why do central banks pump money to comercial banks

[woody234]

In the news today the US and  UK and EUROPE central banks pump 180 billion US dollars to commercial banks to improve liquidity because the commercial banks are not lending to each other at the moment

1 what are the commercial banks actually doing with the money the central banks  are lending them,  ie are they just buying more bad debt or are they buying themselves the latest ferrari or aston martin and a new flat screen tv 

2 why do commercial banks have to lend money to each other

[Anton Redman]

2. First - Banks lend the money which is on current account with them out as long term loans to companies and people who buy things like industrial plant retail premises etc with them as well as houses cars etc. Individual banks have customers whose daily cash flows differ. On the Day Bank A has more money because customer B has received a cheque from its client C then bank D who is used by client C has less money.  At close of business there is a market in overnight money between the banks so that they balance their books and make a margin on their net deposits (larger companies and individuals can also participate)

1. Second. The banks are now loath to do this because they do not trust each other and are not sure who will go broke next. In banking terms this is usually being unable to borrow enough money to appear solvent. BCCI the last major retail bank to fall over I believe eventually repaid its debts it was just to close to the edge for the regulators. If the banks cannot or will not lend to each other they will have to reduce their lending very quickly. The main consequences of this would be:

1.      A huge credit squeeze, which would stop people spending, which would reduce tax revenues and cause job cuts and drive the country into a classic recession.

2.      Large short term job losses as banks tried to save cost to meet their reduced income

3.      Because of the above the Government would be highly unpopular

 

Pretty sure JK Galbraith ‘History of Money’ is still available ditto Tales of Ordinary Madness but will check. Both are good reads. I cannot believe I just spent 5 minutes typing this.

[Logan]

In essence central banks attempt to restore confidence to the financial markets. Without confidence institutions and investors head for safe havens such as gold.

Without investment in capital markets the whole financial system grinds to a halt and heads south.

Confidence is everything. Confidence that if you risk your money in investment it will not be lost and you will receive a return relative to that investment.

So when central banks pump money into the market they are sending a message that all is well and life as we know it has not ended.

Remember financial market people inhabit a different space on the planet to you and me.

[woody234]

1  what do you mean  "there is an market in overnight money between the banks so that they balance there books and make a margin on there net deposits"  and off course bank D will have less money in its bank because its paying the cheque to bank A

2 the problem with banks lending money to each other is when they stop lending money and then "someone" says "bank A what are you worth today my friend" like lehman brothers and lehman says we have total assets of 690 billion US dollars  but then "someone" says" but is that good debt or bad debt" then  lehman says " we dont know but can you lend us 100million" then  "someone" says I will buy you for 100million in a few days time when you go bankrupt, so in the future will it still be important for banks to lend money to each other