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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 expou

by 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...
- User23 8y ago
  Here's a nice description of how it works in the US: https://www.investopedia.com/articles/investing/022416/why-banks-dont-need-your-money-make-loans.asp https://www.investopedia.com/articles/investing/022416/why-b... . From the link, the crux: "The reality is that banks first extend loans and then look for the required reserves later" I'm not familiar with the mechanics of the European banking system so I can't speak to that.
- stephen_g 8y ago
  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.

by User23 8y ago

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...

User23 8y ago
Here's a nice description of how it works in the US: https://www.investopedia.com/articles/investing/022416/why-banks-dont-need-your-money-make-loans.asp https://www.investopedia.com/articles/investing/022416/why-b... . From the link, the crux: "The reality is that banks first extend loans and then look for the required reserves later" I'm not familiar with the mechanics of the European banking system so I can't speak to that.
stephen_g 8y ago
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.