4 ms·

This event doesn't make sense if you have assumed that banks take deposits and then loan that deposit money out. In reality deposits only cover around 10% of t

This event doesn't make sense if you have assumed that banks take deposits and then loan that deposit money out. In reality deposits only cover around 10% of the loan. This is called fractional reserve banking and it means that a bank loan is actually a money creation event! Cash might seem like an asset. But in reality the loan is the asset that pays the bank money and cash is the liability because the cash can be withdrawn at any time (it is owed to someone else). Increased deposits are bad for banks if they cannot use it to generate a loan asset (which is the case today). However, I am still trying to understand why increased deposit liabilities are such a problem that the bank regulations force this issue to be resolved overnight in a reverse repo operation.

Raidion 5y ago
Fairly new at this and don't work in the sector, just someone who enjoys this stuff. I think it's because if the banks have too much cash, that's expensive because it depreciates. They don't want just "mattress money", so when too many people deposit and not enough people withdraw, banks have too much cash, and need a place to park it. If they can't park it anywhere, that means that they don't want more cash, which pushes the interest rates down. Fed has decided that interest rates going down is bad, so they basically say "hey, we'll take the cash off your books, give you a small interest payment for buying the treasuries" and now the banks don't mind taking more cash in. Basically this is a way of keeping the interest rates higher on deposits, because the banks get subsidized to use that cash to borrow Treasuries, this gets unwound every night. So the banks can operate like they don't have too many deposit liabilities, even though they would without reverse repo. I think this is a defense against inflation: If banks can't earn anything from cash, that means they have to push out more loans. Loans add risk/leverage (because it's that money creating event) and they also serve to increase monetary supply, causing inflation. Fed has decided that they'd rather control this process instead of leaving it to the free market in hopes that the situation returns to normal instead of causing additional inflation. This could be just kicking the can down the road, but what do I know.
seoaeu 5y ago
> In reality deposits only cover around 10% of the loan. This is called fractional reserve banking and it means that a bank loan is actually a money creation event! That's not how fractional reserve banking works. If I deposit $100 in a bank, they're not allowed to lend out $1000. In fact given a 10% cash reserve ratio, the limit is actually $90. The other $10 has to stay at the bank "in reserve", at least in theory. (In practice there's additional complexity because banks can borrow money to fulfill their reserve requirements.) When people talk about money creation from fractional reserve banking, what they mean is that someone has $90 from the loan and someone else has $100. Which sums to $190: more than the initial deposit.
- deleted 5y ago
  [deleted]
- spiralx 5y ago
  Fractional reserve banking is an incorrect model of money creation though, banks in today's world really do create money via lending. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
  - imtringued 5y ago
    "The process by which banks create money is so simple that the mind is repelled." - John Kenneth Galbraith
spiralx 5y ago
Fractional reserve banking as a model actually requires deposits in order to make loans, but you're correct in saying that banks do not lend out deposits at all, they in fact create money by lending. This is the clearest overview of the process I've ever come across, and it's from the Bank of England who should know how :) https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-... There's another one covering money more generally as well. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-in-the-modern-economy-an-introduction.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
neilwilson 5y ago
It isn’t resolved. It’s an asset swap that gives the bank free income. Fractional reserve banking is a myth. All deposits come from banks making loans. They are the balancing item on the balance sheet. Banks make loans until they run out of creditworthy customers prepared to pay the current price of money. However government payments effectively force banks to make loans to the Fed on terms dictated by the Fed. All a reverse repo is, is the Fed offering alternative terms for that loan for a day.

Raidion 5y ago

Fairly new at this and don't work in the sector, just someone who enjoys this stuff. I think it's because if the banks have too much cash, that's expensive because it depreciates. They don't want just "mattress money", so when too many people deposit and not enough people withdraw, banks have too much cash, and need a place to park it. If they can't park it anywhere, that means that they don't want more cash, which pushes the interest rates down. Fed has decided that interest rates going down is bad, so they basically say "hey, we'll take the cash off your books, give you a small interest payment for buying the treasuries" and now the banks don't mind taking more cash in. Basically this is a way of keeping the interest rates higher on deposits, because the banks get subsidized to use that cash to borrow Treasuries, this gets unwound every night. So the banks can operate like they don't have too many deposit liabilities, even though they would without reverse repo. I think this is a defense against inflation: If banks can't earn anything from cash, that means they have to push out more loans. Loans add risk/leverage (because it's that money creating event) and they also serve to increase monetary supply, causing inflation. Fed has decided that they'd rather control this process instead of leaving it to the free market in hopes that the situation returns to normal instead of causing additional inflation. This could be just kicking the can down the road, but what do I know.

seoaeu 5y ago

> In reality deposits only cover around 10% of the loan. This is called fractional reserve banking and it means that a bank loan is actually a money creation event! That's not how fractional reserve banking works. If I deposit $100 in a bank, they're not allowed to lend out $1000. In fact given a 10% cash reserve ratio, the limit is actually $90. The other $10 has to stay at the bank "in reserve", at least in theory. (In practice there's additional complexity because banks can borrow money to fulfill their reserve requirements.) When people talk about money creation from fractional reserve banking, what they mean is that someone has $90 from the loan and someone else has $100. Which sums to $190: more than the initial deposit.

deleted 5y ago
[deleted]
spiralx 5y ago
Fractional reserve banking is an incorrect model of money creation though, banks in today's world really do create money via lending. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
- imtringued 5y ago
  "The process by which banks create money is so simple that the mind is repelled." - John Kenneth Galbraith

spiralx 5y ago

Fractional reserve banking as a model actually requires deposits in order to make loans, but you're correct in saying that banks do not lend out deposits at all, they in fact create money by lending. This is the clearest overview of the process I've ever come across, and it's from the Bank of England who should know how :) https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-... There's another one covering money more generally as well. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-in-the-modern-economy-an-introduction.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

neilwilson 5y ago

It isn’t resolved. It’s an asset swap that gives the bank free income. Fractional reserve banking is a myth. All deposits come from banks making loans. They are the balancing item on the balance sheet. Banks make loans until they run out of creditworthy customers prepared to pay the current price of money. However government payments effectively force banks to make loans to the Fed on terms dictated by the Fed. All a reverse repo is, is the Fed offering alternative terms for that loan for a day.