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Banks absolutely do lend out deposits. An average bank will take a $100K in deposits, have $10K in equity, and then lend out $110K in a mortgage. > Banks leve

Banks absolutely do lend out deposits. An average bank will take a $100K in deposits, have $10K in equity, and then lend out $110K in a mortgage. > 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 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.

stephen_g 8y ago
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.
- neilwilson 8y ago
  You don't need reserves for interbank settlement either. That's actually a centralised optimisation to reduce collateral requirements. 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.
- kukx 8y ago
  Then how do the banks profit from deposits, if they can't use them for lending?
  - stephen_g 8y ago
    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.
    - kahnpro 8y ago
      Why would a bank take deposits at all then? 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.
      - neilwilson 8y ago
        "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.
      - soVeryTired 8y ago
        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.

stephen_g 8y ago

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.

neilwilson 8y ago
You don't need reserves for interbank settlement either. That's actually a centralised optimisation to reduce collateral requirements. 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.
kukx 8y ago
Then how do the banks profit from deposits, if they can't use them for lending?
- stephen_g 8y ago
  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.
  - kahnpro 8y ago
    Why would a bank take deposits at all then? 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.
    - neilwilson 8y ago
      "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.
    - soVeryTired 8y ago
      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.