I'm sure this is an interesting article, but not only is my "article limit" reached, but I even can't login to read it.[0] Which is strange, given the hundreds of dollars per year I give The Economist to support them.
If you want to stop people from stealing your articles, maybe give the paying readers access would be a start.
Basically a bank which takes deposits from customers and then deposits the money at the Fed whereby earning a higher interest rate than the customer just depositing at a "regular" bank.
The problem is, the Fed would have to drop rates costing all the banks and reducing liquidity and removing the reason it exists for in the first place, which is being lender of last resort.
It offers preferential rates to banks as they are cooperative agents. It is not running at free market rates.
If it were to open to free market, Fed would have to adjust the rates until it matches the reserve...
Unlike most agents on the market, Fed is free to deny you.
> drop rates costing all the banks and reducing liquidity
Lowering rates raises liquidity. It makes it easier to borrow and thus create money.
> removing the reason it exists for in the first place, which is being lender of last resort
The Federal Reserve has many functions, one of which is acting as a lender of last resort [2]. Acting as a central bank, i.e. managing the country's monetary policy, is its primary purpose. Addressing bank panics, facilitating transfers, and regulating financial institutions are secondary roles (albeit very important ones).
In any case, reducing the interest paid on excess reserves does nothing to the Fed's standing. For most of the Fed's history, excess reserves were not paid special interest. It's a novel monetary policy instrument, and one still very much in its experimental phase.
> It offers preferential rates to banks as they are cooperative agents
The Fed pays 1.95% on reserves [2]. That is 5 bps less than what the Treasury pays to hold your money for one month [3]. It's 3 bps more than the average Fed funds rate, but within the 175-200 target range and less than the 2.1% 99th-percentile rate [4].
There is the usual misinformation in this article. Banks don’t loan out deposits. Originating loans expands their balance sheet. Deposits are useful to satisfy reserve requirements, when they exist[1], but if the loan is profitable the bank can always borrow the reserves at a lower rate on the interbank market.
I vividly remember trying to explain this to people during the financial crisis and people not being able to grasp it. I only learned it from being friends with an accountant who worked for a big bank.
Banks have always loaned out deposits, that's just what they do elsewise they'd be money warehousing operations and there'd be no fractional-reserve banking cartel.
I think there's a bit of a subtlety in the parent comment that you may be missing, because the "banks don't loan out deposits" is a reference to fractional-reserve banking.
That's the whole basis of fractional-reserve banking, banks loan out deposits while keeping a small percentage on hand (last I cared to check it was 10%) to meet their reserve requirements.
Without deposits banks couldn't loan out anything since they couldn't meet their reserve requirements and they'd basically be insolvent.
So, true, banks don't loan out 100% of deposits but they certainly do loan out deposits.
No, that's not correct at all. It does mean that the back loans out an amount of money equal to 90% of its deposits. In some sense it's not the "same" money because the deposit amount is counted as money in its own right... both the amount of money in the loan and the amount of money in the deposit is counted as "money supply".
The 1000% figure comes from the fact that the money that the bank loans out is in turn held in another deposit account somewhere, and so it has a cascading effect... I deposit $100, my bank loans out $90 to person B, that money gets saved in a bank which can then loan out $81, then $72.9 gets created somewhere else. 1000% is just the limit of the sum 1 + 0.9 + 0.81 + ...
Except that fractional reserve banking is not a real thing though. Most central banks have zero reserve requirements. Even when there are requirements, they are for only certain types of loans, and often those reserves need to be met way in the future.
The amount of money created is the entire loan amount. The full deposit still exists in addition to the loan. What the reserve ratio does is create an upper bound on how much new money the bank can create (before it needs more reserves).
It also says that this bank’s customers would be other financial institutions, but why they would need it is unclear, if they could also deposit their reserves with the Fed.
I'm not the GP here but his point is that actually the bank in general does not loan out deposits[0].
Instead, the bank creates money at the moment a counterparty agrees to borrow it (in countries with a certain type of financial system, aka most countries today, with some interesting exceptions).
The name for an institution that loans out deposits is "credit union," but most people think that's what a bank does.
Most people are very surprised by this claim that ordinary banks create money, and deny it when you tell them. But really there's no coverup of this fact, it's written e.g. literally on the websites of most central banks such as e.g. [1], wherein the critical passage (in boldface on the first page) is:
"Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money."
This seems unjust to most people, since in our daily experience, money is not a thing which is very commonly created. I take no position on that alleged injustice here, and instead leave it as an exercise for the reader to reason out the consequences of a private-bankers-printing-money themed financial system (of which consequences there are many) and to ponder the identities of the people doing most of the printing.
[0] Sometimes it actually does turn out that a bank loans out a deposit, as the GP mentions, but this is by construction a small fraction of bank business.
> And is there a special license for being allowed to create money?
The difficulty is not in letting people make accounts and setting balances on those accounts. The difficulty is getting everyone to not immediately withdraw the entire balance as cash.
There are regulatory hurdles, but they're very much secondary.
Right. And you can make a balance+loan agreement with someone if you want. The issue is trying to hang onto the money while also loaning it out.
If everyone immediately took loans in cash form and they never got deposited back to banks, then banks wouldn't be able to create money via loans either.
Yes, my point is they're not untethered to the deposits. The money is synthesized via the leverage (reserve) ratio. A bank with $100 in deposits gets to lend out $1000. But they don't get to lend out any arbitrary figure that they choose.
You can’t actually know how much a bank can lend from the amount of reserves or the amount of deposits they have - how much they can lend is actually based on the amount of capital.
The way banks create money is as follows: you lend a bank X, the bank then lends 9x X and calls the X you gave them "reserves". The reserves don't get lent. If you want to know where the 9x X comes from, the answer is: thin air.
Banks count on (depend on!) there not being a run on the banks, and they count on borrowers to not default at a higher-than-expected rate. As long that is the case, the banks thrive, the borrowers thrive, and the savers thrive. If however, the economy tanks hard enough, then too many borrowers go broke, savers get scared and ask for their money back, and the banks go bust.
That’s called the ‘money multiplier model’, and it’s a popular but incorrect model.
Banks lever capital (paid up shares and retained profits) to create money for loans, not deposits. Existing deposits are funding for interbank settlements (for transfers).
The amount of reserves the bank has doesn’t actually affect lending one bit - it does affect liquidity but most countries don’t even have reserve requirements because banks can just borrow reserves from other banks or the lender of last resort (central bank) if they need to. The main bank regulation now is capital adequacy ratios.
While this is technically true, the statement does not do justice to the real economical case. You start pulling out the banks funding (i.e. deposits, interbank loans etc.) and the bank must start to liquidate its assets (i.e. loan book). In practice it is perfectly fair to say that bank uses deposits to fund its loan book, and thus saying that bank loans out deposits is not that wrong.
It's a bit like we having a lunch but you forgot your wallet. I pay your lunch and when we get back to office you pay me back. Then I start running around and telling that I paid your lunch. Yes, technically true, but not quite representative of practical economic reality.
I agree and thank you for the instructive clarification. Obviously banks can and do fail, so there are limits to their money creating ability. I'd like to expound a bit in the hopes of sharing and gaining knowledge.
I agree that in practice statements like the above are acceptable, but in an erudite paper like the Economist, when the article is discussing banking licenses, I expect a higher level of precision.
Part of the trickiness here is that even electronic reserves[1] and deposits are really different data types. There is something a lot like automatic boxing and unboxing between the two types that greatly confuses casual understanding of the operational realities of the banking system. When one withdraws paper notes from a bank, not one but two accounts are debited[2]: one is the deposit account, which is the one the customer sees, and the other is the institution's reserve account. Getting a grasp on these mirrored transactions was hard, and communicating that is even harder. I'm afraid I'm probably failing here too.
Edit: Similarly, creating deposits is a lot like a malloc(), and extinguishing those liabilities is a lot like a free(). I'd bet money the banking system actually is Turing complete.
Edit edit: It's also interesting that banks usually need reserves to clear inter-bank transactions rather than to meet reserve requirements. This is because inter-bank transfers (like depositing a check from another bank with yours) are also dual operations that involve both reserves and deposits. While a bank can create a million dollar loan without any reserves at all, they can't clear a $20 check drawn on their bank without at least $20 in their reserve account at the end of the business day.
[1] Reserve notes are the only form of reserves the vast majority of citizens ever hold. However Fed members can hold reserves in an online account.
> While a bank can create a million dollar loan without any reserves at all, they can't clear a $20 check drawn on their bank without at least $20 in their reserve account at the end of the business day.
That is an important distinction to grasp. When people say that banks can create money from nothing, that means banks can create liabilities from nothing. But that can anyone do. I can write on a piece of paper that beefield pays 100 dollars to anyone holding this paper, and I need no reserves, no money, nothing but a pen and piece of paper to make that. And that is exactly what happens when bank "creates money". Bank says that some future day bank pays account holder money. And exactly as little as I can create the money that I would use to actually pay my liabilities, banks can't create money to pay their liabilities off.
> While a bank can create a million dollar loan without any reserves at all, [...]
Wait, what? I thought a bank cannot hand out any (book) money without backing [1]. I.e. if they want to loan me a million dollars by crediting it to my account, they have to balance that by "borrowing" the million from another bank or the central bank.
In other words, my bank account does not really sit at my bank. They cannot create money or a loan by just writing to a database [2]. And the other way around is also true: they cannot take (electronic) money. If I wire transfer money into my account, they don't just make an electronic note of it. They have to, in the same instant, deposit the money at another bank. It's always the case that another third party C makes the note "customer A deposited money into bank B's account at bank C". In a sense, the whole banking system is built on distrust.
This is the reason why, at least in Europe, banks "have to" "deposit" money overnight at the ECB, even if it costs due to negative interest rates. It's not a thing they conciously can or cannot do, but taking or lending (book) money always involves an upstream bank - unless it is cash of course.
[1] That might not be the right term. Financial English is not my strength :-)
[2] It would be an interesting model if individual banks could actually create money and anti-money, like the Dirac see model where an electron and a positron are spontaneously taken from the vacuum. Although you would have the same problem with the infinite vacuum energy, which would correspond to inflation I guess...
A bank is absolutely free to create the loan from nothing apart from your promise to pay it back.
