Why 4 O’Clock?

Just a little thing here but as such little things often can be, an indicator of something much more important.

The more important bit here being to kill off one of those memes, or perhaps mimetic misunderstandings, about banking.

You don’t have to travel far – perhaps as far as Positive Money – to be told that banks just create money. Someone comes in for a loan, they issue it, that creates money. Which, if we replace the word money with credit has the usefulness of being true. The bank does just issue that loan.

It’s the next bit which so confuses all too many. Which is the assumption that this means that deposits in the baking system don’t matter. Deposits aren’t used to fund loans, see? If banks just issue loans then they’re not funded, right?

There is also that idea that if people just save in cash – bank cash that is, not under the bed cash – then this is wasted. It doesn’t go on to fund anything because bank deposits just don’t matter. Thus this idea that we could just confiscate – sorry, no, tempt into Green Bonds – everyone’s cash savings and life would be wondrous.

One response to this is that if banks just create money then a bank can never run out of money. Which, given that banks do go bust, clearly isn’t true. In more detail, the reason that Northern Rock went bust is because it simply did not have enough cash – bank cash, no under the bed folding stuff – to fund all the loans it had issued.

Another response is to consider this:

Bank customers could soon find themselves turned away from their local branch if they attempt to make cash-based transactions at certain times.

TSB has announced plans to close its over-the-counter services from 4pm across its branch network.

Why 4 o’clock? Why not 4.30? Or 3.30?

Because 4.30pm is the moment at which a bank’s books have to balance – at least in the British system.

Yes, entirely true, they just issue loans willy nilly. They care not a fart in a thunderstorm for funding the loan at the moment of issuance. How many deposits are coming in doesn’t change whether they issue a or many loans in the slightest. At the moment of issuance deposits do not fund loans.

This is because we are sensible about the banking system. It would be difficult if you were sitting there, asking for a mortgage, and the manager had to check that Mr. Jones hadn’t taken that tenner out of an ATM as that was the last tenner needed to fund your £150k mortgage. And yes, taking a tenner out of an ATM is indeed reducing the deposit base of the bank.

So, the whole lot is aggregated. Over a day. The bank tots up how much money it has sent out – loans, but also peeps reducing their deposits by using an ATM, writing a cheque that clears that day etc – and also how much it has received in deposits – cheques paid in, loans repaid, etc etc.

They do this for everything. Every tenner that went out of the ATMs, every billion they lent to some Third World warlord. And this must all balance. So, if they’ve sent out more money than they received in they have to go borrow to balance those books. Equally, if they’re received more than they paid out then they lend out.

This used to be the interbank market, the overnight and so on. Now it’s largely done through the Bank of England. But bank books must balance. Which means that they must gain deposits to fund loans.

And here’s the thing. They must balance at 4.30 pm each day. At which point we can see how Northern Rock did go bust. They’d issued mortgages, they were funding them – short term – through those overnight markets, then one day no one would lend to them in those interbank markets. Byeee!

Banks have entire departments (usually “treasury”) whose whole and complete job is to keep tabs on all of this and to make sure that at that golden moment each day the books do balance.

This also neatly explaining why banks used to close at 3.30pm. Because computer systems were worse back then and it took longer to add up all the transactions to make sure they balanced at 4.30.

TSB is insisting upon 4 pm in order that there’s a simple and definite end to the banking day to allow time for all the addition and subtraction. Seems like something really simple, which it is. But it does illuminate that larger point too. For the only reason to have such a cut off is that deposits really do fund loans, even if only at the golden moment each day.