To my mind, although it's in-principle equivalent, the clearer way to think about this is that banks borrow money from depositors and lend that money via loans or investments.
The primary business of a bank is borrowing short and lending long - where short and long refer to the holding time: i.e. taking demand or short-duration term deposits and making mortgage, car and other types of loans.
If you do this badly, you can lose money due to duration risk (you might end up paying more on your demand deposits than your mortgage book is bringing in), but you also have liquidity risks because your depositors can ask for those deposits back faster than you unwind your lending.
If you have both of these occurring at the same time, you're then in severe difficulty, because the only way to repay your depositors is by borrowing money ... which is going to be harder if you look unprofitable ... and that very borrowing can exacerbate the perception of a bank in trouble.
OK, sure. It’s a distinction without a difference though. If you read pg. 5 of that document, it explains how the effect of market forces results in essentially the same net effect for an individual bank as if they did “lend deposits”.
This, plus the other effects (like what the BoE calls “prudential regulation”) are the reason why you don’t see banks with zero deposits and a trillion pounds of loans.
Credit vs quantity theory of money is basically a concern of monetary policy (like: what is the expected effect of quantitative easing?) and doesn’t really bear on decisions at the level of individual banks or borrowers: things look consistent with both theories.
Like: it doesn’t matter whether classical or relativistic mechanics are “true” if you’re only following the flight of a baseball.
Maybe, but in the case of SVB, deposit amounts were suspiciously similar to assets....
The BOE is simply pointing out in the link that they are the only proper bank in the UK. All the others borrow from the BOE to make loans. Commercial banks don't "create" money any more than the BOE "borrows" it from elsewhere.... The BOE creates money and lends it to commercial banks who put up a deposit and make a reasonable case for credit.
In a fractional reserve system the amount they can loan out is a multiple of their deposits, with the excess money coming from the central bank.
Also why link an article from the UK when the subject is a US bank? There are differences between the two countries banking systems and monetary policies.
Of course banks are lending deposits. They're throwing in some investor money too but vast majority of loans they write is using deposits. You can try to make some sort of "number on screen go up" argument, btu the underlying value comes from somewhere. When someone takes a loan and withdraws dollars they're usually getting money that was deposited by a customer.
That's a misunderstanding - when a bank originates a loan:
- the bank records an asset (the loan) and a liability (the deposit in the borrower's account)
- the borrower records an asset (the loan money now deposited at the bank) and a liability (the loan)
But is it real? It’s more like an IOU, right? They don’t reduce the amount of money in the depositor’s account, but if the loan defaults would they be able to return the money to the depositor? My guess is no, not really (assuming no other outside cash sources).
So even though the amount of currency looks like it has increased, it hasn’t really… unless I’m misunderstanding still. But my impression is this is pretty much what happened yesterday with SVB.
That's wrong. The loan amount was never anything but a number that someone at the bank punched into a database. It doesn't have anything directly to do with someone else withdrawing their own money.
If the bank is giving cash to the withdrawer, that would come out of their capital reserve I guess. If they didn't have that, they FDIC insurance would kick in.
You’re wrong. If someone took out a loan and withdrew all the money before defaulting the bank would not be able to pay deposits. Insured deposits would be paid by the government and uninsured deposits would go poof.
You can say the loan is a number in a database, but once it’s withdrawn from the bank the bank can’t just go into the database and undo the loan.
Your understanding of banks taking in deposits then lending them out hasn't been true for decades. A bank with no deposits can make loans just fine. They can just borrow at a lower rate than they loan if they actually need to hand out cash.
Your example doesn't make much since because any bank has many good loans and a capital reserve to deal with the few bad loans.
This was basically what I was asking. Okay so, because the bank has access to an external supply of “money”, they can loan out more than they have in reserve. Thanks!
Yes, BUT they do not need to get 1000 USD from anywhere to put 1000 USD in your account. They literally just say you have 1000 USD. You can then electronically transfer that to anyone else's bank. The banks then borrow government money overnight to settle accounts. That's the only place government money comes into it.