Loans are 'backed' by capital (paid up shares, retained earnings, etc). They have to have enough capital to cover at least 8% of the amount of the money they have created by lending with the recent Basel 3 rules.
What the bank is doing is managing IOUs. You do not store money in the bank, and the bank does not loan stored money. When you deposit money in the bank, they take it and give you an IOU (bank credit). When you loan from the bank, you make an IOU to them (loan), and they give you an IOU (a new deposit in bank credit). When you make a withdrawal, you're exchanging one of those IOUs (credit) to cash. When you make a transfer, they reduce their IOU to you, and then either increase an IOU to someone else, or settle that transaction between banks with some asset (such as bank reserves).
The bank does hold some of their assets at the central bank of their country (or ECB for Eurozone banks). But they actually try to keep as little as possible in there, and they don't need that much compared to the amount of bank credit on the bank's balance sheet.
Banks need liquidity funding (including deposits) because they lend, not to lend. It’s actually an extremely important distinction to understanding money and debt (which neoclassical economics tends to, because they assume it all balances out so they can just ignore debt - it’s called the ‘loanable funds’ model and the fact that loans create deposits means it’s dangerously wrong).
Loans and deposits do not have any other direct connection than handling them together being a convenient and sensible way to handle things. You can make a loan without making a deposit (by asking bank to pay the loan out in cash) or bank can make a deposit without there being a respective loan created (E.g. bank paying dividend to shareholder account)
Further, if the banker is really dumb, bank can put money on the account with no economic reason whatsoever by just stating that I owe now to this customer a million dollars. No loan needed. But usually, of course, bank wants the customer to pay the money back, i.e. make a loan agreement.
Also, if the customer is really dumb, he can obviously "take a loan" and promise to pay bank a million dollars in a years time without ever receiving any money on any deposit account. A loan created without any deposit activity. Of course, usually when a customer agrees to pay a million dollar in a years time, he wants to get the money first...
In a competitive market, if the Fed is paying out 1.95% to bank reserves, there is no reason why my savings account shouldn't pay me that figure minus a spread for expenses and a profit spread.
I think that's what's happening, but the "profit spread" expands to fill any additional margin. It's not a competitive market and I see no reason to believe it ever will be.
That is a point not oft appreciated. There is a price at which your bank can maximally use your funds. The should use them at that rate. So what is the rate, and what is the bank that allows that?
This was possible in Germany. At one point this service was closed. I think I still have an account there with the Fed (with 50 Euros or something in it).
Imagine some dystopian future where you walk over homeless people on your way to work, hear about people without access to healthcare, and affordable housing crisis across the country... Meanwhile the government spends 5.6 trillion on in-perpetuity wars on people living in tents, or 4 trillion in helicopter'd money for Wall St; and somehow the people who are working constantly--who actually create the foundation of our economy to fund these wars and plutocrats--hardly ever complain about it because their limited free time to consume the news is overloaded with partisan politics, the latest Trump gaffe, etc?
Way to be good serfs.
No way you look at it, the Fed is not managed as an altruistic institution. At the very least, a very long time ago it should have been handed over to algorithmic monetary policy... but primarily just serving the role as a lender of last resort.
Because it's a pain to do and not in their remit, essentially. They still offer business banking services. My employer, Monzo, has a business account with them.
It would place the central bank into an even more biased role. And offering one retail service is very costly, especially when there's no way to amortize that cost over many services.
Matt Levine at Bloomberg had a great writeup on this recently. (His “Money stuff” newsletter is fantastic.)
Basically: if you were to start from scratch today and build a banking system, you probably wouldn’t build exactly the one we have. On the other hand, given that we do have this one, it may be worse to pull the rug out from existing banks by providing a Fed alternative.
Well nothing stops you from investing abroad, For instance Investing in Indian Bank as a depositor will get you a guaranteed 6-7% return per annum depending on the bank. Long term deposits have even higher return rates, some smaller private banks even give as high as 8-9% on deposits.
Hedging against currency movements is fairly trivial and doesn't cost much, I've gone down this route in Vietnam after getting annoyed at being forced into investments by low interest rates ( putting savings in most western banks is going backwards).
1 year deposit pays over 7%, the currency moved in my favor but still happy taking out the hedge.
Getting a far better return than the riskier corporate bonds I hold locally.
"Covered interest rate parity (CIRP) is found to hold when there is open capital mobility and limited capital controls, and this finding is confirmed for all currencies freely traded in the present day."
There’s a risk that your money isn’t covered by the deposit protection schemes of either country, so if the bank goes bust you lose the lot. Even if you are covered, the amount you get back could be limited.
With that factor built in 6-9% doesn’t look so good.
Investing in Indian Bank as a depositor will get you a guaranteed 6-7% return per annum depending on the bank.
That would be free money, so it’s already priced into the exchange rate. All other things being equal if you transferred US dollars into an Indian account, left them a year, then transferred back then you would be no better off than if you had left the money onshore, but you would be down the transaction fees.
People who make money in FX trading do so by betting that interest rates will move in their favour, and interest rates influence exchange rates (or more accurately expectations about future interest rates set current exchange rates)
Holds true only if you convert your currency to INR. The dollar denominated deposits (FCNR) have far lower yield around 3.4% still better than what the US banks offer.
Actually even i am not sure about that. There should be some route though, Foreign Institutional Investors do invest so there should be some legal route to circumvent this.
Up until recently the Fed didn't pay any interest on reserves (IOR). It was actually extremely controversial when they introduced it, but with quantitative easing it was operationally necessary in order to continue to set the Fed Funds Rate. Generally speaking Fed accounts are like checking accounts. The Fed doesn't issue CDs, they let the Treasury handle that.
The Fed started paying interest on bank deposits as a way of pushing liquidity into the market when the banks themselves were unwilling to do enough lending to restart the economy.
With the deposit rate at 1.95%, a bank has to decide whether they can earn more lending to clients than just parking the cash at the Fed. Obviously at 1.95% there is still an incentive to engage in lending, otherwise the fed would drop the deposit rate to encourage that behavior.
Your bank is paying you that, but it has branches and other expenses(ATMs). If you want a better return on your money, get an online bank. Marcus pays 1.9%. Ally pays 1.85%.
I can't trust my emergency fund to the whims of backroom deals between central bankers, Wall Street, and whatever administration is in power when the economy is grinding to a halt, most especially for almost no additional benefit (comparing interest rates, the spread is only single digit basis points) over an FDIC insured account.
I can see your point, but I really want to stress for others out there reading this thread that it isn't responsible to hope for insurance that doesn't exist when you need it the most.
By using a debit card like this, you give up the benefits (and protections) of a credit card. You can get a credit card that gives 2% back on everything, or more in specific categories. Which way does the math work out better for you?
Capital One 360 is competitive with other mentioned banks; currently 1.85% for > $10k.
Thanks for this info :) I swipe my card at 7/11 for a piece of gum 10 times per mont hahaa. I trust 7/11s infosec I guess, and I use my credit card for everything else.
I don't want to reveal my bank account balance but the interest generated per month pays my phone bill :)
I think their target customers are not banks. The article says it would "take deposits from financial institutions" but this could mean insurance companies, pension funds, credit unions, securities exchanges, etc. Anyone who might have substantial cash reserves as an integral part of their business, but who does not actually have a banking license.
Edit: from the Matt Levine piece linked further down the comments, the target customers are "money-market funds and foreign central banks".
> The Narrow Bank would take deposits but not make loans
That can't work, not if you scale it up across the industry. The Fed could not continue to pay interest even on overnight deposits without it directly turning into inflation. The economy could not function without loans. Alternatively the Fed would have to become the one (and only) lender for commercial (and muni, and...) purposes so that it could make the interest income on those with which to service deposits from these "narrow banks". A narrow bank is essentially free-loading, and politically untenable.
BTW, it's a really great newsletter, always entertaining and has been teaching me a lot about the world of finance. His take on the Tesla scandal is hilarious.
Straying pretty far of off topic, but... in the trading house story why not just act as a market maker or counter party? Ignoring the fee structure and leverage the complaint appears to be that they simply took the deposits and did not actually make trades on behalf of the client. In a private exchange or trading house would it not be as effective for the house, or a “partner”, to selective meet the bid/ask based on the client account? Being generally ignorant Ill assume leaking counterparty information would also fall afoul of regulators?
It would be free loading in the risk sense. They wouldn't participate in the money creation, wouldn't help the economy assess credit risk, etc.
Though I don't see how that would be a problem. If someone wants more yield they have to take on more risk. This bank would essentially become a big vault. If the central bank pays interest then they pay interest, if it doesn't they have to charge for holding the deposit.
And there will be always people willing to take out a loan, and they would be able to at other banks.
How is it different than what happens now except for the fact the the benefactors of the current system are a relatively small group of banks vs a common citizen? Seems to me that a system that benefited everyone would be more politically tenable than one that benefits a select few.
With that line of logic no business would ever work. Shoe shop? No way that would work, if every shop on earth sold shoes no one would be making food and we would all starve!
This is one bank that wants to not make loans, I’m sure that will work fine and we’ll still have people selling shoes, making food, and making loans.
This article has a surprising misunderstanding of the way banks work for a publication called “The Economist”. It is unintuitive, but banks do not and can not lend out deposits. Banks lever their capital (that is, paid up shares and retained profits) to lend, and that lending creates new deposits. Existing deposits and debt funding (money markets etc.) are useful as liquidity so they can settle interbank transfers, but they aren’t allowed to lend out of them, both out of regulations like the Basel framework, but also because it would violate accountancy rules (deposits are liabilities, and you can’t back a liability with a liability. In reality they
create the loan (asset) with a corresponding liability (the deposit).
Someone else goes to the bank and says ‘I want to borrow $1000’
Great the bank says, approved. And they set up a bank account for you that says you have $1000 in it.
Now they’ve got $1000 in reserves and 2 accounts that claim to have $1000 in it.
Now when you withdraw $500 where does that money come from? I can assure you it’s not from the banker’s wallet. That’s coming out of my deposit. Not from my account because my account still says they have $1000 on hold for me, it comes from the actual cash I deposited. (Which of course isn’t actually cash in most cases)
None of that matters in practice because unless everyone tries to withdraw all the money at once there’s plenty to cover all the withdrawals, but they are definitely using money from deposits to cover withdrawals.
