Interbank Relations in the USA

Student: How many correspondent bank accounts do you have?

Banker: We have reserves in six banks. Two of the accounts arc inactive.

S.: Do you use any clearinghouse other than the Fe-

deral Reserve Bank?

B.: Yes, we also get a daily letter from our central bank

in St. Lawrence.

.S,: Are you allowed to make a collection charge on your

items from your central bank?

В.: No. We've agreed to clear them at par.

S.: Will your correspondent banks purchase any in-

stalment loans that you're not licensed to handle?

B.: Yes, any lhat our customers are willing to endorse

to them.

5.: Do they advise you on your investments, like com-

mercial papers and short-term debentures?

B.: Oh, yes. And each week our New York correspon-

dent sends us their report on financial and economic trends, including quotations on listed and unlisted stocks.

S.: And they handle your foreign exchange?

В.: Thai's right.

S.: Suppose I'm remitting by check on your bank an

amount due on my note to a bank in California. Will that bank send the check directly to you for collec­tion?

B.: It could do that. But it'll probably send the check

through the regular channels.

S.: What does that mean?

B.: Well, the bank lo which your check is payable will

send il lo Ihe Federal Reserve Bank in its Reserve
District. The transit dcparlmenl of that bank will
send il to the Federal Reserve Bank in our Reserve
Dislricl. From there it's sent to us. —---

S.: How many Reserve Districts are there?

В.: There are twelve, with one Reserve Bank in each

District. Also, most of our larger banking inslilu-lions like ours are members of Ihc Syslem, and all checks and olher Hems of exchange flowing I hrough the Syslem are cleared at par.

S.: Par means face value?

B.: Yes. And every bank that handles an item endorses

it with recourse.

S.: Does lhal mean lhal if a check isn't honoured by

the drawee bank, it's finally returned to the payee, who is held liable for Ihc amount?

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В.: That's right.

5.: To become member of the System, was your hank

required to subscribe to any slock in the Reserve Bank in your District?

В.: Yes. And, to explain further, all national banks

must be members of the System. Incorporated State Banks, including commercial hunks, mutual sa­vings banks, trust companies and industrial banks, may join the System.

S.: Other than handling items of exchange, what ser-

vices do Federal Reserve Banks offer member banks?

B.: As fiscal agents of the United Stales Treasury, they assist in the issue and redemption of government bonds and the refinancing of bonds that have reached maturity. They'll also accept from us any paper thai can be rediscounled, if our cash reserve becomes low.

Questions on the dialogue:

1. What services do correspondent banks render each other?

2. What are Ihe functions of central banks?

3. If you remit by the check drawn on one bank an amount
due on your note to another bank, what route does your
check usually lake?

4. What does the United States Federal Reserve System con­
sist of?

5. What is the collection charge on checks and olher items
(lowing through the Federal Reserve Banks?

6. Whul does "endorsed with recourse" mean?

7. What does a bank have to do to become a member of the
System?

8. Which banks must be members of the System and which
banks may be?

9. What services do Federal Reserve Banks offer to member
banks?

Dotted about the City, but mostly close to Ihe Bank of En­gland are Ihe eleven discount houses. These relatively small City businesses make their living by borrowing money from those who have it to spare and investing il ij) various easily liquidated paper assets. In particular, they finance the Gov­ernment by buying its Treasury bills each week. To the Bank of England this "covering" of the weekly Treasury bill issue by the discount houses is a useful service. The quid pro quo of this arrangement is that the Bank of England will act as "lender of the last resorl" to the houses, if il so chooses, or buy paper assets from the houses lo provide them'with cash when they can'l obtain il elsewhere.

To understand the role of lender of last resort it is neces­sary first lo have grasped Ihe extremely delicate nature of the discount houses' business. Practically all the money which they invest has itself been lent lo Ihem. Whal is more, mosl of il will have been lent lo them for very short periods of. lime like a week or even overnighl, or else il will be subject

10 recall al very short notice. Using this'sort of money, Ihe
houses purchase bills and even bonds in Ihe open market,
some of which might not be repurchased or redeemed from
them for months or years. This practice is known as "bor­
rowing short and lending long" and can be hazardous. Should
I hose who have lenl lo the houses recall their money, the
houses-would have some difficulty gelling il back in a hurry.
On any given day, each house will find some of ils assets
falling due for repayment and will also receive new loans,
but it quite often happens thai the proceeds of these transac­
tions are insufficient lo provide for all Ihe calls lhal arc made
lhat day by those who have lent to Ihe house. Il is then lhal
Ihe Bank may help in one of a variely of ways. In particular,

11 may offer lo buy back some Treasury bills lo provide Ihe

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necessary money, or it may lend the required sum charging at least the minimum lending rate. This rate is defined as the lowest rale at which the Bank of England will lend and is fixed each week a little above the Treasury bill rate for that week.

The chief sources for cash for the discount houses — often known collectively as the discount market — are the banks, particularly the commercial banks. These are the ordinary High Street banks with which we arc all familiar. Their busi­ness requires them to hold a certain proportion of the money which the general public has deposited with them in a liquid form, that is in the form of cash or some assets which can be turned into cash quickly and without losing its value. For example, a building or something like that is not a liquid asset because it takes lime to sell, a quick sale can only be achieved if Ihc owner is prepared lo see it go at a knock­down price. Loans lo the discount market are ideal from the point of view of the commercial or any other type of bank. They can be at an agreed rale for an agreed period, allhough il can be for as shorl as Ihey like, in which case the houses call Ihem "fixtures", or they can be simply "al call", again al an agreed rale, and Ihen Ihcy can be withdrawn whenever the lender needs them. An important part of the job of the money manager in a discount house is to make sure lhat he has the right balance between fixtures and call money. If there is a general trend in lhc_markel for rates of interest lo rise so that borrowers have lo pay more this week than last and will have lo pay more next week than this, it is in the interests of Ihe house lo persuade inslilutions to lend lo it for fixed periods. Otherwise call money will be quickly with­drawn and offered back to Ihem again al a higher rale! Simi­larly, when Ihc rate in the markel is rising, Ihe houses Ihcm-selves take care not lo make loo many long-term loans, the rale of interest on which will soon fall below the general markel rale. The houses lhat can judge best which way things will go make the grealesl profit.

Questions on the text:

1. In what way do the discounl houses earn money?

2. On what terms is Ihe money lent to the discount houses?

3. How do Ihe discount houses invesl Ihe money lenl lo Ihem?

4. Why can Ihe praclice known as "borrowing shorl and lend-

ing long" be hazardous?

5. In whal circumstances does the Bank of England act as
"lender of last resort"?

6. Why do commercial banks lend money willingly to the
discount houses?

7. Whal are "fixtures" and "call money"?

8. Whal must the money manager in a discount house do to
make the greatesl profil?