Notes on The role of ADIs in the payment system (Bracoud 2019)

Two forms of money in ADI–non-ADI transactions

  • In transactions between an Authorized Deposit-taking Institution (ADI) and a non-ADI that is not a depositor, two forms of money are involved: central bank deposits (for the ADI) and bank deposits (for the counterparty).
  • The money the ADI uses to settle is central bank money, but the money the counterparty receives is private (bank deposits). This creates a perceived paradox: settlement occurs even though different money types are used. The section explains how this is possible within the payment system.
  • Context: This builds on Appendix conclusions from Chapter 1, which described how a nonbank company’s balance sheet changes with various activities. Here we extend to banks/ADIs interacting with households or non-depositor firms.
  • Key terms:
    • ESF: central bank money used in settlement (the central bank’s settlement money).
    • ESA deposits: a bank’s central bank money balance (its central bank reserves).
    • Deposits: private money held by individuals or nonbanks at banks.

Page 1: Income to a bank from a non-ADI payer (income to the bank when payer is not an ADI)

  • Scenario: A bank receives income (e.g., coupon payments on a bond issued by a non-depositor company). The payer is a non-ADI (e.g., a bond issuer) and not a depositor in the paying bank.
  • Settlement mechanics:
    • The payer uses its bank deposits to pay.
    • When the recipient is in a different bank, the payer’s bank loses ESFs when settling, and the ESFs eventually reach the recipient bank.
  • Balance-sheet updates (L+E notation):
    • Non-ADI – payer (L+E):
    • Bank deposits: $-$
    • Equity (accumulated profit): $-$
    • Bank – recipient (L+E):
    • ESA deposits (bank’s central bank money) : $+$
    • Equity (accumulated profit): $+$
    • Bank of the payer (L+E):
    • ESA deposits: $-$
    • Bank deposits of payer: $-$

Page 2: Bank income in central bank money and reallocation of ESFs

  • Key point: The bank receives its income in central bank money, but this is not new ESFs nor a conversion of bank deposits into central bank money.
  • Mechanism:
    • ESFs received by the bank are existing funds that have been transferred from the payer bank’s ESA.
    • The increase in ESF balances is balancing an increase in equity, i.e., the bank’s income increases its equity (accumulated profit).
    • Net effect on private money: total private money in the economy decreases (since ESFs moved but deposits are not created elsewhere to offset the move).
  • Balance-sheet updates (L+E notation):
    • Bank – recipient ESA deposits: $+$
    • Equity (accumulated profit): $+$
    • Bank of the payer ESA deposits: $-$
    • Bank deposits of payer: $-$

Page 3: Bank expense to a non-customer and the counterparty money flow

  • Scenario: The bank pays an expense (e.g., rent or stationery) to a recipient who is not a customer of the bank.
  • Settlement mechanics:
    • The bank pays using its central bank account.
    • Central bank deposits are not destroyed; they are simply transferred to the recipient bank’s central bank account.
    • Private money in the economy increases; no deposits are destroyed, and the private money stock rises overall. Central bank deposits remain the same in total but are reallocated within the banking system.
  • Balance-sheet updates (L+E notation):
    • Bank – payer ESA deposits: $-$
    • Equity (accumulated profit): $-$
    • Bank of the recipient ESA deposits: $+$
    • Bank deposits: $+$

Page 4: ADI–non-ADI transactions where the counterparty has no deposit account at the bank

  • If the counterparty is a non-ADI agent with no deposit accounts at the bank, the bank’s balance sheet follows the same logic as other economic agents, but with a different form of money (ESFs) involved.
  • Important constraint:
    • Central bank money cannot be used by non-ADIs. Therefore, the bank’s counterparty (non-ADI) needs to create or destroy bank deposits to execute the transaction on the non-ADI’s end.
  • Effect on money stock:
    • These transactions affect the stock of private money in the financial system, while not affecting the stock of central bank money.

Page 4/5: Transactions between an ADI and its depositor (no central bank money transfer required)

  • Concept: When a bank engages with one of its own depositors, the transaction can proceed without using central bank money.
  • Practical consequence: The bank may conduct these transactions without using its own money at all (i.e., internal money creation/deletion within the private money system).
  • Example: Bank is paid income by a customer (the payer is a customer of the bank).
  • Balance-sheet updates (L+E notation):
    • Recipient (the bank) equity: $+$
    • Deposits payer: $-$
  • Interpretation: The income does not bring central bank money; it reduces the bank’s liabilities (deposits) and increases equity, effectively converting debt to equity.
    • extBank−recipientoextEquity(accumulatedprofit):+ext{Bank - recipient} o ext{Equity (accumulated profit)}: +
    • extDepositspayer:−ext{Deposits payer} : -

Page 5: Bank expenses when the recipient is a depositor

  • Scenario: The bank pays rent or stationery to a depositor of the bank.
  • Settlement mechanics:
    • The bank does not need money to pay; instead, the expenses increase the bank’s liabilities (deposits).
    • No loss of central bank money is recorded; central bank money remains unchanged, but the bank’s liabilities (deposits) increase.
  • Balance-sheet updates (L+E notation):
    • Bank – payer (equity): $-$
    • Deposits recipient: $+$
  • Interpretation: The bank finances expenses by increasing deposits (debt to the depositor); equity decreases due to the expense (or retained earnings adjustment).

