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Explaining Clearing Drains and Currency Drains

Here is a brief explanation on the nature of clearing drains and currency drains. The applications include part of how banks lend and settle account between each other. Put yourself into a context of the major banks and how they move their money between each other and the central bank (the Federal Reserve if you are based in in the States). But first, some terms.

Intro to Clearing Drain and Currency Drain

Clearing: Loss of cash reserves from one bank to another. We’ll look into both adverse and favorable drains

Currency: Your money, the cash used in transactions. The withdrawal of currency from the banking system into public circulation.

Let’s create a situation where we ask: what allows money to be created?

Public Confidence: The bank only has to hold a percentage of their deposits in reserve (cash). Theoretically, if customers never took money out, the money supply would expand indefinitely as banks continually loaned out their reserves. If the public had no confidence in the banks they would liquidate all their deposits. Since generally that is not the cash in developed economies, the bank need not hold cash reserves on hand at all times to cover all deposits.

Banks will agree or decide on their % of deposits held in form of cash or deposits at the bank. This is called the Desired Reserve Ratio. Currently there are no mandatory reserve ratios for banks.

In reality there is a currency drain, people do keep their money at the bank, do not demand it all the time, but at the same time, still require cash. The currency drain depends on a number of factors including:

a) General income levels
b) Plastic (credit and debit cards)
c) ATM usage
d) Economic uncertainty
e) Seasonal requirements (Christmas)

The currency drain reduces amount the banks have to work with and expand the money supply.

Clearing Drain – Banks gain and lose deposits constantly as customers write cheques (clearing operation). These cheques are later deposited in rival institutions.

A favourable clearing balance over time will allow a bank to expand their money supply, whereas other banks will have a clearing drain (market shore)

Every bank has its own unique situation for loan creation and deposit expansion that depends on such factors:

1) Credit-worthy customers
2) Ratio of cheque to savings deposits

Banks will try to pursue certain clients to with desirable characteristics, i.e. the 55+ age group. Other instruments used to control clearing drains include GIC investments and predictable turnover in accounts.

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