Banking and Financial Institutions

Major Banking Systems of the World

Each country has its own banking system with its own controls for money supply, interest rates, and currency.

Each country has its own banking system. A banking system is a network of institutions that provide financial services to individuals and businesses. A central bank is an institution that manages a country's or state's money supply, interest rates, and currency. Two of the biggest central banks are the European Central Bank (ECB) and the Federal Reserve in the United States.

The European Central Bank (ECB) is the central bank of the European Union countries that have adopted the euro as their currency. The ECB is headquartered in Frankfurt, Germany, and has been responsible for the monetary policy in the eurozone since 1999, when the euro was first adopted by some of the members of the European Union. Since the Governing Council of the ECB has become too large for all members to vote at each meeting, the ECB has a system of rotating voting rights among the national bank governors. The main goal is price stability, or a state in which prices do not change much over time and there is little inflation or deflation. This involves making important financial decisions and guidelines about money objectives, interest rates, and the supply of reserves, or the amount of money banks must have set aside. The ECB is also responsible for bank supervision. Together with the national supervisory authorities of the participating countries, the ECB operates the Single Supervisory Mechanism (SSM), which is in charge of maintaining and streamlining the European banking system. An example of a bank that falls under the ECB's control is the Franco Bank in Paris, France. When changes are made to the policies and regulations in the ECB, they are quickly adopted and followed at the Franco Bank. This helps with price stability.

Another large central bank is the Federal Reserve of the United States. The Federal Reserve is the central bank in charge of setting monetary policy for the nation. It has a central agency (the Board of Governors) in Washington, DC, and 12 regional Federal Reserve banks that are each in charge of their geographic areas. The Federal Reserve is subject to congressional oversight and is tasked with working to achieve the government’s financial and economic objectives. Suppose Ninth Community Bank in Tennessee is a hypothetical bank that falls under the Federal Reserve's watch; the bank must adhere to and follow the regulations that have been put in place by the central bank of the country. Smaller banks such as national banks, for example, which are essentially commercial banks that are chartered under the Federal Reserve, are examples of how the legislation that affects larger banks will also trickle down to smaller banks. Smaller banks can be defined as regional or community banks and these banks serve a specific community or metropolitan area.

The relationship between the Federal Reserve and the U.S. Government is symbiotic in nature. This means the U.S. Government’s treasury department issues bonds in the form of Treasury bonds. These bonds can be issued to the public, banks, and even the Federal Reserve. At the time of bond maturity, the U.S. Treasury pays interest to the public and the banks. However, within the case of the Federal Reserve, interest is paid to them from the Treasury but at the end of the year all interest is remitted back to the Treasury or U.S. Government.

The Federal Reserve bank can and does lend money to banks due to a lower interest rate that banks can experience to spur economic growth and to increase cash flows to business. However, as stated above, the interest collected is ultimately paid back to the U.S. Government, or Treasury, as profits, or interest.

Thus, the U.S. Government issues bonds and pays interest and the Federal Reserve pays back profits, or interest, to the U.S. Government or U.S. Treasury. As a result, the Federal Reserve can and does collect interest but pays this back to the U.S. Government, or Treasury, and this cycle continues so that banks and the public can invest and ultimately lend money to the public to allow for a free and healthy banking system.

In the case of the Federal Reserve Bank, or reserves, these are the reserve balances also called Federal Reserve deposits that private banks keep at their local Federal Reserve Bank. The reason this is done is to protect against certain liabilities to ensure enough money is available to control the monetary supply during inflationary and deflationary periods to stabilize the economy and lending practices. As a result, the Federal Reserve demands that all banks have reserves that can then be issued back to banks to control monetary supply, liability risk, and economic control.

How the Federal Reserve Works

The Federal Reserve works with the government and banks to provide the nation with a safe, flexible, and stable financial and monetary system. The government issues bonds and pays interest and the Federal Reserve pays profits to the government and collects interest, but then pays this back. This allows banks and consumers to invest and ultimately lend money to the public. A continuous cycle between the Federal Reserve, banks and the U.S. Government results in a healthy banking system.
Primarily the same principles for the Federal Reserve system remain consistent when compared to the European Banking system. One difference is that each European government issues bonds and pays interest on those bonds, to banks either domestically or internationally. The banks can then issue bonds to the European Central Bank and similar to the Federal Reserve the Central Bank demands that reserves are also retained to control and minimize cash flows and economic risk. As a result, the Central Bank is paid interest from these bonds by the banks and the profits or interest is paid back to the individual country banks. Thus, the same core concepts from the U.S. Government and Federal Reserve remain true, but the main difference is that the Central Banks act like the Federal Reserve Bank, but for multiple countries. Each country is sovereign in nature and can issue bonds and collect interest from banks. Essentially the Central Bank controls and monitors banking activity and acts as a regulatory agency, similar to the Federal Reserve, to control monetary supply and economic activity that may arise for all European countries.

How the European Central Bank Works

The process of how the European Central Bank works is similar to the U.S. Federal Reserve in that the government issues bonds and pays interest and the European Central bank pays profits to the government and collects interest. The European Central Bank differs in that some of the interest payments spread back to the banking system.