You can't deposit a $1000 unless either a bank or the state created it first. Those greenbacks are just receipts for a deposit at the Fed created by prior government spending.
I think part of the problem to understanding is that you’re assuming that banks are places that store money. They aren’t really, they are places that hold various types of assets and manage IOUs between themselves and other parties (other Banks, the Government/Fed, and customers etc.) in either direction.
Banks don’t really store money, you give them money and they give you bank credit, and then later on you exchange that credit back for money or transfer credit to someone at another bank and the two banks settle that with some asset (could be reserves etc.).
I think this is the main confusion, of course the physical cash the bank gives you for a withdraw might have been given to the bank during a deposit transaction, but in terms of the transactions on the balance sheet it did not come from there.
No, they say "I'm going to claim you can have $5000, because I can document that once I took in $1000 and I assert that I will take in $1000 again, perhaps many times".
Never mind $500, they don't even need to touch the $1000 you put in. They are just making it up as they go because they're a bank and can credibly assert that they will be handling capital in future.
They are using the FACT of having deposits to get the credibility to make up whatever loans they want. This is why leverage is like ten to one making the amount of capital in the world many times the assets of the world and everything in it.
I'm not sure what you mean by "modern bank" - when is the cut off date for you?
I can assure you that banks can and do end up in a position where they are unable to provide loans. Admittedly the process isn't "if deposits <= 0" because banks don't just access funds from depositors. A retail bank will typically have a blend of funding sources where deposit accounts make up 30-40% of the liabilities on the balance sheets. The rest of the funds are raised on money markets and through inter-bank lending or bond issuance.
I can assure you that "if reserves < X" will mean that a bank is unable to offer a loan to a customer - credit worthy or not.
I experienced a banking crisis first hand in the country of my birth and this is exactly what happened. This is why banking crisis are damaging to the economy as a whole - even creditworthy customers and businesses are starved of funds.
Bank deposits. The more deposits there are the more demand there is for bank capital in aggregate.
The system reaches an equilibrium at a price not a quantity. The quantity floats as required by the price of money.
Reserves are always available since the other banks lend them out and the central bank as lender of last resort. They have no control function in quantity. Only in their price.
According to GP's linked article it's true when looking at the banking sector as a whole. For a single bank it seems like more of a technicality.
Also from the article:
> For example, if all of the deposits that a bank held were in the form of instant access accounts, such as current accounts, then the bank might run the risk of lots of these deposits being withdrawn in a short period of time. Because banks tend to lend for periods of many months or years, the bank may not be able to repay all of those deposits — it would face a great deal of liquidity risk.
Withdrawals go elsewhere and the central bank system then lends them back to the original source.
In aggregate you just end up with a lot of label swapping.
All that changes is the cost of the liabilities.
That’s a common misconception. What you have described is called the money multiplier model, and is absolutely incorrect. That’s exactly what the Bank of England paper is saying.
An additional point of reference is the Basel rules, which are pretty clear on this, if you care enough to read a few dozen pages of banking regulation.
> “And with what do the banks lever up their capital? (What is the indirect object of that sentence?) The answer, of course, is deposits.”
Incorrect. It’a a little more abstract than that. Bank credit doesn’t exist as anything but numbers in a database. Deposits are IOUs from the bank, which are increased when the bank lends, and mortgages are IOUs from people to the bank. If everything just stayed within the single bank, they wouldn’t need any existing deposits at all, or any reserves! What you need the reserves for (one source of which is incoming deposits from other banks, or cash deposits, or cheques from the Government) is interbank settlement. But the bank needs only a small fraction of the actual volume of transactions, because they are generally going both ways, and transfers are only a small fraction of the actual amount of bank credit that exists. That’s how the bank maintains solvency.
They don't. They might get some interest on the cash you gave them when you deposited the money, or for a transfer the reserves that they got from settling deposits from the central bank, or from lending those reserves to another bank. Or they might convert those assets into bonds etc.
But the 'bank deposit' itself is just an entry on the liability side of the bank's balance sheet, they can't profit from that. The bank might pay interest on it to the depositor because they want to encourage them to deposit more, because deposits coming in give the bank cheap liquidity, so stop them having to borrow reserves from other banks etc. to maintain liquidity.
I'm not saying you're wrong. It just seems like something is missing from the picture in your explanation.
When I opened my bank account, I deposited say £5000 cash. What does the bank do with this money?
I was under the impression that the bank doesn't actually keep this £5000 in cash, only £500 maybe, and uses the rest to lend money, but you seem to be saying that they can't actually use my deposit.
"When I opened my bank account, I deposited say £5000 cash. What does the bank do with this money?"
It burns it. Probably quite literally.
The cash represents a transfer from the central bank into the commercial bank's deposit account at the central bank - for which it receives an interest rate.
Cash is just a receipt for deposits held at the central bank.
Deposits are a relatively cheap way of attracting reserves. When you added £5000 from say an account at Santander, Santander lost a liability (the deposit) and simultaneously transferred some reserves to your current bank.
Banks can also attract reserves by borrowing in money markets (cheap but short term) or issuing long term debt (stable but expensive), or by persuading customers to open accounts and keep them in positive balance. In practice it will use a mix of all three, attempting to match the maturity profile of its liabilities.
The central bank will also create reserves and lend them to your bank if your bank can't raise them elsewhere for some reason. But borrowing from the central bank can spook investors, and it's also expensive.
A bank that doesn't have reserves can't settle its debts to other banks (like the debt you incurred by moving your £5000) and so can't function in the banking system. It has to get reserves from somewhere, and persuading consumers to park deposits in an account is one useful way to do so.
Deposits have two sides on the books: liability to the depositor, and cash as asset. They don't lend out the liability, they lend out the cash. That converts one asset, cash, into another asset, loans. I don't see this as misleading to say that they lend out deposits.
Yes, in a more realistic situation, they'll be using their assets as security for borrowing short term money that they lend out long term, so it's not exactly the same money, but it's still involved in the same risks.
Nope, that’s not quite it, because if somebody puts $10 in the bank, it creates $10 of assets (cash or reserves) and $10 of liabilities (deposits) so it doesn’t give the bank anything they can do anything with, apart from liquidity.
The only way it can work is if writing a mortgage creates an asset (the loan), and then a new liability is made to match it (a deposit of the same amount).
The security is 100% the bank’s capital, since any assets (cash/reserves) from deposits have matching liabilities.
The article I linked above from the UK’s central bank is confirming that all modem banks work the way I am saying.
It's been a long time since I did eco101, but I thought the multiplier was what made it possible for a bank to receive a $10 deposit and loan out $100.
When someone puts $10 in a bank, it most certainly gives the bank something they can do something with. In this case they can lend $9 out - assuming 10% reserve. On the balance sheet the bank then has $10 on the liability side - the deposit - and $9 loan and $1 reserve on the asset side. I think that you're confusing accounting with business.
That’s called the ‘money multiplier model’, it’s an incorrect model that doesn’t actually describe how any modern bank works. It’s basically a myth at this point.
I’m not confusing anything. Believe it or not, banks actually have to follow double entry accounting rules, and follow regulations about capital adequacy. Most countries don’t even have a reserve requirement, deposits generally don’t factor into lending at all.
Bizarrely, all the textbooks teach that that's how banking works, but it hasn't been true for decades.
It's characteristic of economics that it makes a song and dance about summing a geometric series while completely missing the point about how the system actually works.
- banks take in cash in from depositors (and other creditors)
- banks lend out cash to borrowers
- banks do not lend out all the cash that they've borrowed - they keep some in reserve
Do you have the name of any retail bank which does not operate according to this model? What does their balance sheet look like? The "textbooks" reference is not relevant here - my experience is from working in retail banking operations.
Essentially the bank can make the loan with a zero balance sheet.
If you work at the back end of a retail bank operation then you'll know that the loan department and the treasury department do not talk to each other about quantities. They talk to each other about price. Other than that the two operations operate in parallel. 'Funding' is just swapping the liabilities around in the market to try and reduce the amount the bank pays out in interest.
“I find it difficult to understand how this flow of funds analysis validates an assertion of general principle. What is described is a special case where a highly leveraged bank could find itself temporarily insolvent, with a very limited window of exposure before the bank would be found guilty of criminal fraud.”
I think the problem with what you're saying is the ambiguous use of the word 'cash'. Deposits, reserves, and physical currency are all 'cash' in some sense, but here it helps to be precise.
Banks don't 'lend out cash', they create deposits. Deposits are liabilities for banks. When a bank takes on a deposit, it also takes on a corresponding asset: either a loan in its books, or an increase in its reserve account.
In practice the reserve ratio is unimportant for a bank: in Canada and the UK the ratio is 0%. The real constraint on a banks ability to create money is it's leverage ratio, i.e. (assets - liabilities)/assets. In reality the formula is more complicated and uses risk weighting by asset class, but that's the crux of it.
I am not sure where you saw that banks are not using deposits to fund loans. For instance if you look at lloyd's balance sheet [1]:
loans 482,752
cash and afs (liquidity pool) 100,619
trading assets 163,878
other 64,860
total assets 812,109
Deposits 447,928
trading liabilities 50,877
wholesale funding & capital 140,828
Insurance liabilities 103,413
other 69,063
total liabilities & equity 812,109
I believe the trading assets, trading liabilities and insurance liabilities must have to do with their insurance business and sort of net each others. What is left is basically 450bn of deposits and 140bn of capital and wholesale funding, funding 480bn of loans and 100bn of liquidity.
Now cash is fungible, and you cannot point to a particular asset and say that a particular liability is funding this asset. But overall, deposits are funding loans.
Only 1) the Basel framework of bank regulation which has been internationally adopted, and
2) explanations from the Bank of England (linked above) which categorically states that this is actually how banks work. The Deutsche Bundesbank has also published something to this effect, and the Governer if the Reserve Bank of Australia talked about it in a speech the other day [1].
I don’t want to get into some ad hominem attacks but I don’t think Basel 3 says that. Anyway, this is simple arithmetic, Lloyds could not have such a large loan book if it wasn’t funded by deposits. There are simply just not enough wholesale funding and capital liabilities. And the liquidity requirements are only a fraction of the deposits, particularly for retail deposits which are assumed to be sticky.
