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A lot of financial transactions and central clearinghouses require participants to post collateral. For example if an insurance company enters into an interest
by dcolkitt 7y ago
A lot of financial transactions and central clearinghouses require participants to post collateral. For example if an insurance company enters into an interest rate swap with a bank, both sides will have to post some percent of the contract's notional value in escrow. This protects both sides from counterparty risk (i.e. what if the insurance company goes out of business and can't pay its side of the swap).
The collateral needs to take the form of low-risk, liquid securities. Usually government bonds. Bringing a big bag full of cash to a derivatives exchange is not accepted. If you're a big financial institution, you have no choice but to buy government bonds. Even if they're negative yielding.
Since 2008, there's been a massive increase in financial regulations. Policy-makers have desperately pushed to make banks and other financial institutions less risky. That mostly means much higher capital requirements and more central clearing. In turn that means the demand for holding high-quality government has exploded.
- pergadad 7y agoIn cas that's not obvious I just want to add that the collateral allows you to only keep a fraction of what you're investing in actual collateral. The exact numbers depend on context, but imagine you buy/hold collateral and for that can loan/borrow five or ten or twenty times as much.
- TheSoftwareGuy 7y agoWhy would a derivatives exchange not accept cash? what are people buying those derivatives with? Furthermore, how could any bond (or anything at all for that matter) be less risky than cash? the market value of a bond may change over time but $1 will always be worth $1. Inflation may change the purchasing power of that dollar but then the exact same mechanism will effect the bonds as well.
- dmoy 7y agoCash has risks: * risk of physical destruction * risk of physical theft * risk of forgery etc etc There's some nonzero cost to accept, handle, vet, store, etc for cash. That's not even including if there are extra reporting laws or other for large amounts of cash, which just adds to the overhead.
- jonathankoren 7y agoThese are all concerns with paper, not “cash” as it’s commonly considered in finance. Have $xx,xxx in a checking account at a national bank. It’s a database entry, not a pallet of pennies. Furthermore, with fractional reserve banking, I sincerely doubt if there’s enough coins and bills in the country to account for the total “cash” in all the accounts, let alone all the assets. Similarly, everyone involved in these transactions have access to the same banking system. There’s no reason you need to fly a C-5 with pallets of Swiss francs around. (Even then, it seemed absurd since both governments could access Swiss banks.)
- JumpCrisscross 7y ago> Have $xx,xxx in a checking account at a national bank At the scales of financial infrastructure, bank deposits are not cash. They are debt issued by banks. The point of collateral is to give a bank’s word weight.
- perl4ever 7y agoOr, based on what I read in financial statements, "cash" and "short term securities" kind of blur together. Cash is more of a general category of things that are suitable to use for similar purposes, than one specific thing.
- dmoy 7y agoSure but then you just introduced a completely different type of risk, which is the collapse of that bank.
- jonathankoren 7y agoBank collapse is pretty rare. Even accounting for 2008, there’s now a de facto government insurance plan for banks. i.e. Too big to fail.
- dmoy 7y ago
- Jabbles 7y agoA large amount of cash is expensive to store safely (fire) and securely (theft).
- llcoolv 7y agoNot only - AFAIR the Colombian Steve Jobs had problems with humidity too - 2.1 billion 80s' USD lost to flooding and rotting is what I would call real liquidity :D And also rats I think.
- seandhi 7y agoIt’s extremely insulting to refer to Escobar as the Colombian Steve Jobs, if that is the connection you are making.
- tdhoot 7y agoI think the answer to both your questions is because there are costs to securely storing cash. That also makes cash risky compared to bonds, where you are not responsible for the security.
- SilasX 7y agoWhy is everyone responding to the question under the same misinterpretation, that it means "cash" as in "physical banknotes" rather than "electronic Euros"? I know the principle of charity is hard sometimes, but come on.
- secabeen 7y agoBecause a bank can go under, and you can lose your money in excess of the insured amount.
- deleted 7y ago[deleted]
- SilasX 7y agoNot if it's a bank that specifically caters to this crowd and doesn't take any of the normal risks associated with lending.
- kgwgk 7y agoThey would have two options: A) keep the euro notes in their vault, which only works if you deposit paper bills in the first place B) keep electronic deposits in the ECB and pay interests to do so In either case if they give back the money to the clients when they ask for it how do you expect them to cover their operating costs (plus the interest they are charged by the central bank in case b)?
- deleted 7y ago[deleted]
- rags2riches 7y ago
- SilasX 7y agoThere's no electronic cash account they can put up? If not, why not, and why can't we enable something like that so people aren't forced to buy bonds in order to hold cash?
- dharmab 7y agoAn account that large would require insurance, management and security/auditing. Stuff you don't need with bonds since the government provides those. I'm sure if government bonds were negative for a long enough time an alternative product would appear.
- dmoy 7y agoDeposit guarantee in Germany is only like 100k Euro. This is for institutions buying tens or hundreds of millions of Euro.
- hsk823 7y agoBut the bonds themselves are issued by the same organization that's also issuing the cash to be circulated in the economy. Cash can lose value as well if it just sits, inflation being the key reason.
- dageshi 7y agoIt would be counter productive to society. Put money in a bank, the bank lends it out, the money serves society buy financing a new business or perhaps consumption but either way it is doing something. Lend it to the government in the form of bonds and they'll spend it on something. If it just goes into the cash account you're describing, it does nothing but exist, in the event of recessions this would be severely dangerous to a countries financial system because it would be the safest place to store your money, safer even than bonds, so at the exact time when the economy needs cheap credit, interest rates would rise as money drains into these electronic cash accounts.
- SilasX 7y agoSo people should be forced to invest their money even if they don't think any of the ventures are worthwhile? And physical cash shouldn't exist either?