Economists actually refer to the USD in your account as bank money because it did not come from the government. You could just as easily think of that money in your account as a bank issued stablecoin pegged to the dollar that's convertible to dollars.
except people withdraw money and the bank needs to give those people actual cash. That's deposits. Of course they could take overnight loans or whatnot but deposits are cheaper.
The vast majority of money is not withdrawn. It's all transfers. And that is a major point and difference.
Also, if it was all withdrawn it's a bank run, which has not been a problem in the US for quite a while.
Overall it cancels out for the large banks, of course people transfer money they just borrowed from the bank away, but that bank also has customers that are recipients of money. That, and other mechanisms between banks and banks and central bank(s) to balance such things within all the banks in the overall economy. Money withdrawn from one bank goes to another one, and everybody is not just sender but also recipient from someone else.
Why do you keep insisting on the "cash"? The by far least important kind of money? First of all everything is just virtual, electronic. Only a tiny fraction - and only temporary! It's not stocked at home, but used to buy something and that means deposited again in another bank - is "cash".
Yes banks need some reserves, but this is waayyyy more complicated than them using the deposits. Which, for the most part, are not cash. That's only that tiny fraction of paper money use din circulation, which also is a lot less than it used to be with all the card-money.
USD is different because that currency is used for far more than just regular circulation, and world-wide. But even then estimates are ca. 8% cash maximum, for the world, which includes a lot less sophisticated economies. A bit more for the USD for obvious reasons, but most of that is not circulating in the US economy.
In any case, even in the US, with all its cards and card payments, money is mostly electronic and not cash and is transferred from bank to bank and hardly leaves the banking system.
> commercial banks create private money by transforming an illiquid asset (the borrower’s future ability to repay) into a liquid one (bank deposits); they would quickly be insolvent otherwise
Uhm.. yes, exactly. They can't do it at will, they need a borrower to sign. I mean, now we start arguing definitions, always a bad sign, especially when both sides actually are in perfect agreement and it's about the words used. This article to me is just weird, arguing it's not out of thin air, while everything being described says just that, only that their understanding of "out of thin air" is subjectively different than that of many other people. But there is no difference in knowledge and opinion about the underlying mechanism, only disagreement about some fuzzy term that some like to use and some apparently hate for whatever reason.
I’m not reading that, but I’m using “cash” because that’s what I’m talking about. Yes most of the loan money isn’t cash, but the cash has to be available for withdrawal so “it’s just numbers on a screen” doesn’t actually work all the way down.
Banks don't hold substantial cash. They send whatever cash they collect to the local federal reserve to be recycled and get fresh cash to hand out to people every morning from the same federal reserve. I don't think I've gotten a "used" bill from a bank in over a decade.
So let's assume a bank has collected deposits worth £1000 from all of its customers. Now the bank makes a loan of £100 to one of its customers and puts the money into the customer's current account at the bank.
According to your theory, what is the total amount of deposits at this bank after making the loan?
If, as you say, banks were lending deposits, then the total amount of deposits cannot possibly have changed and that new loan of £100 would have to come out of some other customer's bank account.
I would be pissed if my bank account balance suddenly dropped and the bank told me, sorry we have lent your money to someone else.
They give your money to that guy. And he puts it in his account at the bank and they give it back to you. The money is still real though. Without the deposits they could not make any loans to begin with.
If someone comes to take out a loan for $1000 and withdraw the money what would happen? They'd go get the money everyone left there and give it to the new customer. Now they bank has no money because they just lent all the deposits. $1100 in deposits and $1100 in loans
“ Without the deposits they could not make any loans to begin with.”
Incorrect, banks create deposits when they issue loans and only require reserve balances sufficient to satisfy net flows of funds between institutions.
They can also borrow those reserves.
So deposits are required to increase profitability, and of course a minimum level of profitability is required to be solvent, but banks in now way “lend out deposits”.