It absolutely does say that. The whole of part 1, "Minimum capital requirements and buffers" is 100% based on capital, and deposits don't factor in to any of the definitions of Tier 1 capital. The leverage ratios also factor entirely from capital that doesn't include deposits.
100% is the conversion of a loan balance to leverage exposure. The capital requirements vary between banks and regulator, but they are typicaly 3-5% of the leverage exposure. A leverage ratio requirement of 100% would make lending uneconomical. To achieve a return on equity of 10%+, you would have to charge over 10% on your loans.
My understanding is that deposits are really just a manifestation of a promise that a trusted party holds, so that the party making the deposit can make more promises to other parties. So, in banking a promise is often just as valid as holding a deposit. They aren't really lending you value, they are lending you verification of value.
They are unsecured liabilities. But like all liabilities the bank received an asset when it issued it (cash or else), and like all liabilities the bank must have sufficient assets to pay it back on demand. The bank may not have the necessary liquidity to pay back all deposits at once (some of these assets are 30y mortgages) but it has an asset (otherwise is not solvant).
When lloyds creates another loan it automatically creates the matching deposit.
You get both a mortgage debt and a credit asset when you take out a loan. You then transfer that credit asset to somebody else to pay them.
But it is the loan that creates the credit asset in the first place.
Deposits have no quantity control function on lending. It's only ever a pricing issue.
When you lend to someone, he is free to transfer the money immediatly to whomever, who may or may not be a customer of that bank. The loan must have been funded for the bank to be able to afford to transfer the deposit away. Now you may get some deposit back that same day but the funding decision has to be made before.
Anyway, neither funding or pricing determines the amount of lending these days, capital ratios are the limiting constraint.
The bank needs liquidity to settle inter-bank transfers after they've lent, some of that is deposits but they can also just borrow reserves from other banks if they need to do that.
The lending itself created new bank credit, it was never "funded". If the bank has capital adequacy, they make the loan.
Ah, but when they transfer that money, it'll be to some customer of some bank whose loan customers will also be transferring money in the other direction. This means, in practice, that the main constraint on a bank's ability to lend money is how willing all the other banks are to lend money at the time. The Bank of England paper linked earlier in the thread explains why this has undesirable economic implications that are missed by the incorrect money multiplier model.
> You then transfer that credit asset to somebody else to pay them.
So the matching deposit disappears from the liabilities side of Lloyd’s balance sheet while the loan remains in the assets side? That leaves the balance sheet unbalanced, doesn’t it?
The deposit may disappear from lloyds' liabilities, but it needs to transfer an equivalent amount from its reserve account to (say) Santander's reserve account. So Lloyd's loses both liabilities and assets when someone moves deposits to another bank.
Of course, my point is that neilwilson’s statement (emphasis mine): “When lloyds creates another loan it automatically creates the matching deposit. (..) Deposits have no quantity control function on lending.” is at best misleading.
A bank with an empty balance sheet cannot give a loan.
Lending money is transforming one asset (reserves) into another (loan). The fact that the loan is created as a new deposit in the name of the borrower, keeping the reserves constant, muddles the issue a bit but the simplest description of the process is something like:
1) D makes a $1mn cash deposit at the bank. The bank has liabilities: $1mn owed to D and assets: $1mn in cash.
2) The bank lends $1mn in cash to B. The bank has liabilities: $1mn owed to D and assets: $1mn lent to B.
We can add an intermediate step where the loan is still a deposit at the bank (liabilities: $1mn owed to D. + $1mn owed to B., assets: $1mn in cash + $1mn lent to B.) but it is just a distraction. Not many people borrows money to keep it in a deposit at the same bank.
A bank with an empty balance sheet can give a loan. It is simply Dr Loans, Cr Deposits. That's it.
Nobody ever makes cash deposits into a bank. The cash is just burned when the bank receives it (if it is worn enough).
A cash deposit to a bank is just a deposit transfer from the central bank. Cash is just a receipt for entries already at the central bank.
You are starting half way down the process.
To take your example
1) The balance sheet is $1mn Fed deposit asset, $1mn Credit to D.
2) The Balance sheet is $1mn Fed deposit asset + $1mn Loan Asset to B, $1mn Credit to B, $1mn Credit to D.
3) If the cash is withdrawn then the Fed deposit asset and the Credit to B is marked down. The cash will be new cash issued as a receipt for the deposit at the Fed.
You can do exactly the same without the deposit of D first. At that point the Fed asset would be negative and become the lender with the loan posted as collateral.
> A bank with an empty balance sheet can give a loan. It is simply Dr Loans, Cr Deposits. That's it.
A banks needs capital, an empty balance sheet doesn’t cut it.
> Nobody ever makes cash deposits into a bank.
Yes, they do. If you pay $5 for a capuccino or whatever what do you think they are going to do with your $5 bill at the end of the day?
> The cash is just burned when the bank receives it (if it is worn enough).
So they never receive cash because nobody ever deposits cash. And at the same time they do receive cash and they just burn it. You have convinced me, there is something seriously wrong with the banking system.
I'm not really sure what you mean. The Bank of England article you linked says:
> that would leave the buyer’s bank with fewer reserves and more loans relative to its deposits than before.
[...]
> By attracting new deposits, the bank can increase its lending without running down its reserves, as shown in the third row of Figure 2.
So actually the banks need deposits to hand out loans. What you are saying is that the deposits get a new label before handing them out as loans?
Sure, it's fairly cheap liquidity, the more the better. But no bank ever stops lending because they don't "have enough" deposits, because there is nothing of the mechanics of lending that relies on having existing deposits.
They just need to be 1) solvent and 2) within their capital adequacy requirements and leverage ratios.
Of course they do. That's what fractional reserve banking is all about. Banks borrow money (e.g. from depositors, on the money markets, from other banks) and lend out the money they raise while keeping a "reserve".
A typical bank's balance sheet will contain deposits on one side and loans on the other. Without deposits, or other sources of borrowing, a bank cannot lend money.
Again, that’s just a popular misconception. The document I linked to before from the Bank of England [1] is all about how what you describe, while commonly believed, is not how modern, real world banks work.
The document you linked does not contradict my claim. Your document describes the role of banks in the M2 money supply NOT how individual banks work.
I can assure you that what I describe IS how real world banks work. You can look at the balance sheet of any retail bank and it will spell this out clearly. I've worked in retail banks and have some hands one grasp of their day to day operations.
Your confusion is a common one - you mistake the process that results in the creation of M2 money with the day-to-day operations of retail banking.
Modern retail banking is a very simple business - they borrow funds (from depositors, other banks, sometimes central banks, commercial loans, etc.) and then lend out the SAME funds while keeping some back in liquid assets (cash, deposits in central banks, short term government notes, etc.) in reserve. The trick is to charge more interest on what you lend out than you pay on what you borrow while managing the risk and cash flows involved when you have a mixture of terms (expiries) of borrowings and lendings.
I think I've given a reasonable summary in my posts of how banks work. I've studied the balance sheets of retail banks and have been exposed to their day to day operations so please don't simply disagree with me and point me to a document on M2 money creation - if you think I've stated something untrue, then highlight it and describe where I'm wrong.
Banks are not merely intermediaries between savers and borrowers. Loans create money, but only loans that are not used to repay other loans result in an increase to the money supply. The following text comes from an ING Bank research note, quoted by The Economist [1]:
"Banks do not view the creation of money as an objective itself. It is a by-product of the banking sector’s business operations. However, it is of great economic and social relevance.
Not every loan ultimately results in new money. The majority of new lending is used to redeem existing loans. Money is only created to the extent the gross lending exceeds the value of the existing loans being redeemed."
That note refers to the "great economic and social relevance" of these banking operations. Here's Professor Richard Werner talking about this at length. [2]
Here's Perry Mehrling (who teaches Coursera's Economics of Money and Banking) weighing in [3]. He explains that it's a nuanced issue but clearly agrees that the "credit creation view" is important and quotes a Group of 30 report:
“In a barter economy, there can rarely be investment without prior saving. However, in a world where a private bank’s liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet.”
Again banks' role in the creation of M2 money does not reflect how individual retail banks operate.
Just because you have a model that seems to describes the behavior of flock of birds doesn't mean that the model is useful when discussing the anatomy and wing-aerodynamics of individual birds.
You've posted a bunch of links describing the various forms of money and the role of banks in modern (post 18th century) M2 money creation. I know all of this material but it's not relevant to the operations of individual retail banks.
OK, so if each individual retail bank only lends out pre-existing, deposited funds, where does the increase in the money supply come from? Bear in mind that money created as a by-product of bank lending makes up the vast majority of the total money supply in various modern economies (97% in the UK [1]).
The increase occurs because of the different definitions of money. If you define money as the sum of amounts available in demand account at banks (with is roughly what M2 is), then lending from a bank increases this number as the borrowed money ends up in the account of the borrower or in the accounts of the people the borrower spends the money with.
This fact means that retail banks "create money out of nothing" only when money is defined as the sum across all banks of the amounts available to customers on demand. No individual bank "creates money out of nothing", individually they borrow money and lend a fraction of it out; they have balance sheets which balance - i.e. ignoring shareholder equity, for every asset (money owed to them by a borrower), there must be a liability (money they owe to lenders including depositors). The M2 money supply counts the latter but does not deduct the former from the sum; as a result, the M2 money supply has a direct relationship with the total size of retail banking balance sheets.
M2 is an economic statistic and it's behavior tells you nothing about how individual banks operate.
OK, how does that gel with a report from S&P [1] that says:
“Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”?
Also Prof Werner's analysis, he reaches the same conclusion.
That statement is misleading or reflects a misunderstanding on the part of the author.
"Credit" is an accounting concept. Balance sheets are accounting artifacts. The way the bank records it's transactions is a model, not reality. For example, lots of intangibles can have accounting entries created for them for various purposes, but these don't create reality.
Btw, a big problem when discussing bank operations are that the terms "debit" and "credit" can be confusing as their roles are relative to the bank not the customer. Even "asset" and "liability" can be confusing. An Irish media finance and economics professor, Brian Lucey, mixed them up and suggested that a troubled bank could be fixed if it sold its deposits which is impossible - deposits are a liability for banks, not an asset.
