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> 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

> 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
- beefield 8y ago
  > 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.
  - User23 8y ago
    A buddy of mine and I made each other trillionaires for giggles. Sadly we've yet to find a depository institution willing to credit our IOUs.
- captainmuon 8y ago
  > 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...
stephen_g 8y ago
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).
- beefield 8y ago
  > fact that loans create deposits 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...
- twic 8y ago
  > Banks need liquidity funding (including deposits) because they lend, not to lend. 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.

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

beefield 8y ago
> 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.
- User23 8y ago
  A buddy of mine and I made each other trillionaires for giggles. Sadly we've yet to find a depository institution willing to credit our IOUs.
captainmuon 8y ago
> 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...

stephen_g 8y ago

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).

beefield 8y ago
> fact that loans create deposits 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...
twic 8y ago
> Banks need liquidity funding (including deposits) because they lend, not to lend. 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.