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>a more pedantic means of saying "they lend out the money given to them by depositors" As the other commenter mentioned: they lend out more money than the depo

>a more pedantic means of saying "they lend out the money given to them by depositors" As the other commenter mentioned: they lend out more money than the depositors gave them. It works roughly along these lines: depositors give the bank $10 million. The bank can now make loans worth $100 million (or some such number depending on the type of debt). They're creating money "out of thin air". Neffy probably knows more about how it actually works, but what I described is the basic principle of fractional reserve banking.

dd36 8y ago
It’s important to understand that they don’t typically lend out 10x. My business banker (WF) said they have trouble lending out 0.5x. There’s just not enough high quality lending opportunities.
neilwilson 8y ago
There's no limit to the multiple. The 'fractional reserve banking' model is just wrong. (That there are no real reserve requirements in places like Canada or the UK, should really tell people this). In reality it works like this. Loans create deposits. So you lend $10 million and end up with $10 million of loans and $10 million of deposits. The regulator then says you have insufficient capital, so you issue equity or bonds to the tune of $1 million and convince 10% of your depositors to swap their deposits (that you created) for that equity/bond by setting an appropriate interest rate on it. Rinse and repeat until you run out of people to lend to at a price they are prepared to pay. Neither deposits, nor equity have a quantity control function. It's all about the price, not the quantity. In other words the amount of money in the system floats at the current price of money.
- cm2187 8y ago
  > There's no limit to the multiple. That is factually wrong. You have significant capital requirement both in term of RWA or Leverage Exposure (the latter is more likely to be binding for mortgages), particularly in the UK which along with Switzerland gold pleated every international (BIS, EU) regulations. Banks cannot extend their balance sheet indefinitely, and if you look at UK banks, they significantly deleveraged since the financial crisis, as they adapted to new regulations. In fact these capital requirements, along with increased liquidity requirement are probably why the multiplier effect considerably reduced after the crisis.
  - neilwilson 8y ago
    It's factually correct. Deposits are created and then converted into the required capital at a price. To buy equity you need to use a deposit, and that comes from a prior loan. That's just how it works. Same with liquidity which is just increased amounts of loans to the central bank (government) in the form of government bonds. Collateral uplift can give you that. All these just add to the cost of the bank, which changes the price and that reduces the number of people taking the loans. But the fact remains that the quantity floats at the current price of money. Liquidity and capital requirements just change the current price of money.
creato 8y ago
> It works roughly along these lines: depositors give the bank $10 million. The bank can now make loans worth $100 million (or some such number depending on the type of debt). They're creating money "out of thin air". I think this is an oversimplification to the point where it is misleading. Banks can't literally create money like this. What happens is that if a bank has $10m in deposits, they have $10m to loan out, but not more. In practice, they are limited by how much they can loan out by the fractional reserve. If that limit is 10%, then this bank can loan out $9m, so there is now $19m in existence. If you follow this out to the limit, you get $100m with $10m of initial deposits and a fractional reserve of 10%, but a bank can't just multiply its money by 100%/10% and loan out that much money.
- candiodari 8y ago
  Sadly it does: in practice there are 5 big banks in an economy. Maybe less. So let's say a bank has $10m deposits. You're right: they will lend out $10 million, most of that in mortgages, a bit in business loans, a tiny bit in personal loans. Mortgages come with the condition that you don't get the money, you get to write a checque (or do a bank transfer), verified by an official like a notary public. Now you might notice ... so wait ... they lend you money that you can only deposit into another bank account (and then very likely stays in that bank account) ? So that means they can pull this: $10 million in deposits. They lend out $10 million, $9.5 ends up into accounts in that same bank and become deposits. So now they have $9.5 million in new deposits and $10 million in assets (money people owe them). Plus an additional $1 million in interests. Because there's only 5 banks where money can be kept, they're pretty much guaranteed, once above a certain size, to keep or exchange 1:1 deposits created from loans in their bank. So now they lend out the new deposits ... and of course also the assets. So now they lend out a further $21.5 million. Next step is a further ~$40 million. In most of the world laws specify that they can only multiply ~50 times this way (Australia being a very notable exception). So with $10 million in source deposits a bank would lend out a little less than half a billion $. Obviously in practice it's 100 times more complex than described above. For example, banks will usually sell a good part of those assets, like loans, and then take that as a profit, and pay it out to shareholders. This changes their risk profile in positive ways. There's business loans which mostly (the larger amounts at least) work like mortgages but not entirely. There's international transactions, ... The thing to remember is: large amounts of money simply don't "really exist". Starting at maybe $100 million it is simply not possible to "have" that amount of money. Something else is happening, some financial construction is involved.

