4 ms·

"Fractional reserve banking" is the thing to look up but, yes.

by Jgrubb 4y ago

civilized 4y ago
But you can have fractional reserves without the ability to magically credit to customers more real dollars than you have. If I take my customers' deposits and loan out 90% of the currency they gave me to other people, that's fractional reserve banking too. At the beginning the author explicitly tells us that this "Wonderful Life" depiction of banking is NOT what actually happens. And then he seems to imply that, actually, banks just get to magically credit borrowers with 10x the deposits their customers give them.
- drexlspivey 4y ago
  The author is right, commercial banks create money out of thin air https://www.bankofengland.co.uk/knowledgebank/how-is-money-created https://www.bankofengland.co.uk/knowledgebank/how-is-money-c...
- mattnewton 4y ago
  Banks requirement is that they have 10% of assets on hand at any moment. So if you, or the federal reserve gives them a dollar, that means they can create a record of 9 dollars owed to other parties without being over levered. Remember that's what is being done here, numbers in ledgers are increased but nobody has to send a brinks truck to move pieces of paper or bullion.
- christophilus 4y ago
  You have to use 2nd order thinking. I give you $10. You lend $9 to Joe. Joe takes that money and deposits it in your bank. So, now you have $19 in your bank. You lend Sally $8.1 of the $9 that Joe gave you. Sally deposits the $8.1 in your bank. Your bank now has $27 in deposits. Continue until you've basically got 10x what you originally had in deposits.
  - type111 4y ago
    This is not how it works in reality. $10 of new deposits can be created in a single fell swoop.
- type111 4y ago
  I think much confusion comes from association with the word 'loan'. In reality, a bank 'loan' is actually an extension of credit. You are indeed 'magically' credited, in an instant, with say $100 of new deposits which is a liability to the bank. Simultaneously the bank gains an asset: your signed promise to pay that $100 or otherwise forfeit equivalent collateral. A key point here is that this new 'magical' deposit is not the same stuff as cash or reserves. It is confined to that particular institution. Nothing that is being 'magically' created can escape the bank. Only cash and reserves can do that.
  - asvitkine 4y ago
    Ok, but if the credit is say a mortgage for a property being bought, the seller still receives the money in full, no? I guess the idea that they fully cash it out is unlikely and so that scenario would indeed come from the reserve - and otherwise if they just deposit it, even if at another bank, then it's just updating some ledgers around (i.e. the ledgers of the two banks with each other)?
    - type111 4y ago
      The only ledger that two different banks share is the ledger of reserves at the central bank. The bank deposit that is created through the mortgage process has no means of escaping the buyer's bank and into the seller's account -- it's an artifact of the contract between the buyer and their bank. The seller's account grows only in response to a bank-to-bank transfer of reserves or a huge cash withdrawal and deposit (which are essentially similar.)
- jkhdigital 4y ago
  Economics textbooks used to explain it that way, with a "money multiplier". That is, in the limit, if you keep lending 90% of each deposit then you'll 10x the money supply. The reality is that banks don't "shuffle around" dollars like this, they just make accounting entries in ledgers. The vast majority of transactions are between member banks, and they just use FedWire or whatever to securely move the numbers from one bank's ledger to another. If the bank needs "cash" (i.e. the numbers in the ledger are too low) because there happens to be more outflows than inflows on a particular day they just lend assets overnight or whatever.
throw0101c 4y ago
> "Fractional reserve banking" is the thing to look up but, yes. No, it is not. Relending customers' money hasn't been a thing for decades. Tobin called this the "Old View" in 1963: * https://cowles.yale.edu/sites/default/files/files/pub/d01/d0159.pdf https://cowles.yale.edu/sites/default/files/files/pub/d01/d0... > Business schools teach that banks obtain deposits and then leverage those deposits ten times or so. This is why we call the modern banking system a fractional reserve banking system. Banks supposedly lend a portion of their reserves. There’s just one problem here: banks are never reserve constrained. Banks are always capital constrained. This can best be seen in countries such as Canada, which has no reserve requirements. Reserves are used for two purposes—to settle payments in the interbank market and to meet the Fed’s reserve requirements. Aside from this, reserves have little impact on the day-to-day lending operations of banks in the United States. * https://www.pragcap.com/the-basics-of-banking/ https://www.pragcap.com/the-basics-of-banking/ > The role of reserves and money in macroeconomics has a long history. Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations. Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons. * https://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf https://www.federalreserve.gov/pubs/feds/2010/201041/201041p...
- jkhdigital 4y ago
  This is a very good point, and it really points to the changing role of banks over the ~500 year history of modern global-industrial society. Economics textbooks have not done a good job of staying current.

