Today’s daily writing prompt is the word “float”. In reading up about the various meanings of this word, I came across one interesting one from the financial world.
Say, I draw a cheque for $10,000 from my bank (let’s call it Bank A) and give it to you. You go to your bank (let’s call it Bank B) and deposit it. There will be a brief delay between the time bank B transfers the money to your account and the time Bank A pays the money to Bank B. In effect, Bank B has duplicated the money until Bank A pays it. This effect is called the ‘float’. This is apparently a well understood and regulated phenomenon and affects the money supply of countries.
Back before electronic cheque clearance however, there was a curious practice of fraud known as cheque kiting. Here is how I understand it.
Say I have an account in Bank A for $10,000
I also have another account in Bank B for $5,000
I draw a cheque form my account in Bank A for $12,000 and deposit it at bank B.
At the same time, I also cash another cheque drawn on Bank B for $16,000.
Now, Bank B will honour my cheque believing that it will receive $12,000 from my account in Bank A. So they will still have $17,000 – $16,000 = $1,000 left in my account after my withdrawal.
But of course, Bank A cannot pay Bank B because the account I have there only has $10,000. So Bank B ends up paying me $1,000 more than it can hope to recover. Of course, by the time Bank B realizes this, the perpetrator (i.e. me) will try to be far away.
On the legal side, banks can actually use float as valid money for investment. So if a bank B is waiting for bank A to transfer funds to it, it can invest those funds as if they were already there. Banks can invest this money in government securities. Countries adjust the float rate to trade currency.