If you actually believe this describes the process then follow me on this thought experiment.
TWB (unrelated to SVB) realizes that it’s in trouble - customers are taking a lot of their deposits out, and confidence in the institution is low.
So, instead of trying to liquidate some of their assets or raise capital (which is what would be conventional) they decide to lend their bank president a trillion dollars of interest free loan with a recall feature, on the contingency that he deposit it in a non-interest bearing account with a 300 year notice requirement.
In your understanding of the mechanics of banking; this is fine. The bank magics $1tn of deposits out of thin air, records an equivalent asset, and can then just pay all of their customers from these new deposits they have.
By issuing deposits, each bank creates essentially its own money which is valid as long as it is inside the bank (used in transactions with other clients that use the same bank), but when clients send money to other banks, the bank has to use 'central bank money'.
Which means banking system as a whole creates 'private money' when flows of 'central bank money' between banks are balanced, but each individual bank cannot do it faster than others, otherwise these flows will be negative and it will be losing 'central bank money' and/or hard assets (which would be sold to acquire 'central bank money').
In your worldview, where does the money a bank needs to operate from?
In your worldview, can you explain how it is possible for a bank to have far more loans on their books than they have deposits (see: fractional reserve banking)?
> A bank can make an infinite amount of loans. They are not constrained by anything.
They are constrained by capital and/or reserve requirements
> The way a loan works is: they make a loan to someone and then "just in time", they borrow the money from the Fed to cover that loan.
Nope. Banks can borrow against their government securities from Central Banks by "rediscounting" them during discount windows, should they need extra liquidity. Note that this is not the preferred method since Central Banks usually charges a premium. These are secured loans.
But loans aren't typically available immediately - they take time to clear. It doesn't seem unreasonable to me that they'd bundle the day's loans (or maybe a few hours at a very large bank) to limit the number of transactions they'd have to make.
The money that gets borrowed from the Fed is used to settle balances between banks. When a bank originates a loan, they just add a number to an account. The money doesn't come from anywhere. This works mainly because most money transfers are electronic.
tl;dr yes, banks create money out of thin air. It's been this way for decades.
> can you explain how it is possible for a bank to have far more loans on their books than they have deposits (see: fractional reserve banking)?
Fractional reserve banking is about having more deposits (on the liability side) than reserves (on the assets side).
I won't say that it's not possible for a bank to have far more loans on their books than they have deposits (they could finance themselves differently) but I'm not sure if that actually happens. Can you give an example of a bank having far more loans on their books than they have deposits?
Banks don’t have far more loans than deposits. When they make a loan most of the money is just redeposited, so effectively each oringal deposit gets 10x’d by people just leaving the money in the bank. That’s how fractional reserve banking and “creating money out of thin air” works.
If none of the loan money was redeposited than the bank couldn’t create new money.
You are thinking of a nation - and even a single bank - as a closed system. But this is an oversimplification that makes it impossible for you to make steps in your understanding of how this all works.
I've worked for a bank, both on the 'banking' side and on the IT side. One of the first things that gets drilled into your head is that banks create money. With every loan on the books more money gets put into circulation. There are some restrictions on how much you can put into circulation and there are some restrictions on how much cash you have to have on hand compared to the number of deposits that you have lying around.
But a bank could easily (as long as the bank is 'solvent' according to the rules set by the local central bank) write loans well in excess of it's deposits, technically it need not have any deposits at all.
I wonder if it’s correct to also think about it in this way: idle cash devalues over time. Coupled with interest (no matter how small) that they pay out to their depositors, this exposes banks to future liability. To counter that, they have to give “jobs” to as much of this cash as possible so that they can make those payments while also pocketing a profit for themselves.
As for money markets, don’t those get invested in treasury bills/notes anyway? Why go through a “middleman” when one has enough volume to invest directly?
Short-term obligations may not provide the yield that their financial structure requires.
