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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

by User23 8y ago

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. [1]https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm

BurningFrog 8y ago
I know all those words, but I have no idea what you said.
- ddingus 8y ago
  Banks create money at the time someone gets a loan, and or risk is valued. Their reserve, deposits, determine the size of loan they can create.
  - nazgulnarsil 8y ago
    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.
    - lucio 8y ago
      "Banks create money" (from thin air). That's the concept a lot of people struggle with.
UncleEntity 8y ago
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.
- klodolph 8y ago
  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.
  - UncleEntity 8y ago
    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.
    - didgeoridoo 8y ago
      Edit: my comment was misleading and confusing and I’m too tired to fix it right now so into the bin it goes :)
      - klodolph 8y ago
        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 + ...
        Dylan16807 8y ago
        And to put that all together, it means the bank is responsible for $1000 in deposits, has $900 owed to it in loans, and has $100 of cash in the vault.
Finnucane 8y ago
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.
- jey 8y ago
  Yeah, so it must be intended for some kind of non-bank financial institutions that can't directly open Fed reserve accounts?
  - JumpCrisscross 8y ago
    > some kind of non-bank financial institutions that can't directly open Fed reserve accounts? This describes every financial institution that isn't a national bank, e.g. broker-dealers, insurance companies, hedge funds, et cetera.
darawk 8y ago
> but if the loan is profitable the bank can always borrow the reserves at a lower rate on the interbank market. They're still loaning out deposits, though. They're just borrowing someone else's deposits to do it.
- avn2109 8y ago
  >> "They're still loaning out deposits, though." 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-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
  - kzrdude 8y ago
    What's the exception? And is there a special license for being allowed to create money?
    - Dylan16807 8y ago
      > 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.
beefield 8y ago
> Banks don’t loan out deposits. 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.
- User23 8y ago
  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. [2] Informal usage

by User23 8y ago

BurningFrog 8y ago

I know all those words, but I have no idea what you said.

ddingus 8y ago
Banks create money at the time someone gets a loan, and or risk is valued. Their reserve, deposits, determine the size of loan they can create.
- nazgulnarsil 8y ago
  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.
  - lucio 8y ago
    "Banks create money" (from thin air). That's the concept a lot of people struggle with.

UncleEntity 8y ago

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.

klodolph 8y ago
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.
- UncleEntity 8y ago
  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.
  - didgeoridoo 8y ago
    Edit: my comment was misleading and confusing and I’m too tired to fix it right now so into the bin it goes :)
    - klodolph 8y ago
      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 + ...
      - Dylan16807 8y ago
        And to put that all together, it means the bank is responsible for $1000 in deposits, has $900 owed to it in loans, and has $100 of cash in the vault.

Finnucane 8y ago

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.

jey 8y ago
Yeah, so it must be intended for some kind of non-bank financial institutions that can't directly open Fed reserve accounts?
- JumpCrisscross 8y ago
  > some kind of non-bank financial institutions that can't directly open Fed reserve accounts? This describes every financial institution that isn't a national bank, e.g. broker-dealers, insurance companies, hedge funds, et cetera.

darawk 8y ago

> but if the loan is profitable the bank can always borrow the reserves at a lower rate on the interbank market. They're still loaning out deposits, though. They're just borrowing someone else's deposits to do it.

avn2109 8y ago
>> "They're still loaning out deposits, though." 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-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
- kzrdude 8y ago
  What's the exception? And is there a special license for being allowed to create money?
  - Dylan16807 8y ago
    > 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.

beefield 8y ago

> Banks don’t loan out deposits. 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.

User23 8y ago
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. [2] Informal usage