dd36 8y ago

It’s important to understand that they don’t typically lend out 10x. My business banker (WF) said they have trouble lending out 0.5x. There’s just not enough high quality lending opportunities.

neilwilson 8y ago

There's no limit to the multiple. The 'fractional reserve banking' model is just wrong. (That there are no real reserve requirements in places like Canada or the UK, should really tell people this). In reality it works like this. Loans create deposits. So you lend $10 million and end up with $10 million of loans and $10 million of deposits. The regulator then says you have insufficient capital, so you issue equity or bonds to the tune of $1 million and convince 10% of your depositors to swap their deposits (that you created) for that equity/bond by setting an appropriate interest rate on it. Rinse and repeat until you run out of people to lend to at a price they are prepared to pay. Neither deposits, nor equity have a quantity control function. It's all about the price, not the quantity. In other words the amount of money in the system floats at the current price of money.

cm2187 8y ago
> There's no limit to the multiple. That is factually wrong. You have significant capital requirement both in term of RWA or Leverage Exposure (the latter is more likely to be binding for mortgages), particularly in the UK which along with Switzerland gold pleated every international (BIS, EU) regulations. Banks cannot extend their balance sheet indefinitely, and if you look at UK banks, they significantly deleveraged since the financial crisis, as they adapted to new regulations. In fact these capital requirements, along with increased liquidity requirement are probably why the multiplier effect considerably reduced after the crisis.
- neilwilson 8y ago
  It's factually correct. Deposits are created and then converted into the required capital at a price. To buy equity you need to use a deposit, and that comes from a prior loan. That's just how it works. Same with liquidity which is just increased amounts of loans to the central bank (government) in the form of government bonds. Collateral uplift can give you that. All these just add to the cost of the bank, which changes the price and that reduces the number of people taking the loans. But the fact remains that the quantity floats at the current price of money. Liquidity and capital requirements just change the current price of money.

creato 8y ago

> It works roughly along these lines: depositors give the bank $10 million. The bank can now make loans worth $100 million (or some such number depending on the type of debt). They're creating money "out of thin air". I think this is an oversimplification to the point where it is misleading. Banks can't literally create money like this. What happens is that if a bank has $10m in deposits, they have $10m to loan out, but not more. In practice, they are limited by how much they can loan out by the fractional reserve. If that limit is 10%, then this bank can loan out $9m, so there is now $19m in existence. If you follow this out to the limit, you get $100m with $10m of initial deposits and a fractional reserve of 10%, but a bank can't just multiply its money by 100%/10% and loan out that much money.

candiodari 8y ago
Sadly it does: in practice there are 5 big banks in an economy. Maybe less. So let's say a bank has $10m deposits. You're right: they will lend out $10 million, most of that in mortgages, a bit in business loans, a tiny bit in personal loans. Mortgages come with the condition that you don't get the money, you get to write a checque (or do a bank transfer), verified by an official like a notary public. Now you might notice ... so wait ... they lend you money that you can only deposit into another bank account (and then very likely stays in that bank account) ? So that means they can pull this: $10 million in deposits. They lend out $10 million, $9.5 ends up into accounts in that same bank and become deposits. So now they have $9.5 million in new deposits and $10 million in assets (money people owe them). Plus an additional $1 million in interests. Because there's only 5 banks where money can be kept, they're pretty much guaranteed, once above a certain size, to keep or exchange 1:1 deposits created from loans in their bank. So now they lend out the new deposits ... and of course also the assets. So now they lend out a further $21.5 million. Next step is a further ~$40 million. In most of the world laws specify that they can only multiply ~50 times this way (Australia being a very notable exception). So with $10 million in source deposits a bank would lend out a little less than half a billion $. Obviously in practice it's 100 times more complex than described above. For example, banks will usually sell a good part of those assets, like loans, and then take that as a profit, and pay it out to shareholders. This changes their risk profile in positive ways. There's business loans which mostly (the larger amounts at least) work like mortgages but not entirely. There's international transactions, ... The thing to remember is: large amounts of money simply don't "really exist". Starting at maybe $100 million it is simply not possible to "have" that amount of money. Something else is happening, some financial construction is involved.