Reality is much more simple. Bank lending starts when a customer asks for a loan. Assuming the loan application meets all risk requirements, etc. AND sufficient funds (reserves) are available on the bank's balance sheet, the loan can be issued and the funds transfered to the customer. Reserves are reduced as part of this process but an asset is created for the bank (the loan) so the balance sheet remains the same size.
Well, that's the crux of it right there. You are disagreeing with several authoritative sources who say that no such transfer happens, and in general the loaned funds are created out of thin air.
Standard & Poor's: “Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”
Group of 30: "... banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet."
Richard Werner: "...each individual bank creates credit and money newly when granting a bank loan."
Banks are subject to constraints. They need to retain enough capital to absorb losses on their loan book, and they need to retain enough reserves to cover withdrawals and clearing requirements. They are free to create money "out of thin air" insofar as they meet regulatory requirements associated with those constraints. [1]
You wrote: "I've worked in retail banks and have some hands one (sic) grasp of their day to day operations."
I suggest that your experience does not encompass the whole sector, and that may be the source of your confusion.
Maybe it's just me but this really seems like quibbling over semantics. Cash is fungible: banks need cash in order to lend it out and they get cash from deposits. The rest is just bookkeeping.
banks need deposits to keep their leverage ratio in check.
and due to overleveraging one unit of deposit ends up as multiple units of loans.
and sure, deposits are not the main factor for lending, risk is. but usually taking deposits is cheaper than taking out a loan from an institution and lending that out. hence banks want/need deposits.
Ugh. It is a bit like saying that people don't earn money to buy things, but earn money because they buy things! By this line of reasoning when I go to a store, I am totally unconstrained by how much I earn - I just take my credit card, swipe it and buy whatever I want. Now, this strategy would be unsustainable in the long run if not backed by sufficient inflow of cash from my employer. So I have to work every day. But these are totally separate processes!
A lot of bookkeeping gets done, assets and liabilities change hands, but in the end it can still be described simply as "people earn money and buy things with it."
> So actually the banks need deposits to hand out loans. What you are saying is that the deposits get a new label before handing them out as loans?
Well, no. What the BoE paper is saying is this: Suppose there are two banks, A and B.
If Bank A went on a lending spree without attracting new deposits (or otherwise bringing in new reserves), many of the deposits it created would end up with bank B, because bank A has no control over how its deposits are used. Bank A would have to transfer reserves to bank B to settle the transactions. Eventually bank A would run low on reserves and would need to raise more (by issuing debt, or by making its deposit rate more attractive).
But if bank B was going on a similar lending spree at the same time, the two banks wouldn't run down each others's reserves. If the two banks act in tandem (e.g. by getting caught up in speculative mortgage lending), they can create plenty of money without needing to attract new deposits.
The biggest regulatory hurdle that stops this happening is that there's a regulatory constraint on the leverage ratio (assets - liabilities) / assets.
The accounting view is a useful frame, but money is fungible so there’s a real sense it which that view doesn’t represent what is “really” happening. See, for example, the MMT take on government financial flows.
For those wondering, here is an empirical paper on the subject demonstrating no connection between deposits and loans.
"This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air"."
Since you keep breaking the guidelines over and over we've banned the account. We're happy to unban accounts if you email hn@ycombinator.com and we believe you'll start following them.
Unless I'm missing something, why doesn't every bank have an "internal narrow bank" that takes deposits and puts them at the central bank?
Actually, I thought that is exactly how banks have to operate right now... All deposits are settled in the interbank system or ultimately with the central bank. You can't just deposit money in a bank, because "depositing" $100 means telling an upstream bank that your bank now owes you $100.
They can do, quite a lot of money is on deposit at the Fed. But they may find it more profitable to lend the money elsewhere. All true government issued money is either in the form of banknotes and coins or deposits held at the central bank.
What is gov issued money? The money created by the fed is gov issued too, no? And it sits on the Fed's balance sheet as liability, debt, but not as deposit.
For simplicity I'm taking the Fed as part of the government. I know the setup in the USA is a bit strange. A government can create as much money as it likes, debt on a balance sheet is an optional accounting detail.
Debt is not money, but it has a flipside, the debt claim, which can be readily converted into money at a (central) bank. That's the fundemantal if somewhat hidden mechanism of our monetary system.
Actually, that is pretty much exactly how it works. Banknotes (i.e. cash), are explicitly IOUs from a bank. Usually, it is a central bank, such as the Bank of England, but sometimes, it could be another bank. There are three retail banks in Scotland that are authorised to issue banknotes:
https://en.m.wikipedia.org/wiki/Banknotes_of_Scotland
Why is it so crucial to their business model that the customers' deposits are deposited directly with the Fed, rather than lent out to other banks on the overnight Fed Funds market? The Fed Funds rate is typically lower than the IOER rate paid on deposits with the Fed, but only by a small amount:
since early 2009 the fed funds rate has generally been 5 to 20 basis points (one basis point is equal to 0.01 percentage points) lower than the IOER [1]
For example, money lent out on the Fed Funds market on thursday earned 1.92% [2], while money deposited with the Fed earned 1.95% [3].
The Not-Quite-So-Narrow Bank wouldn't be able to pay as high a rate of interest to depositors as the true Narrow Bank, but it also wouldn't be dependent on the cooperation of the Fed, and Congress's authorization to the Fed, in collecting the IOER rate.
While looking up those numbers, i came across a nice detailed series of posts by George Selgin on IOER [4] and the Narrow Bank in particular [5] [6] - well worth a read.
Because then you have counterparty risk, which means you then have greater regulatory/compliance costs and have to pay up to 0.4% on assets for FDIC insurance.
Counterparty risk on Fed Funds loans, which are for one day only and to solid, highly regulated financial institutions, is negligible - that's why it's treated as the risk-free rate.
Would you need FDIC insurance if you only took deposits from financial institutions?
> Why is it so crucial to their business model that the customers' deposits are deposited directly with the Fed
Note that whether interest was earned via IOER or via the Fed Funds market, the funds would be deposited with the Fed either way (whether in the bank's own Fed account or overnight in the Fed account of the counterparty of a Fed funds loan).
It wouldn't be possible to accept transfers from other banks, to send funds to other banks or to participate in the Fed Funds market unless the bank had an account with the Fed.
On the point of "risk-free", the TED spread was north of 1% for much of the 20 months between August 2007 and April 2009, and peaked at over 4%. So it's not always what I'd call negligible risk. https://fred.stlouisfed.org/series/TEDRATE
... The central bank may worry that narrow banks, which lend to neither companies nor individuals, could hamper the effectiveness of monetary policy. Their business model may also risk unsettling incumbent banks, which could have large economic consequences. ...
This is almost certainly a big reason for the opposition. The Federal reserve wants to keep people from "hoarding" (saving) money at all costs. Driving down interest rates and causing inflation is one tactic. Preventing the emergence of banks who can out-compete the rest of the market on interest rates is another.
The Fed is probably concerned that, if the idea catches on, trillions in deposits could be vacuumed out of the fractional reserve banking system, leaving less available for lending.
If that were to happen, the Fed would lose considerable influence over liquidity. Its only lever on narrow banks would be to adjust the deposit rate encouraging savers to go elsewhere.
202 comments
[ 3.9 ms ] story [ 268 ms ] threadIf you want to stop people from stealing your articles, maybe give the paying readers access would be a start.
[0] https://imgur.com/a/2uo4hnE
Basically a bank which takes deposits from customers and then deposits the money at the Fed whereby earning a higher interest rate than the customer just depositing at a "regular" bank.
It offers preferential rates to banks as they are cooperative agents. It is not running at free market rates. If it were to open to free market, Fed would have to adjust the rates until it matches the reserve...
Unlike most agents on the market, Fed is free to deny you.
Lowering rates raises liquidity. It makes it easier to borrow and thus create money.
> removing the reason it exists for in the first place, which is being lender of last resort
The Federal Reserve has many functions, one of which is acting as a lender of last resort [2]. Acting as a central bank, i.e. managing the country's monetary policy, is its primary purpose. Addressing bank panics, facilitating transfers, and regulating financial institutions are secondary roles (albeit very important ones).
In any case, reducing the interest paid on excess reserves does nothing to the Fed's standing. For most of the Fed's history, excess reserves were not paid special interest. It's a novel monetary policy instrument, and one still very much in its experimental phase.
> It offers preferential rates to banks as they are cooperative agents
The Fed pays 1.95% on reserves [2]. That is 5 bps less than what the Treasury pays to hold your money for one month [3]. It's 3 bps more than the average Fed funds rate, but within the 175-200 target range and less than the 2.1% 99th-percentile rate [4].
[1] https://www.federalreserve.gov/monetarypolicy/reqresbalances...
[2] https://en.wikipedia.org/wiki/Federal_Reserve_System#Purpose
[3] https://www.treasury.gov/resource-center/data-chart-center/i...
[4] https://apps.newyorkfed.org/markets/autorates/fed%20funds
[1]https://www.federalreserve.gov/monetarypolicy/reservereq.htm
Their reserve, deposits, determine the size of loan they can create.
Without deposits banks couldn't loan out anything since they couldn't meet their reserve requirements and they'd basically be insolvent.
So, true, banks don't loan out 100% of deposits but they certainly do loan out deposits.
The 1000% figure comes from the fact that the money that the bank loans out is in turn held in another deposit account somewhere, and so it has a cascading effect... I deposit $100, my bank loans out $90 to person B, that money gets saved in a bank which can then loan out $81, then $72.9 gets created somewhere else. 1000% is just the limit of the sum 1 + 0.9 + 0.81 + ...
Sure. So we have a 10% reserve requirement.
Logically that means we have 90% loans, and 90% is nine times as much as 10%.
So loans are 900% as big as reserves.
Is that supposed to be surprising?
(I believe you, just want to learn more.)
NVM, I was confused over another statistic. ~97 percent of all new money is created in local banks, the government only creating ~3 percent.
This describes every financial institution that isn't a national bank, e.g. broker-dealers, insurance companies, hedge funds, et cetera.
They're still loaning out deposits, though. They're just borrowing someone else's deposits to do it.
I'm not the GP here but his point is that actually the bank in general does not loan out deposits[0].
Instead, the bank creates money at the moment a counterparty agrees to borrow it (in countries with a certain type of financial system, aka most countries today, with some interesting exceptions).
