profits in the process. On the other hand, the dangers of excess reservation is that banks will be forced to use large amounts of reserves to maintain the customer account balances and this will shrink the amount that banks can lent, hence, they will make little money. Therefore, it is dangerous for customer to return unusually large sum of money within a short period same as to withdraw large sum of money in the same manner, since filling up and wiping out the bank reserve makes it bankrupt.

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