4 ms·

> 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 backin

> 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.

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.