3 ms·

Suppose you are a goldsmith and someone makes a deposit with you of two bars of gold, for which you give them two certificates. Now the regulator demands you ke

by alimw 6y ago

Suppose you are a goldsmith and someone makes a deposit with you of two bars of gold, for which you give them two certificates. Now the regulator demands you keep 50% of your assets in gold. According to your way of thinking there is just one way to proceed: lend out one gold bar and stick the resulting IOU in its place on the asset side of your balance sheet. But suppose your would-be-debtor really wanted a larger amount, and in addition thinks she can pay her suppliers in your certificates as easily as in gold. Then you might hang on to the gold, write out two certificates for her and put the resulting IOU against them on the asset side of your balance sheet. Either way the regulator's demands have been met and you remain fully legal and solvent.

zhte415 6y ago
To add in both sides of the balance sheet in this example: Balance sheet, ignoring Capital (Assets = Liabilities + Capital). In your example: Before IOU lending, the goldmith's balance sheet is: 2 Gold (asset); 2 Gold-equivalent Deposit Certificates (liabilities). 100% backed deposits. Lending 1 Gold: 1 Gold (asset), 1 Gold-loan (asset); 2 Gold-equivalent Deposit Certificates (liabilities). 50% backed deposits, as the regulator asks for. That sounds like a Liquidity Coverage Ratio though, not a capital requirement (as above, ignoring Capital for this). Lending 0 Gold, 2 Gold-like Notes: 2 Gold (asset), 2 Gold-like Notes (asset); 2 Gold-equivalent Deposit Certificates (liability), double-entry required for 2 Gold-like Commercial Paper/Note/Bond Certificates issued (liabilities). As 50% is the LCR, within regulator requirements. Issuing more than 2 Gold-like notes, outside the LCR. Just adding, to make it clear balance sheets always need to balance, I find this makes clarity much.. well, clearer.
- derriz 6y ago
  Yes this is a very good way to think about it. I've had this argument many times - it's seems the web has endless sources erroneously "explaining" how retail banking works that has convinced people that there is shenanigans involved in retail banking. Generally they mix up M2 money supply with retail bank operations. It's very difficult to convince people that they are wrong in this regard as they become convinced they've been let into some huge Matrix-like secret of how the financial system operates and tend to savour such knowledge (wow - money doesn't really exist!!) even in defiance of reasonableness or logic.
  - alimw 6y ago
    I find both zhte415's comments in support of my argument that your initial contention was wrong. It's very strange that you interpret them otherwise. To quote you: > What the author is describing is pure and simple fraud ... The goldsmiths were passing off paper certificates under false pretence that they correspond with real stored gold. ... At no point does fractional reserve banking involve "lending out more than what you have on deposit". Yet that is exactly what happens in the second hypothetical course of action I described. Are we now agreed that it is fine? I will concede that this hastily written statement of mine was ill-thought-through: "If this were true then the only money in circulation would be that created by the Central Bank." I cannot edit it now.
    - derriz 6y ago
      zhte415 comment covers two cases: lending out no gold and lending out one unit of gold. I don't see it supporting your argument that a bank can loan out more gold than it has borrowed. The reason I welcome zhte415's comment is that thinking in terms of balance sheets usually clarifies things (as noted in the comment). For example, the top 5 biggest retail banks in the US hold between 20%-40% more in deposits than they have issued loans individually as well as in aggregate. Don't you think that if retail banks worked in the way you are claiming - i.e. raising $X in deposits but issuing >$X in loans that there would be some example of this happening? For at least one bank in the US? It just doesn't happen.

by alimw 6y ago

zhte415 6y ago

To add in both sides of the balance sheet in this example: Balance sheet, ignoring Capital (Assets = Liabilities + Capital). In your example: Before IOU lending, the goldmith's balance sheet is: 2 Gold (asset); 2 Gold-equivalent Deposit Certificates (liabilities). 100% backed deposits. Lending 1 Gold: 1 Gold (asset), 1 Gold-loan (asset); 2 Gold-equivalent Deposit Certificates (liabilities). 50% backed deposits, as the regulator asks for. That sounds like a Liquidity Coverage Ratio though, not a capital requirement (as above, ignoring Capital for this). Lending 0 Gold, 2 Gold-like Notes: 2 Gold (asset), 2 Gold-like Notes (asset); 2 Gold-equivalent Deposit Certificates (liability), double-entry required for 2 Gold-like Commercial Paper/Note/Bond Certificates issued (liabilities). As 50% is the LCR, within regulator requirements. Issuing more than 2 Gold-like notes, outside the LCR. Just adding, to make it clear balance sheets always need to balance, I find this makes clarity much.. well, clearer.

derriz 6y ago
Yes this is a very good way to think about it. I've had this argument many times - it's seems the web has endless sources erroneously "explaining" how retail banking works that has convinced people that there is shenanigans involved in retail banking. Generally they mix up M2 money supply with retail bank operations. It's very difficult to convince people that they are wrong in this regard as they become convinced they've been let into some huge Matrix-like secret of how the financial system operates and tend to savour such knowledge (wow - money doesn't really exist!!) even in defiance of reasonableness or logic.
- alimw 6y ago
  I find both zhte415's comments in support of my argument that your initial contention was wrong. It's very strange that you interpret them otherwise. To quote you: > What the author is describing is pure and simple fraud ... The goldsmiths were passing off paper certificates under false pretence that they correspond with real stored gold. ... At no point does fractional reserve banking involve "lending out more than what you have on deposit". Yet that is exactly what happens in the second hypothetical course of action I described. Are we now agreed that it is fine? I will concede that this hastily written statement of mine was ill-thought-through: "If this were true then the only money in circulation would be that created by the Central Bank." I cannot edit it now.
  - derriz 6y ago
    zhte415 comment covers two cases: lending out no gold and lending out one unit of gold. I don't see it supporting your argument that a bank can loan out more gold than it has borrowed. The reason I welcome zhte415's comment is that thinking in terms of balance sheets usually clarifies things (as noted in the comment). For example, the top 5 biggest retail banks in the US hold between 20%-40% more in deposits than they have issued loans individually as well as in aggregate. Don't you think that if retail banks worked in the way you are claiming - i.e. raising $X in deposits but issuing >$X in loans that there would be some example of this happening? For at least one bank in the US? It just doesn't happen.