Why there is never enough cash in the bank

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

10 April 2016

Brace yourself for the shocking news: according to the 2015 Central Bank of Kenya annual report, on 30th June 2015, the total sum of all bank account deposits in the country was Sh2.583 trillion. At the same time, the total value of all Kenyan currency notes and coins in circulation (that is, in all bank vaults, our safes and pockets and even under our mattresses) was Sh222 billion.

In other words, only about 8.6 per cent of our money was in the form of notes and coins. That is, if we all woke up one morning and went to our respective banks demanding our money in cash, only 8.6% would be available. Over 90% would be turned away! The banking system would collapse and the entire economy would come to a standstill.

What happened? Did someone raid the banks and steal it? Was it used in political campaigns?

Not really; there was no theft and there is nothing to worry about. That is how modern banking systems are. In fact, our economy is quite cash-heavy: in more developed countries, only about 5 percent of their bank balances are available in notes and coins.

To understand how this situation arises, imagine a remote village very far away from any urban centre. Suppose there is no bank and the villagers there do all their transaction using notes and coins only.

Then one day, a bank opens a branch there. Suppose it manages to convince all the villagers to deposit their notes and keeps an accurate record of how much each person has deposited.

In order to win their confidence, the bank keeps all the money deposited in its vault at the branch. That way, any person willing to verify can go in and do so. From then onwards, the villagers will only be withdrawing the cash they need for a particular transaction.

As time goes by, some of the currency notes get worn out and are no longer usable. So the bank takes them out of circulation and keeps them in a separate safe. It keeps doing this until almost all the notes have moved to the second safe.

At that point, the bank picks all the old notes and takes them back to the Central Bank for replacement. But the CBK tells it to wait until new ones are printed. In the meantime, the CBK counts and records the value of notes received from this bank and promptly destroys them to avoid the risk of theft.

Now, back at the remote village, only a small portion of the villagers’ money is held in the bank, but no one is worried because every time they need some cash, they easily get it without question.

The village branch manager quickly realises that she doesn’t need to replace all the notes she had sent to the CBK – after all, the villagers don’t need it! So she informs CBK to only send her a small amount. From that moment, she’ll never have all the villagers’ money in her vault. In fact, it won’t be at CBK either – remember, the old notes were destroyed.

And so it shall be: the villagers’ bank balances will always be more than the notes and coins in their bank. What would happen if they all went to withdraw all their money at the same time? That’s what happened to Chase Bank mid this week. No bank in the world can survive such withdrawals – not even a Central/Reserve Bank!