"Fractional reserve banking" is the thing to look up but, yes.

by Jgrubb 4y ago

"Fractional reserve banking" is the thing to look up but, yes.

But you can have fractional reserves without the ability to magically credit to customers more real dollars than you have. If I take my customers' deposits and loan out 90% of the currency they gave me to other people, that's fractional reserve banking too. At the beginning the author explicitly tells us that this "Wonderful Life" depiction of banking is NOT what actually happens. And then he seems to imply that, actually, banks just get to magically credit borrowers with 10x the deposits their customers give them.

drexlspivey 4y ago
The author is right, commercial banks create money out of thin air https://www.bankofengland.co.uk/knowledgebank/how-is-money-created https://www.bankofengland.co.uk/knowledgebank/how-is-money-c...
mattnewton 4y ago
Banks requirement is that they have 10% of assets on hand at any moment. So if you, or the federal reserve gives them a dollar, that means they can create a record of 9 dollars owed to other parties without being over levered. Remember that's what is being done here, numbers in ledgers are increased but nobody has to send a brinks truck to move pieces of paper or bullion.
christophilus 4y ago
You have to use 2nd order thinking. I give you $10. You lend $9 to Joe. Joe takes that money and deposits it in your bank. So, now you have $19 in your bank. You lend Sally $8.1 of the $9 that Joe gave you. Sally deposits the $8.1 in your bank. Your bank now has $27 in deposits. Continue until you've basically got 10x what you originally had in deposits.
- type111 4y ago
  This is not how it works in reality. $10 of new deposits can be created in a single fell swoop.
type111 4y ago
I think much confusion comes from association with the word 'loan'. In reality, a bank 'loan' is actually an extension of credit. You are indeed 'magically' credited, in an instant, with say $100 of new deposits which is a liability to the bank. Simultaneously the bank gains an asset: your signed promise to pay that $100 or otherwise forfeit equivalent collateral. A key point here is that this new 'magical' deposit is not the same stuff as cash or reserves. It is confined to that particular institution. Nothing that is being 'magically' created can escape the bank. Only cash and reserves can do that.
- asvitkine 4y ago
  Ok, but if the credit is say a mortgage for a property being bought, the seller still receives the money in full, no? I guess the idea that they fully cash it out is unlikely and so that scenario would indeed come from the reserve - and otherwise if they just deposit it, even if at another bank, then it's just updating some ledgers around (i.e. the ledgers of the two banks with each other)?
  - type111 4y ago
    The only ledger that two different banks share is the ledger of reserves at the central bank. The bank deposit that is created through the mortgage process has no means of escaping the buyer's bank and into the seller's account -- it's an artifact of the contract between the buyer and their bank. The seller's account grows only in response to a bank-to-bank transfer of reserves or a huge cash withdrawal and deposit (which are essentially similar.)
jkhdigital 4y ago
Economics textbooks used to explain it that way, with a "money multiplier". That is, in the limit, if you keep lending 90% of each deposit then you'll 10x the money supply. The reality is that banks don't "shuffle around" dollars like this, they just make accounting entries in ledgers. The vast majority of transactions are between member banks, and they just use FedWire or whatever to securely move the numbers from one bank's ledger to another. If the bank needs "cash" (i.e. the numbers in the ledger are too low) because there happens to be more outflows than inflows on a particular day they just lend assets overnight or whatever.

throw0101c 4y ago

> "Fractional reserve banking" is the thing to look up but, yes. No, it is not. Relending customers' money hasn't been a thing for decades. Tobin called this the "Old View" in 1963: * https://cowles.yale.edu/sites/default/files/files/pub/d01/d0159.pdf https://cowles.yale.edu/sites/default/files/files/pub/d01/d0... > Business schools teach that banks obtain deposits and then leverage those deposits ten times or so. This is why we call the modern banking system a fractional reserve banking system. Banks supposedly lend a portion of their reserves. There’s just one problem here: banks are never reserve constrained. Banks are always capital constrained. This can best be seen in countries such as Canada, which has no reserve requirements. Reserves are used for two purposes—to settle payments in the interbank market and to meet the Fed’s reserve requirements. Aside from this, reserves have little impact on the day-to-day lending operations of banks in the United States. * https://www.pragcap.com/the-basics-of-banking/ https://www.pragcap.com/the-basics-of-banking/ > The role of reserves and money in macroeconomics has a long history. Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations. Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons. * https://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf https://www.federalreserve.gov/pubs/feds/2010/201041/201041p...

jkhdigital 4y ago
This is a very good point, and it really points to the changing role of banks over the ~500 year history of modern global-industrial society. Economics textbooks have not done a good job of staying current.