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It's a little more than a technicality. It's to do with the order of processes. Essentially there is nowhere in a modern bank where they go "if deposits <= 0 d

It's a little more than a technicality. It's to do with the order of processes. Essentially there is nowhere in a modern bank where they go "if deposits <= 0 deny loan" Yet I see that time and again in economic models that supposedly have banks in them. Bank lending and the treasury backfill process that manages the equity buffer are parallel processes that are linked by price not quantity. That means that banks will and can lend to any and all creditworthy customers they get prepared to pay the current price of money. It's a dynamic system that can expand and shrink based upon the demand for credit.

derriz 8y ago
I'm not sure what you mean by "modern bank" - when is the cut off date for you? I can assure you that banks can and do end up in a position where they are unable to provide loans. Admittedly the process isn't "if deposits <= 0" because banks don't just access funds from depositors. A retail bank will typically have a blend of funding sources where deposit accounts make up 30-40% of the liabilities on the balance sheets. The rest of the funds are raised on money markets and through inter-bank lending or bond issuance. A bank's balance sheet looks like: - Liabilities: deposit accounts, issued bonds, borrowings - Assets: loans, reserves, equity. I can assure you that "if reserves < X" will mean that a bank is unable to offer a loan to a customer - credit worthy or not. I experienced a banking crisis first hand in the country of my birth and this is exactly what happened. This is why banking crisis are damaging to the economy as a whole - even creditworthy customers and businesses are starved of funds.
- neilwilson 8y ago
  What do you buy capital Bonds/ equity with? Bank deposits. The more deposits there are the more demand there is for bank capital in aggregate. The system reaches an equilibrium at a price not a quantity. The quantity floats as required by the price of money. Reserves are always available since the other banks lend them out and the central bank as lender of last resort. They have no control function in quantity. Only in their price.
  - pas 8y ago
    You can buy bonds with credit, and that is limited by risk, as you say. That's why banks like deposits, they are cheap, and thus they can lend out cheaper.

derriz 8y ago

I'm not sure what you mean by "modern bank" - when is the cut off date for you? I can assure you that banks can and do end up in a position where they are unable to provide loans. Admittedly the process isn't "if deposits <= 0" because banks don't just access funds from depositors. A retail bank will typically have a blend of funding sources where deposit accounts make up 30-40% of the liabilities on the balance sheets. The rest of the funds are raised on money markets and through inter-bank lending or bond issuance. A bank's balance sheet looks like: - Liabilities: deposit accounts, issued bonds, borrowings - Assets: loans, reserves, equity. I can assure you that "if reserves < X" will mean that a bank is unable to offer a loan to a customer - credit worthy or not. I experienced a banking crisis first hand in the country of my birth and this is exactly what happened. This is why banking crisis are damaging to the economy as a whole - even creditworthy customers and businesses are starved of funds.

neilwilson 8y ago
What do you buy capital Bonds/ equity with? Bank deposits. The more deposits there are the more demand there is for bank capital in aggregate. The system reaches an equilibrium at a price not a quantity. The quantity floats as required by the price of money. Reserves are always available since the other banks lend them out and the central bank as lender of last resort. They have no control function in quantity. Only in their price.
- pas 8y ago
  You can buy bonds with credit, and that is limited by risk, as you say. That's why banks like deposits, they are cheap, and thus they can lend out cheaper.