10-year notes, in certain situations, provide an optimal combo of yield and risk. Provided, of course, that nothing major happens to the economy which wasn’t the case here. Then again, who’s good at predicting that?
In the end, it seemed like, given what was true at the time the decision was made, SVB made a rational choice.
> banks borrow money from depositors and lend that money via loans or investments.
Do they? Reserve requirements are almost non-existent. A better way to put it is that banks pretty much have a state-granted privilege for creating money and in the form of loans.
People read “reserve requirements have gone to zero” (which is true) and assume it is so that banks can keep lower reserves.
In fact, reserve requirements became meaningless because banks had (and continue to have) so much more in reserves than they were ever required to have under the prior system.
I don't understand this, could you clarify? If they have so much more money than the requirements demand, what is the point of lowering the requirements? Who does it help?
The point wasn’t that reserve requirements were “lowered”; they were removed - because the Fed moved to a different mechanism to set short-term interest rates.
If banks choose to keep lots of reserves (because you’re paying interest on them), it’s hard to change the willingness of banks to lend by changing the reserve requirement, right?
In economic terms, the supply of reserves is meeting the demand curve for reserves in an inelastic region.
So the Fed decided to announce a new approach; the so-called “ample reserves regime” where short term interest rate control would be achieved by administered rates rather than by the reserve requirements of the “limited reserves regime” that went before.
If this sounds very far from the quotidian business of deposit taking and loan making: that’s because it is.
I hear this a lot and it's in a lot of "explainer" videos on youtube and so on. The idea that banks have a special state-sponsored privilege to create credit is completely and very obviously untrue.
Try this thought experiment. You and I are in a bar. We order drinks but oh no the bar's card machine is down and you don't have cash. No problem I'll lend you a tenner.
1) Am I a bank?
2) Did I first contact the state to check it was ok to create money in the form of a loan to you?
I go back to the bar on another day on my own. Oh no! Their card machine is down again! This time I don't have cash on me. No problem the barman sees me all the time I can have the drink this time and pay up when I next get there and either have cash or their card machine is working.
3) Are they a bank?
4) Did they first contact the state to check it was ok to create money in the form of a loan to me?
The answer to all these questions is obviously no. Credit is created throughout the economy at all levels and it is not a special function perculiar to banks.
You are talking about credit, not money. Banks create actual state-backed money, which can be physically (or more likely electronically) paid to a third party after they've loaned it to you.
A better example would be if you were in the bar alone, and had no money, and instead just wrote an IOU on a bit of paper with your contact details. If we lived in a mythical 100% trustful utopia, then the barman would just accept this as money and so would anyone else in future who the barman needed to pay for anything. But we obviously don't live in such a society so unfortunately no, not anyone can just create money!
Banks don't create state-backed money either. The central bank creates money and gets it into the financial system by performing open market activities (eg buying treasuries with it) or depositing it into the accounts it holds with various banks.
Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money. You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed.
The explainer videos I have seen are wildly wrong. I learned this stuff by reading the Basel accords [2], working with banking regulators and central bankers, working on banks' capital reserve models etc. That is to say I know how this actually works because I have been inside the sausage-making process for good or ill - I didn't learn it second-hand from someone who probably also learned it second-hand which is the feel I get from these videos.
Almost any time you see someone "explain" fractional reserve banking it is about 99% probably total bullshit. It's got to the point where "fractional reserve" is almost a trigger phrase for me - I know when I hear it that it is highly likely the speaker doesn't know what they are talking about. Almost like when you hear the word "fiat currency" you know it's very likely someone is going to try to shill you some crypto. An explanation which is not nonsense is here. [3] Fractional reserve banking means the bank doesn't need to keep the full amount of deposits in reserve, but can use some percentage to make loans. These loans are assets the bank has, but as with the example I gave above where you lend to a friend, no additional money is created in this process and when a bank does it, it's not fundamentally any different.
