Reserve Bank and the payments system
- The Reserve Bank holds all digital money
- Each bank would bank with the Reserve Bank
- Individual banks manage individual accounts
- Making transactions between banks
- A worked example
We now look at the bigger picture and explain how the payments system works in the post-reform economy. Understanding the payments system is a pre-requisite for understanding how loan making and investment will take place in the modernised banking system.
It is important to understand that money - at least, 98% of it - now has no physical form. It is merely numbers in computer systems.
With that in mind, it should be remembered that unless you are referring to physical cash, money is never actually 'kept' or 'stored' anywhere. It is only recorded in one computer system or another.
This is important because our modernised system requires some subtle changes to the computer systems used in the banking network, and these changes are easily misunderstood if the nature of money itself is misunderstood.
The Reserve Bank holds all digital money
Firstly, all digital money would be 'held' in a central computer system under control of the Reserve Bank. In the UK the Bank of England already has a computer system, known as the 'RTGS (Real-Time Gross Settlement) Processor', which records the amount of 'central bank money' or 'reserves' in the reserve account of each bank in the UK.
This computer system handles millions of transactions every day, and with a few small tweaks can be used to handle full-reserve banking under the proposals on this website. A similar system could be designed for New Zealand.
Each bank would bank with the Reserve Bank
In the same way that customers might hold personal bank accounts with the ASB or Kiwibank, ASB and Kiwibank (and every other bank) would in turn hold accounts with the Reserve Bank. Each individual bank would have three main accounts (stored in a system similar to the Bank of England's RTGS Processor):
- The Customer Funds Account
This is the account in which all of each bank's Transaction Account funds are held. When a payment is made to a Transaction Account holder by someone at another bank, the balance of this account will increase. When a Transaction Account holder makes a payment to someone who uses a different bank, the balance of this account will decrease.
- The Investment Pool Account
This is the account that the bank uses to receive investments from customers, receive repayments from borrowers, make payments back to Investment Account holders and make loans to borrowers.
- The Bank's Operational Accounts
This is the account where the bank can hold funds for its own purposes - retained profits, own capital, money to pay staff wages etc.
Each of these accounts may be split into sub-accounts to help the bank manage and segment its own funds
Individual banks manage individual accounts
While the Reserve Bank would hold the real 'money' (in digital form), it would not hold any information on individual customers or customer accounts. This would be the responsibility of the individual banks.
The three accounts at the Reserve Bank would be huge 'pots' of money. Legally, the money would belong to the banks (with the exception of the Customer Funds Account, where it would belong to the individual customers).
For its Customer Funds Account, each bank would record the amount of this money that is owned by each and every one of its individual customers, and the transactions made in and out of each customer's account. As a simplistic example, a bank's database may look something like this:
- Mrs K Smith: balance $546.21
- Mr W Riley: balance $1942.52
- Mr J Heath: balance $26.78
The Investment Pool Account is money that technically belongs to the bank, so the bank would not have corresponding records to divide this pool up between customers.
However, each bank would need to keep records of all its 'contracts' and agreements, both to Investment Account holders and to borrowers.
For borrowers, it needs to know:
- the amount lent
- the agreed interest rate
- the date of monthly repayments
- the quantity of repayments to be taken, and so on.
For each Investment Account, the bank will need to have a record of:
- the amount invested
- the date the investment was made
- the maturity date or minimum notice period
- whether the minimum notice period has been exercised
- the interest rate agreed
Making transactions between banks
Understanding the following is not essential to understanding the wider reform. However, an understanding of the following will dispel a few misconceptions and misunderstandings about how the new system works.
In the present day, money is simply information. Consequently, we need to look at computer systems to understand how the monetary system will work.
The first thing that must be understood is that, under the new system, a commercial bank will have no more power to create money than a customer has the ability to log into his or her internet banking and choose their own account balance.
Since all real digital money will be held in the Reserve Bank computer systems, the Reserve Bank gets to determine how the commercial banks can interact with this money. As a result, they can ensure with 100% certainty that it is impossible for money to be created by anyone other than the Reserve Bank, even in digital form.
A worked example
Imagine that a customer, Jack, banks with ASB and pays using internet banking to transfer $400 in rent to his landlord.
- Jack logs in to his internet banking and fills in the landlord’s account number and sort code, the amount he wants to pay, and clicks ‘Make Payment’.
- If the landlord banks with ASB, then ASB will simply adjust its internal records to reduce the balance of Jack’s Transaction Account by $400, and increase the balance of the landlord’s Transaction Account by $400. The payment has now been completed and cleared within fractions of a second. The balance of ASB’s Customer Funds Account at the Reserve Bank remains unchanged, since this was an internal transfer within ASB.
However, if the recipient (the landlord) is at another bank, say the National Bank, then ASB must:
- Reduce the balance of Jack’s Transaction Account by $400.
- Send a message (via the computer system) to the Reserve Bank. The message, in plain English, will read something like this: Transfer $400 from our Customer Funds Account (CFA) to The National banks CFA. Tell National that the payment is for account number 295283742, on behalf of account 192384192 ('Jack Smith'), with the sender's reference 'Here's the rent...'
- The Reserve Bank will then decrease the balance of ASB's Customer Funds Account by $400, and simultaneously increase the balance of The National Banks Customer Funds Account by $400 (in other words, it will transfer $400 from ASB to National).
- The Reserve Bank's computer system will then send a message to The National Bank that will read, in plain English, something like the following: You have received a payment of $400 for Customer Account No. 295283742. The payment was sent from ASB Account number 192384192 ('Jack Smith'), with the sender's reference 'Here's the rent...'
- The computer systems at The National bank would then update their own customer account record by increasing the balance of the landlord’s Transaction Account by $400.
The entire process outlined above could be done in less than 30 seconds, and the funds would have ‘cleared’ instantly and be immediately available to the landlord for making payments to other accounts.
(For those with little experience of computer programming, the above may sound complicated, but in reality the technology behind this process is actually much simpler than the technology that allows you to order a book at Amazon - just a little more heavy-duty to handle millions of transactions a day!)
With an understanding of the post-reform payments system, we can now look at how loans will be made after the changes.