The name for an institution that loans out deposits is "credit union," but most people think that's what a bank does.
Most people are very surprised by this claim that ordinary banks create money, and deny it when you tell them. But really there's no coverup of this fact, it's written e.g. literally on the websites of most central banks such as e.g. [1], wherein the critical passage (in boldface on the first page) is:
"Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money."
This seems unjust to most people, since in our daily experience, money is not a thing which is very commonly created. I take no position on that alleged injustice here, and instead leave it as an exercise for the reader to reason out the consequences of a private-bankers-printing-money themed financial system (of which consequences there are many) and to ponder the identities of the people doing most of the printing.
[0] Sometimes it actually does turn out that a bank loans out a deposit, as the GP mentions, but this is by construction a small fraction of bank business.
[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
And is there a special license for being allowed to create money?
The difficulty is not in letting people make accounts and setting balances on those accounts. The difficulty is getting everyone to not immediately withdraw the entire balance as cash.
There are regulatory hurdles, but they're very much secondary.
If everyone immediately took loans in cash form and they never got deposited back to banks, then banks wouldn't be able to create money via loans either.
[1]https://www.dfs.ny.gov/banking/iasc.htm
Banks count on (depend on!) there not being a run on the banks, and they count on borrowers to not default at a higher-than-expected rate. As long that is the case, the banks thrive, the borrowers thrive, and the savers thrive. If however, the economy tanks hard enough, then too many borrowers go broke, savers get scared and ask for their money back, and the banks go bust.
Banks lever capital (paid up shares and retained profits) to create money for loans, not deposits. Existing deposits are funding for interbank settlements (for transfers).
The amount of reserves the bank has doesn’t actually affect lending one bit - it does affect liquidity but most countries don’t even have reserve requirements because banks can just borrow reserves from other banks or the lender of last resort (central bank) if they need to. The main bank regulation now is capital adequacy ratios.
While this is technically true, the statement does not do justice to the real economical case. You start pulling out the banks funding (i.e. deposits, interbank loans etc.) and the bank must start to liquidate its assets (i.e. loan book). In practice it is perfectly fair to say that bank uses deposits to fund its loan book, and thus saying that bank loans out deposits is not that wrong.
It's a bit like we having a lunch but you forgot your wallet. I pay your lunch and when we get back to office you pay me back. Then I start running around and telling that I paid your lunch. Yes, technically true, but not quite representative of practical economic reality.
I agree that in practice statements like the above are acceptable, but in an erudite paper like the Economist, when the article is discussing banking licenses, I expect a higher level of precision.
Part of the trickiness here is that even electronic reserves[1] and deposits are really different data types. There is something a lot like automatic boxing and unboxing between the two types that greatly confuses casual understanding of the operational realities of the banking system. When one withdraws paper notes from a bank, not one but two accounts are debited[2]: one is the deposit account, which is the one the customer sees, and the other is the institution's reserve account. Getting a grasp on these mirrored transactions was hard, and communicating that is even harder. I'm afraid I'm probably failing here too.
Edit: Similarly, creating deposits is a lot like a malloc(), and extinguishing those liabilities is a lot like a free(). I'd bet money the banking system actually is Turing complete.
Edit edit: It's also interesting that banks usually need reserves to clear inter-bank transactions rather than to meet reserve requirements. This is because inter-bank transfers (like depositing a check from another bank with yours) are also dual operations that involve both reserves and deposits. While a bank can create a million dollar loan without any reserves at all, they can't clear a $20 check drawn on their bank without at least $20 in their reserve account at the end of the business day.
[1] Reserve notes are the only form of reserves the vast majority of citizens ever hold. However Fed members can hold reserves in an online account.
[2] Informal usage
That is an important distinction to grasp. When people say that banks can create money from nothing, that means banks can create liabilities from nothing. But that can anyone do. I can write on a piece of paper that beefield pays 100 dollars to anyone holding this paper, and I need no reserves, no money, nothing but a pen and piece of paper to make that. And that is exactly what happens when bank "creates money". Bank says that some future day bank pays account holder money. And exactly as little as I can create the money that I would use to actually pay my liabilities, banks can't create money to pay their liabilities off.
Wait, what? I thought a bank cannot hand out any (book) money without backing [1]. I.e. if they want to loan me a million dollars by crediting it to my account, they have to balance that by "borrowing" the million from another bank or the central bank.
In other words, my bank account does not really sit at my bank. They cannot create money or a loan by just writing to a database [2]. And the other way around is also true: they cannot take (electronic) money. If I wire transfer money into my account, they don't just make an electronic note of it. They have to, in the same instant, deposit the money at another bank. It's always the case that another third party C makes the note "customer A deposited money into bank B's account at bank C". In a sense, the whole banking system is built on distrust.
This is the reason why, at least in Europe, banks "have to" "deposit" money overnight at the ECB, even if it costs due to negative interest rates. It's not a thing they conciously can or cannot do, but taking or lending (book) money always involves an upstream bank - unless it is cash of course.
[1] That might not be the right term. Financial English is not my strength :-)
[2] It would be an interesting model if individual banks could actually create money and anti-money, like the Dirac see model where an electron and a positron are spontaneously taken from the vacuum. Although you would have the same problem with the infinite vacuum energy, which would correspond to inflation I guess...
I'm not familiar with the mechanics of the European banking system so I can't speak to that.
Loans are 'backed' by capital (paid up shares, retained earnings, etc). They have to have enough capital to cover at least 8% of the amount of the money they have created by lending with the recent Basel 3 rules.
What the bank is doing is managing IOUs. You do not store money in the bank, and the bank does not loan stored money. When you deposit money in the bank, they take it and give you an IOU (bank credit). When you loan from the bank, you make an IOU to them (loan), and they give you an IOU (a new deposit in bank credit). When you make a withdrawal, you're exchanging one of those IOUs (credit) to cash. When you make a transfer, they reduce their IOU to you, and then either increase an IOU to someone else, or settle that transaction between banks with some asset (such as bank reserves).
The bank does hold some of their assets at the central bank of their country (or ECB for Eurozone banks). But they actually try to keep as little as possible in there, and they don't need that much compared to the amount of bank credit on the bank's balance sheet.
Loans and deposits do not have any other direct connection than handling them together being a convenient and sensible way to handle things. You can make a loan without making a deposit (by asking bank to pay the loan out in cash) or bank can make a deposit without there being a respective loan created (E.g. bank paying dividend to shareholder account)
Further, if the banker is really dumb, bank can put money on the account with no economic reason whatsoever by just stating that I owe now to this customer a million dollars. No loan needed. But usually, of course, bank wants the customer to pay the money back, i.e. make a loan agreement.
Also, if the customer is really dumb, he can obviously "take a loan" and promise to pay bank a million dollars in a years time without ever receiving any money on any deposit account. A loan created without any deposit activity. Of course, usually when a customer agrees to pay a million dollar in a years time, he wants to get the money first...
And if they know they won't be able to get the funding, they won't lend. This seems like an entirely pointless distinction to draw.
Way to be good serfs.
No way you look at it, the Fed is not managed as an altruistic institution. At the very least, a very long time ago it should have been handed over to algorithmic monetary policy... but primarily just serving the role as a lender of last resort.
Wikipedia says this, but not why.
Basically: if you were to start from scratch today and build a banking system, you probably wouldn’t build exactly the one we have. On the other hand, given that we do have this one, it may be worse to pull the rug out from existing banks by providing a Fed alternative.
Currency fluctuations.
1 year deposit pays over 7%, the currency moved in my favor but still happy taking out the hedge.
Getting a far better return than the riskier corporate bonds I hold locally.
The cost is essentially the (risk-free) interest rate differential that you were trying to capture in the first place.
"Covered interest rate parity (CIRP) is found to hold when there is open capital mobility and limited capital controls, and this finding is confirmed for all currencies freely traded in the present day."
With that factor built in 6-9% doesn’t look so good.
That would be free money, so it’s already priced into the exchange rate. All other things being equal if you transferred US dollars into an Indian account, left them a year, then transferred back then you would be no better off than if you had left the money onshore, but you would be down the transaction fees.
People who make money in FX trading do so by betting that interest rates will move in their favour, and interest rates influence exchange rates (or more accurately expectations about future interest rates set current exchange rates)
https://www.icicibank.com/nri-banking/RHStemp/rates.page
But I think you need to hold an Indian passport to open these deposits. I am not sure though.
Seems strange to pay banks to do nothing, surely that reduces their incentive to provide capital.
With the deposit rate at 1.95%, a bank has to decide whether they can earn more lending to clients than just parking the cash at the Fed. Obviously at 1.95% there is still an incentive to engage in lending, otherwise the fed would drop the deposit rate to encourage that behavior.
Some examples:
Goldman Sachs (1.90%): https://www.marcus.com/us/en/savings/high-yield-savings
Ally Bank (1.85%): https://www.ally.com/bank/view-rates/
Alliant Credit Union (1.80%): https://www.alliantcreditunion.org/rates
I can see your point, but I really want to stress for others out there reading this thread that it isn't responsible to hope for insurance that doesn't exist when you need it the most.
Dunno how long the suspension lasted, or if he was merely confused, but it would suck to not be able to withdraw money when you need it most.
Capital One 360 is competitive with other mentioned banks; currently 1.85% for > $10k.
I don't want to reveal my bank account balance but the interest generated per month pays my phone bill :)
https://www.doctorofcredit.com/high-interest-savings-to-get/
Edit: from the Matt Levine piece linked further down the comments, the target customers are "money-market funds and foreign central banks".
That can't work, not if you scale it up across the industry. The Fed could not continue to pay interest even on overnight deposits without it directly turning into inflation. The economy could not function without loans. Alternatively the Fed would have to become the one (and only) lender for commercial (and muni, and...) purposes so that it could make the interest income on those with which to service deposits from these "narrow banks". A narrow bank is essentially free-loading, and politically untenable.
BTW, it's a really great newsletter, always entertaining and has been teaching me a lot about the world of finance. His take on the Tesla scandal is hilarious.
If you are curious as I was, here is the link:
https://www.bloomberg.com/view/articles/2018-08-13/funding-f...
Also, are you implying the current banking system does not free load from the government?
Though I don't see how that would be a problem. If someone wants more yield they have to take on more risk. This bank would essentially become a big vault. If the central bank pays interest then they pay interest, if it doesn't they have to charge for holding the deposit.