Page 6: Non-ADI counterparty with a deposit account at the bank

  • Scenario: The counterparty to the bank is a non-ADI agent that does hold a deposit account at the bank.
  • Key mechanics:
    • In this case, no ESFs are paid or received by the bank.
    • All transactions involve a change in the bank’s debt (private money) rather than a change in ESFs (central bank money).
  • Effect on money stock:
    • These transactions affect the stock of private money in the financial system, while central bank money remains unaffected.

Concluding notes on the money system mechanics

  • Central bank money (ESFs) is used for interbank settlements and can be reallocated without changing the total central bank money stock.
  • Private money (bank deposits) can be created, destroyed, or reallocated via interbank transactions and with non-deposit-taking counterparties, affecting the stock of private money.
  • Banks can perform settlements with non-deposit-taking counterparties by transferring central bank money between banking systems, or by creating/destroying private money as needed when central bank money cannot be used.
  • When dealing with own depositors, banks can perform transactions without transferring central bank money, converting debt to equity or increasing deposits as appropriate, which highlights the unique role of banks in monetary liquidity and the creation of private money.

Summary of balance-sheet conventions used in the notes

  • L+E notation used to track changes:
    • Entries shown as: Bank – [party] [type of account] : sign, Equity (accumulated profit) : sign, Deposits payer : sign, Bank deposits : sign, ESA deposits : sign, etc.
  • Signs indicate the direction of change:
    • $+$ indicates an increase
    • $-$ indicates a decrease
  • Example snapshot conventions from the pages:
    • Non-ADI payer: Bank deposits $-$; Equity $-$
    • Bank – recipient ESA deposits $+$; Equity $+$
    • Bank of the payer ESA deposits $-$; Bank deposits of payer $-$
    • Recipient ESA deposits $+$; Bank deposits $+$
    • Payer ESA deposits $-$; Equity $-$
    • Recipient ESA deposits $+$; Bank deposits $+$
  • Core implication: The movement of central bank money (ESFs) often accompanies a compensating movement in equity or private money, ensuring that settlements can occur even when the types of money differ between counterparties.

Practical implications and connections

  • The framework explains how payment systems can settle transactions between entities holding different forms of money without requiring a uniform balance in a single money form at the outset.
  • The distinction between ESFs (central bank money) and private bank deposits is central to understanding how central banks enable interbank settlement while banks create private money through transactions with customers and each other.
  • The analysis links back to Chapter 1’s balance-sheet perspectives on nonbank entities by extending the same logic to banking institutions and their interactions with households and firms.
  • Real-world relevance: This underpins the monetary transmission mechanism, illustrating how central bank money flows and private money flows interact during interbank transfers, intermediation, and common banking operations (rent, income, interest, and payments for services).

Key formulas and notational references (LaTeX)

  • Balance-sheet updates for a typical interbank payment where ESFs move between banks:
    • Non-ADI payer (L+E):
    • Bank deposits: −-
    • Equity (accumulated profit): −-
    • Bank – recipient (L+E):
    • ESA deposits: ++
    • Equity (accumulated profit): ++
    • Bank of payer (L+E):
    • ESA deposits: −-
    • Bank deposits of payer: −-
  • Income to a bank via central bank money (not new ESFs):
    • Bank – recipient (ESA deposits): ++
    • Equity (accumulated profit): ++
    • Bank of payer (ESA deposits): −-
    • Bank deposits of payer: −-
  • Bank expense to non-customer (central bank money transfers):
    • Bank – payer (ESA deposits): −-
    • Equity (accumulated profit): −-
    • Bank of recipient (ESA deposits): ++
    • Bank deposits: ++
  • Transactions with depositor (no central bank money transfer):
    • Recipient (bank): Equity (accumulated profit): ++
    • Deposits payer: −-
  • Bank payment to depositor (expenses):
    • Payer (equity): −-
    • Deposits recipient: ++
  • Non-ADI counterparty with a bank deposit account (no ESFs paid/received):
    • All changes are in the bank’s debt/private money, central bank money unchanged.

Final takeaway

  • The notes illustrate how ADIs and non-ADIs interact in a payment system using two money forms, how central bank money is allocated and reallocated, and how private money (bank deposits) can be created, destroyed, or shifted without a net change in central bank money in certain transactions. The L+E entries provide concrete templates for how these effects appear on balance sheets across different transaction types.