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> The main argument presented here is that banks do not have central bank-like special powers in relation to money creation; the process in which banks create m

> The main argument presented here is that banks do not have central bank-like special powers in relation to money creation; the process in which banks create money is entirely pedestrian. I think this is wrong in a subtle way. Regular banks have a reserve requirement that limits their ability to create money. They must hold a certain number of federal reserve notes to meet the reserve requirement. The Federal Reserve can create federal reserve notes.

baobabKoodaa 6y ago
Even if there was no reserve requirements, or other regulation to limit money creation by banks, a regular bank still would not have powers similar to the central bank. Imagine a fraudulent banker who keeps adding billions to his own account. Suppose no-one notices. The banker starts to buy mansions and islands with this made-up money. Every time his bank transfers money to other banks (to buy those mansions), the bank loses some reserves. At some point the bank has no reserves left. Even if the reserve requirement was 0, having no reserves would mean that you could no longer transfer money to other banks.
eru 6y ago
Not all countries have minimum reserve requirements. Eg if memory serves right, Canada didn't have them. And Scotland also didn't have them during their free banking episode. What the Scottish banks had instead where crazy high equity cushions (like 1/3 of assets, instead of the about 8% common these days). But not because of any law, but because customers insisted. Equity cushions are much more important in protecting depositors than reserves.
mgraczyk 6y ago
Reserve requirements haven't mattered in US banks for a long time. One way to think about it is that reserve requirements constrain bank behavior, but the optimal strategy for banks would be the same regardless of whether that requirement were removed. The requirement was removed in the US in March 2020 but has been a formality for most banks for a long time. https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm
- jkhdigital 6y ago
  Right; the hard limitation on money creation is that banks exist in order to earn profits for shareholders, and there is only a finite pool of profitable lending opportunities at any given time. With no reserve requirement a bank could theoretically create unlimited amounts of money but it would eventually go bankrupt as it would take massive losses on bad loans.
  - eru 6y ago
    It's more complicated than that. Even without laws requiring reserves, banks still want to hold some precautionary reserves to eg settle interbank transfers or to serve cash withdrawal requests. But those precautionary reserves can be very small without causing much trouble. In Scotland in the 19th century they had about 2% gold reserves and where doing fine. What's more important are equity cushions to take the blow of losses before the depositors do. Scottish banks typically had about 30% equity cushions because that's what depositors demanded. (These days laws require about 8%. Depositors don't care much anymore, because government deposit insurance numbs them.)
- zimablue 6y ago
  Can you please explain this in further detail or provide a link?

baobabKoodaa 6y ago

Even if there was no reserve requirements, or other regulation to limit money creation by banks, a regular bank still would not have powers similar to the central bank. Imagine a fraudulent banker who keeps adding billions to his own account. Suppose no-one notices. The banker starts to buy mansions and islands with this made-up money. Every time his bank transfers money to other banks (to buy those mansions), the bank loses some reserves. At some point the bank has no reserves left. Even if the reserve requirement was 0, having no reserves would mean that you could no longer transfer money to other banks.

eru 6y ago

Not all countries have minimum reserve requirements. Eg if memory serves right, Canada didn't have them. And Scotland also didn't have them during their free banking episode. What the Scottish banks had instead where crazy high equity cushions (like 1/3 of assets, instead of the about 8% common these days). But not because of any law, but because customers insisted. Equity cushions are much more important in protecting depositors than reserves.

mgraczyk 6y ago

Reserve requirements haven't mattered in US banks for a long time. One way to think about it is that reserve requirements constrain bank behavior, but the optimal strategy for banks would be the same regardless of whether that requirement were removed. The requirement was removed in the US in March 2020 but has been a formality for most banks for a long time. https://www.federalreserve.gov/monetarypolicy/reservereq.htm https://www.federalreserve.gov/monetarypolicy/reservereq.htm

jkhdigital 6y ago
Right; the hard limitation on money creation is that banks exist in order to earn profits for shareholders, and there is only a finite pool of profitable lending opportunities at any given time. With no reserve requirement a bank could theoretically create unlimited amounts of money but it would eventually go bankrupt as it would take massive losses on bad loans.
- eru 6y ago
  It's more complicated than that. Even without laws requiring reserves, banks still want to hold some precautionary reserves to eg settle interbank transfers or to serve cash withdrawal requests. But those precautionary reserves can be very small without causing much trouble. In Scotland in the 19th century they had about 2% gold reserves and where doing fine. What's more important are equity cushions to take the blow of losses before the depositors do. Scottish banks typically had about 30% equity cushions because that's what depositors demanded. (These days laws require about 8%. Depositors don't care much anymore, because government deposit insurance numbs them.)
zimablue 6y ago
Can you please explain this in further detail or provide a link?