Overdrafts, Banking Firm Lines, Too Negative Money

This article touches on some of the issues amongst banking concern lending inwards its less good known forms: overdrafts, as well as credit lines. I simply wanted to response to some questions equally good equally some articles yesteryear Nick Rowe.

(As an aside, I believe that the British English linguistic communication spelling would live overdraught. In this case, the Canadian English linguistic communication spelling matches the American -- overdraft. One of the joys of beingness Canadian is that y'all tin convince people on both sides of the Atlantic that y'all cannot spell, fifty-fifty when y'all are right yesteryear domestic standards...)

What Is An Overdraft?

Influenza A virus subtype H5N1 individual or a line of piece of work organization overdraws their banking concern line of piece of work organization human relationship if they somehow take to a greater extent than coin than they had inwards the line of piece of work organization human relationship inwards the outset place. For the depositor, it looks similar they receive got a negative banking concern line of piece of work organization human relationship balance. (My quick scan of the topic suggests that the client would either gear upward off this negative residuum versus positive balances, or else process it equally a liability. Note that nada inwards this article constitutes accounting advice, yadda, yadda, yadda.) This would usually live prohibited, but it could conduct house equally a resultant of odd events.

The exception is the instance when the client negotiates an overdraft amongst the banking concern (before the lawsuit of the negative balance).

• In North America, the entirely fourth dimension y'all tend to encounter this is when customers teach overdraft protection; they tin overdraw upward to a for certain limit. These negative balances typically incur a punishment involvement rate, but the charge per unit of measurement volition live cheaper than the punishment for a banking concern check (see what I said almost Canadian spelling) bouncing due to non-sufficient funds.
• In the United Kingdom, I believe that it is (or at to the lowest degree it was) an accepted practise for overdrafts to live used instead of banking concern loans. The amount of the overdraft was gear upward inwards advance, but the expectation is that the overdraft would live drawn upon, as well as thence the involvement charge per unit of measurement was a "normal" charge per unit of measurement of involvement for that business.

The interesting constituent is that the deposit residuum tin flip sign.

Credit Lines

Credit lines appear real similar, but they are to a greater extent than evidently loans. They are a split account, as well as if y'all depict upon them, y'all by as well as large demand to transfer the residuum out of the credit line line of piece of work organization human relationship to your regular account. (It mightiness live possible to write cheques against the credit line, but I believe the fees would live much higher than for a regular account.)

Since they are inwards a split account, the residuum volition by as well as large e'er live positive, as well as thence at that spot is no work amongst accounting for drawn credit lines equally loans.

What is interesting almost credit lines is when they are undrawn. They effectively are an choice yesteryear the banking concern client to depict on banking concern liquidity, upward to a for certain amount. Therefore, although they create non exhibit upward on the residuum sheet, they are effectively a contingent liability. (Although an property is created when they are drawn upon, the demand to provide liquidity upon demand is non to the bank's advantage.) This agency that the accounting for credit lines is elementary (they are at most of an off residuum canvas memo item), their regulatory affect is much less simple. The liquidity issues that they pose are non easily modelled inwards mainstream economic science as well as finance, which assume an interplanetary space capacity to finance positions.

I am non an skilful on the subject, but regulators spotter bank's credit lines, equally they are 1 of the agency yesteryear which a banking concern tin blow itself up.

These liquidity options are non simply of theoretical interest; they are what allows the non-bank fiscal organization to function. Commercial newspaper (and securities dealing) entirely plant if the issuers receive got backup credit lines at banks.

Why create issuers demand lines from banks, as well as non from other institutions? Because banks tin telephone scream upward on the lender-of-last-resort, the key bank. Hyman Minsky explained inwards Chapter three of Stabilizing an Unstable Economy how Manufacturers Hanover Trust -- a large New York Bank -- refrained from usually lending to bond dealers, but would footstep inwards entirely during an emergency. It was a credible backstop, equally "It was understood that if Manufacturers Hanover ran a reserves deficiency because it financed bond dealers, Manufacturers Hanover would receive got access to the discount window of the Federal Reserve." (page 82).

Therefore, fifty-fifty if the financing is supplied yesteryear the non-bank fiscal system, the formal banking organization is withal required to backstop its liquidity needs. 

Accounting For Overdrafts (For Banks)

I receive got non validated this against the accounting literature, but I believe that nether Generally Accepted Accounting Principles, an overdrawn banking concern line of piece of work organization human relationship would live treated equally a receivable or loan asset. (I did non encounter a line special for overdrafts inwards the U.S. of A. Flow of Funds, inwards whatever event.) However, the number hither is non how accountants bargain amongst overdrafts, but rather inside economical models.

In principle, nosotros could process the overdrawn line of piece of work organization human relationship equally beingness a negative deposit. This negative deposit would cancel out a positive deposit somewhere, as well as the internet lawsuit would live to cut the "money supply." It should live noted that this would piece of work if nosotros simply recast existing accounting statements to the novel convention.

However, it does non piece of work from a behavioural perspective, as well as thence nosotros cannot this in realistic economic models.

• From the perspective of a bank, an overdraft cannot live right away called, spell a deposit tin walk out the door at whatever time. In a organization amongst banking concern reserves, or liquidity requirements, the banking concern needs to concur liquid assets/bank reserves against the positive balances, as well as gets no relief for the negative deposit balances. Therefore, if nosotros tried to cancel out the negative balances, banking concern reserve calculations inside the model would appear incorrect.
• We cannot persuasion transactions equally beingness a transfer of a negative deposit balance. (For example, a seller giving the buyer a goodness addition a negative deposit balance.) We tin transfer claims on a 3rd political party that are inwards the shape of a negotiable instrument, but nosotros cannot transfer claims against ourselves. If nosotros wanted to transfer a debt nosotros owe to a 3rd party, nosotros demand to teach the permission of the lender, equally the 3rd political party mightiness live a greater credit conduct chances than nosotros are.

It should live noted that nosotros create non receive got the right to transfer all debts owed to us to others, entirely negotiable instruments. Influenza A virus subtype H5N1 company that is required to percentage proprietary fiscal data to its banking concern volition non let that banking concern to transfer that loan (along amongst its covenants that laissez passer on it access to information) to a commercial rival.

Red/Green Money

Nick Rowe suggested that overdrafts (and other loans) could live a shape of negative money; normal (positive) coin is "green," as well as negative coin is "red."

He discusses this thought inwards ii articles:

1. Negative money
2. Money demand as well as provide inwards a red/green world.

His framework volition business office -- inwards the globe of a (neo-) classical economical model.

The key to those models is that entities create non default. (If the individual sector inwards your model consists of entirely 1 representative household, who precisely is that family going to default to?) As he notes, inwards his framework, hereafter generations receive got to inherit the debt ("red money") of their parents. However, this machinery does non comprehend corporate defaults nor what happens when those without heirs top on.

In the absence of default risk, my instant objection to treating overdrafts equally negative coin disappears; the entirely remaining objection revolves around reserve requirements (which are typically non imposed inwards models).

Of course, inwards the existent world, people as well as corporations default all the time. Thus whatever model that captures that reality cannot rely on "negative money." (Admittedly, defaults are complex to model, as well as create non appear inwards most post-Keynesian macro models.)

Nick Rowe wrote (in "Negative Money"):

And thence some New Keynesian macroeconomists said that coin didn't be inwards the novel combined world. They said at that spot was no "cash", entirely "credit".

One may greenback an interesting symmetry here. I am attempting to abolish coin from economical models (replacing it amongst credit), spell Nick Rowe is attempting to abolish credit as well as supervene upon it amongst money.

(c) Brian Romanchuk 2016