[2] Which are not secret by the way - you don't have to be initiated into the templars or something to understand them. They are boring as all hell to read but otherwise reasonably understandable with a little bit of background https://www.bis.org/basel_framework/
I feel like there are quite a lot of people here that do not understand that the relationship between theories of money and the actual day-to-day operations of banks is about as close as that between weather forecasting and umbrella manufacturing.
I'm confused. Under link [3] you posted, the section entitled "Fractional Reserve Banking Process" states the following:
>The fractional reserve banking process creates money that is inserted into the economy. When you deposit that $2,000, your bank might lend 10% of it to other customers, along with 10% from five other customers' accounts. This creates a loan of $1,000 for the customer needing a loan.
>The bank essentially created $1,000 and lent it to the borrower.
The above explanation was always my understanding. Is this a case of semantics?
> Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money. You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed.
When a bank gives someone a loan M1/M2 increases (unlike in your loan-between-friends example). The increase in "currency in circulation plus deposits" is the very thing that those numbers try to measure.
You assert that the act of individual act of lending creates the money - this is known as the credit creation theory of money; the GP asserts that the central bank creates the money and banks are just moving it around - this is known as the financial intermediation theory of money. That also happens to be the theory that underlies most banking regulation, like the various Basel Accords.
You can look at it either way; or indeed you can take a third view, the fractional reserve theory of money, which suggests that the banking system as a whole creates money in aggregate, but not individual banks.
All of these are theories with their adherents and none has yet been proven right or wrong. The only wrong position is a failure to acknowledge that discussion is still open on this point, or to believe that these are anything other than macroeconomic models.
As far as I can understand seanhunter asserts that bank lending doesn't create money - pointing to the definition of M1/M2 money - and claims that bank lending is not different from me lending you $100 and that the amount of M1 or M2 money in supply doesn't changed in either case.
> The only wrong position is a failure to acknowledge that discussion is still open on this point
Saying that bank lending doesn't increase M1/M2 money supply is wrong. I don't think that discussion is still open on that. It's just how those things are defined. That's the only thing that I asserted.
>As far as I can understand seanhunter asserts that bank lending doesn't create money - pointing to the definition of M1/M2 money - and claims that bank lending is not different from me lending you $100 and that the amount of M1 or M2 money in supply doesn't changed in either case.
Right. That is the basic definition of the financial intermediation theory of money. It's actually a predominant view in the literature: for example, the Diamond-Dybvig model is based on the assumption that banks are not special as intermediaries; and it won the Nobel Prize for its authors in 2022.
I don't know if the financial intermediation theory of money has its own definition of M1 and M2 but the one given by seanhunter is the standard one. If we're using the same definition [are we?] then it either changes or it doesn't.
If money supply is "currency in circulation plus deposits[, etc.]" how does bank lending not increase the "currency in circulation plus deposits[, etc.]" amount?
(Of course lending between friends doesn't: the $100 bill in circulation is the same as before and the friendly IOU is not a deposit nor included in the [, etc.]")
A loan only increases the money supply if it's made without replacing the deposits that were loaned out. The financial intermediation theory is that that doesn't happen: a bank is just a place where money flows come together to find allocations to investments, and that the benefit is that the size mismatches between those in surplus and those who need to borrow can be reconciled, so banks that do this skillfully are economically valuable and make profits.
This is not, prima facie a bad theory, right? Go take a look at JP Morgan's balance sheet. The asset and liability sides of the sheet are basically loans and investments (on the asset side) plus deposits and outstanding debt (on the liability side), and these balance.
One may also say that turning up the heater doesn't increase the temperature of a room - because I open the window at the same time.
Anyway, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
M1 would change if it was defined as "currency in circulation plus debts between friends" and the "oh, but my friend would sell the debt to the central bank or whatever in the end so there is no change in money supply" argument seems goalpost moving. The original analogy doesn't work and bank lending does increase money supply everything else being equal.
>Still, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
Can you not see why there are some who would say "it is obviously wrong to suggest money has been created in the second case, but not the first" or indeed "in neither case has money been created"?