And there will be always people willing to take out a loan, and they would be able to at other banks.
But what if they make it work? A bank doesn't have to rule the world, it can exist in equilibrium, or am I wrong here?
>A narrow bank is essentially free-loading, and politically untenable.
If they exist and are (barely) profitable, what does it matter that it is politically untenable?
This is one bank that wants to not make loans, I’m sure that will work fine and we’ll still have people selling shoes, making food, and making loans.
The Bank of England (basically the UK federal bank) has published a good article on this - https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
Isn't that just a book-keeping technicality? Fundamentally, the bank is still using deposits to leverage a loan. Or am I misunderstanding your point?
Someone else goes to the bank and says ‘I want to borrow $1000’
Great the bank says, approved. And they set up a bank account for you that says you have $1000 in it.
Now they’ve got $1000 in reserves and 2 accounts that claim to have $1000 in it.
Now when you withdraw $500 where does that money come from? I can assure you it’s not from the banker’s wallet. That’s coming out of my deposit. Not from my account because my account still says they have $1000 on hold for me, it comes from the actual cash I deposited. (Which of course isn’t actually cash in most cases)
None of that matters in practice because unless everyone tries to withdraw all the money at once there’s plenty to cover all the withdrawals, but they are definitely using money from deposits to cover withdrawals.
Banks don’t really store money, you give them money and they give you bank credit, and then later on you exchange that credit back for money or transfer credit to someone at another bank and the two banks settle that with some asset (could be reserves etc.).
I think this is the main confusion, of course the physical cash the bank gives you for a withdraw might have been given to the bank during a deposit transaction, but in terms of the transactions on the balance sheet it did not come from there.
Never mind $500, they don't even need to touch the $1000 you put in. They are just making it up as they go because they're a bank and can credibly assert that they will be handling capital in future.
They are using the FACT of having deposits to get the credibility to make up whatever loans they want. This is why leverage is like ten to one making the amount of capital in the world many times the assets of the world and everything in it.
When you withdraw $500 _they_just_make_it_up_.
Essentially there is nowhere in a modern bank where they go "if deposits <= 0 deny loan"
Yet I see that time and again in economic models that supposedly have banks in them.
Bank lending and the treasury backfill process that manages the equity buffer are parallel processes that are linked by price not quantity.
That means that banks will and can lend to any and all creditworthy customers they get prepared to pay the current price of money.
It's a dynamic system that can expand and shrink based upon the demand for credit.
I can assure you that banks can and do end up in a position where they are unable to provide loans. Admittedly the process isn't "if deposits <= 0" because banks don't just access funds from depositors. A retail bank will typically have a blend of funding sources where deposit accounts make up 30-40% of the liabilities on the balance sheets. The rest of the funds are raised on money markets and through inter-bank lending or bond issuance.
A bank's balance sheet looks like: - Liabilities: deposit accounts, issued bonds, borrowings - Assets: loans, reserves, equity.
I can assure you that "if reserves < X" will mean that a bank is unable to offer a loan to a customer - credit worthy or not.
I experienced a banking crisis first hand in the country of my birth and this is exactly what happened. This is why banking crisis are damaging to the economy as a whole - even creditworthy customers and businesses are starved of funds.
Bank deposits. The more deposits there are the more demand there is for bank capital in aggregate.
The system reaches an equilibrium at a price not a quantity. The quantity floats as required by the price of money.
Reserves are always available since the other banks lend them out and the central bank as lender of last resort. They have no control function in quantity. Only in their price.
That's why banks like deposits, they are cheap, and thus they can lend out cheaper.
Also from the article:
> For example, if all of the deposits that a bank held were in the form of instant access accounts, such as current accounts, then the bank might run the risk of lots of these deposits being withdrawn in a short period of time. Because banks tend to lend for periods of many months or years, the bank may not be able to repay all of those deposits — it would face a great deal of liquidity risk.
> Banks lever their capital
And with what do the banks lever up their capital? (What is the indirect object of that sentence?) The answer, of course, is deposits.
Take an example of a bank local to me: http://ir.cambridgetrust.com/AsReported/Index
They have about a $1.370B in deposits. Where do they put it? Look in the assets section and you'll see it's all commercial and residential mortgages.
An additional point of reference is the Basel rules, which are pretty clear on this, if you care enough to read a few dozen pages of banking regulation.
> “And with what do the banks lever up their capital? (What is the indirect object of that sentence?) The answer, of course, is deposits.”
Incorrect. It’a a little more abstract than that. Bank credit doesn’t exist as anything but numbers in a database. Deposits are IOUs from the bank, which are increased when the bank lends, and mortgages are IOUs from people to the bank. If everything just stayed within the single bank, they wouldn’t need any existing deposits at all, or any reserves! What you need the reserves for (one source of which is incoming deposits from other banks, or cash deposits, or cheques from the Government) is interbank settlement. But the bank needs only a small fraction of the actual volume of transactions, because they are generally going both ways, and transfers are only a small fraction of the actual amount of bank credit that exists. That’s how the bank maintains solvency.
At root if you transfer your deposit to another bank that target bank becomes the depositor in the source bank. Or the transfer can't happen.
Banks then shuffle those deposits they have take on around until they are happy with the risk. That's interbank clearing.
But the 'bank deposit' itself is just an entry on the liability side of the bank's balance sheet, they can't profit from that. The bank might pay interest on it to the depositor because they want to encourage them to deposit more, because deposits coming in give the bank cheap liquidity, so stop them having to borrow reserves from other banks etc. to maintain liquidity.
I'm not saying you're wrong. It just seems like something is missing from the picture in your explanation.
When I opened my bank account, I deposited say £5000 cash. What does the bank do with this money?
I was under the impression that the bank doesn't actually keep this £5000 in cash, only £500 maybe, and uses the rest to lend money, but you seem to be saying that they can't actually use my deposit.
It burns it. Probably quite literally.
The cash represents a transfer from the central bank into the commercial bank's deposit account at the central bank - for which it receives an interest rate.
Cash is just a receipt for deposits held at the central bank.
Banks can also attract reserves by borrowing in money markets (cheap but short term) or issuing long term debt (stable but expensive), or by persuading customers to open accounts and keep them in positive balance. In practice it will use a mix of all three, attempting to match the maturity profile of its liabilities.
The central bank will also create reserves and lend them to your bank if your bank can't raise them elsewhere for some reason. But borrowing from the central bank can spook investors, and it's also expensive.
A bank that doesn't have reserves can't settle its debts to other banks (like the debt you incurred by moving your £5000) and so can't function in the banking system. It has to get reserves from somewhere, and persuading consumers to park deposits in an account is one useful way to do so.
Yes, in a more realistic situation, they'll be using their assets as security for borrowing short term money that they lend out long term, so it's not exactly the same money, but it's still involved in the same risks.
The only way it can work is if writing a mortgage creates an asset (the loan), and then a new liability is made to match it (a deposit of the same amount).
The security is 100% the bank’s capital, since any assets (cash/reserves) from deposits have matching liabilities.
The article I linked above from the UK’s central bank is confirming that all modem banks work the way I am saying.
I’m not confusing anything. Believe it or not, banks actually have to follow double entry accounting rules, and follow regulations about capital adequacy. Most countries don’t even have a reserve requirement, deposits generally don’t factor into lending at all.
It's characteristic of economics that it makes a song and dance about summing a geometric series while completely missing the point about how the system actually works.
- banks take in cash in from depositors (and other creditors)
- banks lend out cash to borrowers
- banks do not lend out all the cash that they've borrowed - they keep some in reserve
Do you have the name of any retail bank which does not operate according to this model? What does their balance sheet look like? The "textbooks" reference is not relevant here - my experience is from working in retail banking operations.
https://www.sciencedirect.com/science/article/pii/S105752191...
Essentially the bank can make the loan with a zero balance sheet.
If you work at the back end of a retail bank operation then you'll know that the loan department and the treasury department do not talk to each other about quantities. They talk to each other about price. Other than that the two operations operate in parallel. 'Funding' is just swapping the liabilities around in the market to try and reduce the amount the bank pays out in interest.
https://www.cooperative-individualism.org/dodson-edward_revi...
Banks don't 'lend out cash', they create deposits. Deposits are liabilities for banks. When a bank takes on a deposit, it also takes on a corresponding asset: either a loan in its books, or an increase in its reserve account.
In practice the reserve ratio is unimportant for a bank: in Canada and the UK the ratio is 0%. The real constraint on a banks ability to create money is it's leverage ratio, i.e. (assets - liabilities)/assets. In reality the formula is more complicated and uses risk weighting by asset class, but that's the crux of it.
Now cash is fungible, and you cannot point to a particular asset and say that a particular liability is funding this asset. But overall, deposits are funding loans.
[1] https://www.lloydsbankinggroup.com/globalassets/documents/in...
1. https://www.rba.gov.au/speeches/2018/sp-ag-2018-09-19.html
Anyway, neither funding or pricing determines the amount of lending these days, capital ratios are the limiting constraint.
The lending itself created new bank credit, it was never "funded". If the bank has capital adequacy, they make the loan.
That's effectively what 'interbank lending' is. The central bank system then centralises that peer-to-peer processes.
Deposits are swapped for capital in the same way.
So the matching deposit disappears from the liabilities side of Lloyd’s balance sheet while the loan remains in the assets side? That leaves the balance sheet unbalanced, doesn’t it?
A bank with an empty balance sheet cannot give a loan.
Lending money is transforming one asset (reserves) into another (loan). The fact that the loan is created as a new deposit in the name of the borrower, keeping the reserves constant, muddles the issue a bit but the simplest description of the process is something like:
1) D makes a $1mn cash deposit at the bank. The bank has liabilities: $1mn owed to D and assets: $1mn in cash.
2) The bank lends $1mn in cash to B. The bank has liabilities: $1mn owed to D and assets: $1mn lent to B.
We can add an intermediate step where the loan is still a deposit at the bank (liabilities: $1mn owed to D. + $1mn owed to B., assets: $1mn in cash + $1mn lent to B.) but it is just a distraction. Not many people borrows money to keep it in a deposit at the same bank.
A bank with an empty balance sheet can give a loan. It is simply Dr Loans, Cr Deposits. That's it.
