If you have heard any news from the UK in the past few days you would know that the savings bank Northern Rock has had people lining up to take their hard earned savings out of the bank and move them elsewhere. I was lucky enough at the weekend to talk to Ben Costella who is a financial consultant in the UK and understands exactly how all of this works.
Ben told me that a bank has to hold funds that are in the region of 10% of what their current lending is. This means that every time the bank lends out $100 they have to top up their reserves with $10. This is the way that banks work.
Banks have from the beginning of time been using this system, however due to there being a little bit of panic in the US market at the moment with over lending on mortgages and credit the banks have stopped lending money to each other. So now when Chase go to MBNA and ask them to top up their reserves the answer is no. This means that the banks have to borrow from the central funding that is available should they need it.
Central funding in the USA comes from the Federal Reserve and in the UK it is from the Bank of England. The reason that the Northern Rock currently have thousands of people lining up outside their branches all across the UK is because they asked the Bank of England for funding to top up their reserves. In the past this has been a sign of a bank being in financial difficulty and people have put their trust in the banks and lost a lot of money.
So now it has happened again people want to take their money from Northern Rock and place it somewhere safe, however there is a large amount of distrust in the UK when it comes to banks at the moment and the government are doing all they can to keep people calm but banks don’t get into financial difficulties unless there is something wrong.
Looking at this from a different angle it is something that happens all the time all around the world banks in Spain and Italy also borrowed from central reserves in the past few weeks in order to keep their top up reserve in touch. The difference being in the UK the last time a bank was in a serious financial state was the demise of Bearings bank back in the 1980’s where the bank went bust due to what they claimed was a rogue trader rather than their borrowing but they were topping up from the Bank of England on a regular basis.
So with Northern Rock facing a lot of questions over the coming weeks there could be more problems to come for the worlds economy due to the borrowing habbits that banks allow us all to participate in fairly freely.Immobilienmakler Heidelberg Makler Heidelberg
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Source by Steven Turner