By the way, in case it is not obvious: the fact you don't have a compelling rationale to make me believe your description of the world, and I don't have a compelling rationale to convince you of my view of the world is why there are multiple competing theories.
I am not trying to tell you that you're wrong; just that you're not right.
I'm just claiming that saying that M2 money supply doesn't change in the second case is wrong because it has been defined to measure exactly that. Under the assumption that money has been created in the second case, but not the first - whether we find that obviously wrong or not is irrelevant.
> the fact you don't have a compelling rationale to make me believe your description of the world
I'm only trying to make you believe that the thing that seanhunter wrote is seems incompatible with his own definition of money supply which makes the bank loan situation different from the friend loan situation.
No; M2 has been defined to measure the money stock. You're a believer in the credit theory of money creation, so you obviously think increase in the money stock happens due to lending. If you're a believer in the financial intermediation theory, you don't think that - you think the central bank adds to or removes from the money stock (by controlling short-term interest rates, and therefore the amount of loanable funds), and the banks just move it around.
These are macro theories; they don't tell you anything at all about an individual loan - only aggregate behavior of the entire system.
The only think I've been repeating all along is that in your own example
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
M2 goes up in the second case where they end with $100 each (but doesn't in the first case where $100 change hands) because the example doesn't include any mention to a central bank removing from the money stock.
In the first case, the friend has given you $100 and won't see it back for a year, and then will get $5 interest.
In the second case, the friend has given the bank $100 and won't see it back for a year, and will then get $2 interest. The bank then lends you $100 which it won't see back for a year, and will then get $5 in interest.
The cases are economically the same; except in the second case, the bank takes the net interest margin of $3.
The second case, scaled up hugely, is observably what happens in the real world; it's not my theoretical construct. I refer you again to JP Morgan's balance sheet - the extent to which assets (mostly loans) exceed liabilities (mostly deposits) is simply the equity of the bank. That's the whole point of a balance sheet; it balances. If deposits exceed loans then, well, we saw what happens there, right?
You can't break half of the balance sheet off and say "look, these loans are increasing deposits at other banks; M2 has gone up"; that's literally meaningless.
But that's literally the definition of M2. You look at the currency in circulation, the deposits at banks and other things not present in that example and you add them up.
(I'm not sure why would you think that I'm not aware that the balance sheet of a bank is full of deposits and loans among other things, by the way. The whole discussion is about banks taking deposits and making loans!)
> Fractional reserve banking absolutely does not create money[1]. It creates credit exactly the same as if you lend a friend of yours some of your money.
Yes, it creates credit that people think is money. I suspect that's a big problem with it. People think their money is in the bank. Instead the bank is just extending them some credit that they can pass on to others when they "purchase" something.
Sure, but they don't have unlimited ability to make loans. They are subject to complex balance sheet constraints. And it's cheaper to borrow money from depositors than the Fed.
"As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions."
Read more - the reason is the "ample reserves" regime, where, as I showed, reserves are vastly higher than usual. This is because the Fed has transitioned to a better method to handle what used to be called the reserve requirement. The new (and as the above data demonstrated) is higher actual reserves. This is done via changes in mechanisms, described in the FAQ.
It's not like banks suddenly loan out all the money. The Fed page has a FAQ and you can look up related papers.
From the FAQ:
"For many years, reserve requirements played a central role in the implementation of monetary policy by creating a stable demand for reserves. In January 2019, the FOMC announced its intention to implement monetary policy in an ample reserves regime. Reserve requirements do not play a significant role in this operating framework."
People see the change, which is a good move for good reasons, and flip out, just like goldbug times or when CPI get adjusted and so on. A simple way to look at it for a long time there has been a idea battle between what's called endogenous and exogenous money creation (somewhat overview of the debate [1]), and over the past 50 years, most central banking systems have evolved as market needs evolved, to allow banks to lend beyond reserve requirements as long as they soon replenish, which was done via overnight lending windows through central banks. The practical effect is there has not been a "reserve requirement" except in name only for decades. Banks can lend whatever they want, and only have to borrow back to the old requirement which is simply an inefficiency.