Nobody ever makes cash deposits into a bank. The cash is just burned when the bank receives it (if it is worn enough).
A cash deposit to a bank is just a deposit transfer from the central bank. Cash is just a receipt for entries already at the central bank. You are starting half way down the process.
To take your example 1) The balance sheet is $1mn Fed deposit asset, $1mn Credit to D. 2) The Balance sheet is $1mn Fed deposit asset + $1mn Loan Asset to B, $1mn Credit to B, $1mn Credit to D. 3) If the cash is withdrawn then the Fed deposit asset and the Credit to B is marked down. The cash will be new cash issued as a receipt for the deposit at the Fed.
You can do exactly the same without the deposit of D first. At that point the Fed asset would be negative and become the lender with the loan posted as collateral.
A banks needs capital, an empty balance sheet doesn’t cut it.
> Nobody ever makes cash deposits into a bank.
Yes, they do. If you pay $5 for a capuccino or whatever what do you think they are going to do with your $5 bill at the end of the day?
> The cash is just burned when the bank receives it (if it is worn enough).
So they never receive cash because nobody ever deposits cash. And at the same time they do receive cash and they just burn it. You have convinced me, there is something seriously wrong with the banking system.
> that would leave the buyer’s bank with fewer reserves and more loans relative to its deposits than before. [...] > By attracting new deposits, the bank can increase its lending without running down its reserves, as shown in the third row of Figure 2.
So actually the banks need deposits to hand out loans. What you are saying is that the deposits get a new label before handing them out as loans?
On the bank's balance sheet, they cannot take deposits and lend them out.
They just need to be 1) solvent and 2) within their capital adequacy requirements and leverage ratios.
A typical bank's balance sheet will contain deposits on one side and loans on the other. Without deposits, or other sources of borrowing, a bank cannot lend money.
1. https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
I can assure you that what I describe IS how real world banks work. You can look at the balance sheet of any retail bank and it will spell this out clearly. I've worked in retail banks and have some hands one grasp of their day to day operations.
Your confusion is a common one - you mistake the process that results in the creation of M2 money with the day-to-day operations of retail banking.
Modern retail banking is a very simple business - they borrow funds (from depositors, other banks, sometimes central banks, commercial loans, etc.) and then lend out the SAME funds while keeping some back in liquid assets (cash, deposits in central banks, short term government notes, etc.) in reserve. The trick is to charge more interest on what you lend out than you pay on what you borrow while managing the risk and cash flows involved when you have a mixture of terms (expiries) of borrowings and lendings.
I think I've given a reasonable summary in my posts of how banks work. I've studied the balance sheets of retail banks and have been exposed to their day to day operations so please don't simply disagree with me and point me to a document on M2 money creation - if you think I've stated something untrue, then highlight it and describe where I'm wrong.
"Banks do not view the creation of money as an objective itself. It is a by-product of the banking sector’s business operations. However, it is of great economic and social relevance.
Not every loan ultimately results in new money. The majority of new lending is used to redeem existing loans. Money is only created to the extent the gross lending exceeds the value of the existing loans being redeemed."
That note refers to the "great economic and social relevance" of these banking operations. Here's Professor Richard Werner talking about this at length. [2]
Here's Perry Mehrling (who teaches Coursera's Economics of Money and Banking) weighing in [3]. He explains that it's a nuanced issue but clearly agrees that the "credit creation view" is important and quotes a Group of 30 report:
“In a barter economy, there can rarely be investment without prior saving. However, in a world where a private bank’s liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet.”
[1] https://www.economist.com/buttonwoods-notebook/2014/06/11/wh...
[2] https://www.youtube.com/watch?v=N-FDdHj7rPk
[3] http://www.perrymehrling.com/2016/01/great-and-mighty-things...
Just because you have a model that seems to describes the behavior of flock of birds doesn't mean that the model is useful when discussing the anatomy and wing-aerodynamics of individual birds.
You've posted a bunch of links describing the various forms of money and the role of banks in modern (post 18th century) M2 money creation. I know all of this material but it's not relevant to the operations of individual retail banks.
[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
This fact means that retail banks "create money out of nothing" only when money is defined as the sum across all banks of the amounts available to customers on demand. No individual bank "creates money out of nothing", individually they borrow money and lend a fraction of it out; they have balance sheets which balance - i.e. ignoring shareholder equity, for every asset (money owed to them by a borrower), there must be a liability (money they owe to lenders including depositors). The M2 money supply counts the latter but does not deduct the former from the sum; as a result, the M2 money supply has a direct relationship with the total size of retail banking balance sheets.
M2 is an economic statistic and it's behavior tells you nothing about how individual banks operate.
“Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”?
Also Prof Werner's analysis, he reaches the same conclusion.
[1] http://positivemoney.org/2013/08/repeat-after-me-banks-can-n...
"Credit" is an accounting concept. Balance sheets are accounting artifacts. The way the bank records it's transactions is a model, not reality. For example, lots of intangibles can have accounting entries created for them for various purposes, but these don't create reality.
Btw, a big problem when discussing bank operations are that the terms "debit" and "credit" can be confusing as their roles are relative to the bank not the customer. Even "asset" and "liability" can be confusing. An Irish media finance and economics professor, Brian Lucey, mixed them up and suggested that a troubled bank could be fixed if it sold its deposits which is impossible - deposits are a liability for banks, not an asset.
Reality is much more simple. Bank lending starts when a customer asks for a loan. Assuming the loan application meets all risk requirements, etc. AND sufficient funds (reserves) are available on the bank's balance sheet, the loan can be issued and the funds transfered to the customer. Reserves are reduced as part of this process but an asset is created for the bank (the loan) so the balance sheet remains the same size.
Well, that's the crux of it right there. You are disagreeing with several authoritative sources who say that no such transfer happens, and in general the loaned funds are created out of thin air.
Standard & Poor's: “Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”
Group of 30: "... banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet."
Richard Werner: "...each individual bank creates credit and money newly when granting a bank loan."
Banks are subject to constraints. They need to retain enough capital to absorb losses on their loan book, and they need to retain enough reserves to cover withdrawals and clearing requirements. They are free to create money "out of thin air" insofar as they meet regulatory requirements associated with those constraints. [1]
You wrote: "I've worked in retail banks and have some hands one (sic) grasp of their day to day operations."
I suggest that your experience does not encompass the whole sector, and that may be the source of your confusion.
[1] https://www.goodreads.com/book/show/13144133-where-does-mone...
and due to overleveraging one unit of deposit ends up as multiple units of loans.
and sure, deposits are not the main factor for lending, risk is. but usually taking deposits is cheaper than taking out a loan from an institution and lending that out. hence banks want/need deposits.
A lot of bookkeeping gets done, assets and liabilities change hands, but in the end it can still be described simply as "people earn money and buy things with it."
Well, no. What the BoE paper is saying is this: Suppose there are two banks, A and B.
If Bank A went on a lending spree without attracting new deposits (or otherwise bringing in new reserves), many of the deposits it created would end up with bank B, because bank A has no control over how its deposits are used. Bank A would have to transfer reserves to bank B to settle the transactions. Eventually bank A would run low on reserves and would need to raise more (by issuing debt, or by making its deposit rate more attractive).
But if bank B was going on a similar lending spree at the same time, the two banks wouldn't run down each others's reserves. If the two banks act in tandem (e.g. by getting caught up in speculative mortgage lending), they can create plenty of money without needing to attract new deposits.
The biggest regulatory hurdle that stops this happening is that there's a regulatory constraint on the leverage ratio (assets - liabilities) / assets.
"This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air"."
https://www.sciencedirect.com/science/article/pii/S105752191...
Just the basics, but I doubt these are obvious to everybody.
There is only one banknote in the US, so there is only one bank. A lent deposit is no deposit. A dollar is 25 grains of gold.
https://news.ycombinator.com/newsguidelines.html
Actually, I thought that is exactly how banks have to operate right now... All deposits are settled in the interbank system or ultimately with the central bank. You can't just deposit money in a bank, because "depositing" $100 means telling an upstream bank that your bank now owes you $100.
since early 2009 the fed funds rate has generally been 5 to 20 basis points (one basis point is equal to 0.01 percentage points) lower than the IOER [1]
For example, money lent out on the Fed Funds market on thursday earned 1.92% [2], while money deposited with the Fed earned 1.95% [3].
The Not-Quite-So-Narrow Bank wouldn't be able to pay as high a rate of interest to depositors as the true Narrow Bank, but it also wouldn't be dependent on the cooperation of the Fed, and Congress's authorization to the Fed, in collecting the IOER rate.
While looking up those numbers, i came across a nice detailed series of posts by George Selgin on IOER [4] and the Narrow Bank in particular [5] [6] - well worth a read.
[1] https://www.stlouisfed.org/publications/regional-economist/a...
[2] https://apps.newyorkfed.org/markets/autorates/fed%20funds
[3] https://www.federalreserve.gov/monetarypolicy/reqresbalances...
[4] https://www.alt-m.org/2017/06/01/ioer-and-banks-demand-for-r...
[5] https://www.alt-m.org/2018/09/10/the-skinny-on-the-narrow-ba...
[6] https://www.alt-m.org/2018/09/14/the-narrow-bank-a-follow-up...
Would you need FDIC insurance if you only took deposits from financial institutions?
Note that whether interest was earned via IOER or via the Fed Funds market, the funds would be deposited with the Fed either way (whether in the bank's own Fed account or overnight in the Fed account of the counterparty of a Fed funds loan).
It wouldn't be possible to accept transfers from other banks, to send funds to other banks or to participate in the Fed Funds market unless the bank had an account with the Fed.
On the point of "risk-free", the TED spread was north of 1% for much of the 20 months between August 2007 and April 2009, and peaked at over 4%. So it's not always what I'd call negligible risk. https://fred.stlouisfed.org/series/TEDRATE
This is almost certainly a big reason for the opposition. The Federal reserve wants to keep people from "hoarding" (saving) money at all costs. Driving down interest rates and causing inflation is one tactic. Preventing the emergence of banks who can out-compete the rest of the market on interest rates is another.
If that were to happen, the Fed would lose considerable influence over liquidity. Its only lever on narrow banks would be to adjust the deposit rate encouraging savers to go elsewhere.