This is summed up in one sentence on the Wikipedia article on reserve requirements as "Under this view, reserves therefore impose no constraints, as the deposit multiplier is simply, in the words of Kydland and Prescott (1990), a myth" [2]
Under the new system, the Fed changed other rates to account for this bookkeeping trick, with the same net effect on the banking system, but under simpler and more transparent accounting. They're not idiots.
So, since this was the reality of banking, the FED changed how things are tallied. Just like when CPI changed some terms to handle changes in reality, changes that were well documented, for good reason, people not reading carefully got upset and were sure they got cheated somehow.
So setting the old rate to zero and adopting the new methods for monetary control are the same pattern: terms change, in practice things are actually better off, but people used to the old term are upset and mischaracterize it as some a sign of financial calamity or underhandedness.
It's not. When people dig this out during an unrelated bank issue as some smoking gun it's worth stopping the nonsense in it's tracks in the same vein as COVID or climate or goldbug nonsense.
Not how it works. How it works is that there are a number of constraints and metrics placed on banks that they need to satisfy and prevent them taking risk. At any time it could be any one of these that is the limiting factor on risk. It may not be a measure of "reserves" that is the constraint.
That's not what GP is saying. When reserve requirements are low, banks are essentially no longer forbidden from lending out other customers' deposits.
When you decrease the reserve requirement, you're unlocking reserves that were previously locked up to back your deposits so that they can be loaned out to other customers, who will then promptly either directly or indirectly end up depositing their loaned amount into the banking system again, where the part that remains after the reserve requirement once again gets loaned out, deposited back in, etc.
In effect, because you're making this money go around, you're increasing the total supply of money, because these deposits are the money supply, and there can and often is more than a $1 net increase in overall deposits for each $1 deposited with a bank. Another way to state it is like so: you deposit $1, bank loans out $0.90, someone else deposits that $0.90, their bank loans out $0.81, so on and so forth for $10 of net deposit generation for a $1 initial deposit at 10% reserves held.
Of course, individual banks can elect to lock up more reserves than necessary, which would negate this effect.
> Is it possible for a regular bank to lend money it does not have?
Banks create money from nothing to lend out:
> Therefore, if you borrow £100 from the bank, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account.
> This also means as you pay off the loan, the electronic money your bank created is ‘deleted’ – it no longer exists. You haven’t got richer or poorer. You might have less money in your bank account but your debts have gone down too. So essentially, banks create money, not wealth.
> This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
Money is a psychological construct of humans to facilitate trade and the exchange of goods and services. Some societies don't (didn't) even have money/currency: everyone kept a mental 'tally' of who gave or took things, and there were social expectations of giving "gifts" for repayment. Physical tokens (bones, shells, gold, paper, etc) came later.
The posts above are incorrect about how banks work, but your question is spot on. Actually, banks always lend out money they don’t have - they can’t actually “lend deposits”. The risk of what banks do is why banking licenses are hard to get and it’s so regulated.
They borrow and repay with interest, so the don't borrow unless they have some use for the money that will return value to the borrower, and some profit to the bank, in order to repay the loan the bank got.
The primary business of a bank is borrowing short and lending long - where short and long refer to the holding time: i.e. taking demand or short-duration term deposits and making mortgage, car and other types of loans.
If you do this badly, you can lose money due to duration risk (you might end up paying more on your demand deposits than your mortgage book is bringing in), but you also have liquidity risks because your depositors can ask for those deposits back faster than you unwind your lending.
If you have both of these occurring at the same time, you're then in severe difficulty, because the only way to repay your depositors is by borrowing money ... which is going to be harder if you look unprofitable ... and that very borrowing can exacerbate the perception of a bank in trouble.
That's basically what happened here.