7 ms·

From what I understand, when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed),

• xyzzyz 4y ago
  Fed hates that and fights this tooth and nail. See, for example: https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-bank.html https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-... https://johnhcochrane.blogspot.com/2019/03/fed-vs-narrow-banks.html https://johnhcochrane.blogspot.com/2019/03/fed-vs-narrow-ban...
  • tasubotadas 4y ago
    Crazy. How did the story with narrow bank end?
    • xyzzyz 4y ago
      It’s dead.
    • SOLAR_FIELDS 4y ago
      I’m curious about this as well, because the top comment (TNB takes over an existing bank that already has this account) seems like a perfectly viable alternative. Given that they had the resources to get to this point in the first place, was there a reason why this wasn’t an option?
    • fuoqi 4y ago
      You can be your own narrow bank by directly investing into short-term bonds or by buying a money market fund.
      • rocqua 4y ago
        That has massive fee friction, does not eliminate counter party risk entirely, and earns different (lower?) rates than the Fed offers.
        • chrchang523 4y ago
          I don’t know how long this will last, but I started doing this recently with Vanguard’s VUSXX (short-term Treasury) fund when I realized it had significantly higher after-tax yield than high-interest savings accounts without the hassle of manually rolling over T-bills, and it looks like many other people have been moving in this direction.
        • guepe 4y ago
          If you buy t-bills yourself fees are low, and brokers aren't banks - so risk of money being stuck there is low. It's a bit of work but very manageable. 10/10 recommend, you earn more than a savings account.
          • ac29 4y ago
            Fees on buying treasuries are zero if you buy them directly from the treasury or any of the large brokers (Vanguard, Fidelity, etc).
  • em500 4y ago
    Cochrane's speculates a bit about the Fed's motives near the end. He doesn't think they're outright evil, in cahoots with the incumbent commercial banks, etc. He thinks it's a misguided attempt to cross-subsidize the lending activities at the current commercial banks. If the super safe narrow bank draws away a lot of the common depositors, the commercial bank will need to get more other (more expensive) funding sources (bonds and other loans) which can make mortgages, business loans etc more expensive. edit: It was Scott Sumner, commenting on Cochrane's blog, who speculated that the motive might be cross-subsidizing the normal bank lending activities: https://www.econlib.org/why-does-the-fed-oppose-narrow-banking/ https://www.econlib.org/why-does-the-fed-oppose-narrow-banki...
    • prox 4y ago
      In r/askeconomics this was exactly the answer by the leading answers. https://www.reddit.com/r/AskEconomics/comments/11vtl1c/what_if_we_had_a_type_of_bank_that_was_legally/ https://www.reddit.com/r/AskEconomics/comments/11vtl1c/what_...
    • imtringued 4y ago
      The narrow bank restricts the Fed's ability to hawkishly raise the interest rate. It won't be able to get away with gross market Vs policy mismatches anymore. I mean think about it, the Fed makes an unintended policy error and raises the interest rate far above what banks can pay, everyone goes to the narrow banks. If the interest rate is too low nobody goes to the narrow bank. So the Fed essentially would have to perfectly choose the optimal interest rate which it probably can't do. It always overshoots or undershoots.
      • TheOtherHobbes 4y ago
        Which is ok, because that's just the market punishing the Fed for poor decisions.
    • dgb23 4y ago
      Am I reading this right? They expected this mechanism to be too efficient for regular, already established banks to compete? So a safer, more efficient mechanism for banking is declined in order to keep the established banks competitive? Isn't that sort of outrageous?
  • blitzar 4y ago
    Funnily enough, this concept is the central bank digital currency - CBDC business model, with extra steps.
  • dageshi 4y ago
    They hate it for good reason. The narrow bank would be safer than US Treasury Bonds. In a financial crisis similar to 2008 this would amplify chaos as money drained from all other investment classes into the narrow bank at a time when the government probably needs low interest rates on their debt to solve things.
• mrfox321 4y ago
  It give banks far too much leverage. If they took large losses or lent out too much, inflation would skyrocket.
• fuoqi 4y ago
  >when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. Commercial banks can not create loans out of thin air during normal operation. They either have to use depositors' money or share holders' capital. In other words, bank's liabilities (e.g. user deposits) should not exceed its assets (loans to users, securities, reserves at Fed, etc.). There are games which can played with how assets worth is measured (e.g. mark-to-market vs. mark-to-maturity), but otherwise the rule must be followed by banks. >Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money. When a bank receives a deposit, it has to decide what to do with it. It can either loan it to someone (either directly or by buying bonds), invest (e.g. by buying stocks), pay it as a dividend to share holders (assuming it has far more assets than liabilities), or keep it in bank's reserve account at Fed. In the later case it gets payed roughly the key interest rate. This is why rate hikes suppress inflation (at least in the near term), banks instead of deploying their capital into the economy deposit it at Fed, thus temporarily removing it from circulation. It also means that cost of loans in the wider economy rises accordingly, since banks will not loan without a sufficient premium to the Fed's rate.
  • the_optimist 4y ago
    This is outright incorrect. https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
    • fuoqi 4y ago
      What exactly is incorrect in my explanation? Are you saying that bank's liabilities can exceed its assets for a prolonged time? Or that reserves at a central bank do not pay interest? The second order effects (such as loan at one banks creates deposit at another, meaning M2 gets essentially "printed"), which are important for monetary policy and regulation, are not relevant when we view operation of a bank in isolation.
• dgrin91 4y ago
  If I'm a bank why would I want to get X% interest from the Fed when I can instead get X+Y% interest from some other investment option[0]? Yes the risk is higher, but typically only marginally so. Obviously you have big failures like SVB & others, but the reality is that those aren't common. It also lets the bank pass on the increased rates to customers. The current fed interest rate is ~4.5%, but there are banks out there right now where you can get >5% in a savings account[1]. Your system would remove that option for consumers. [0] Other option being some regulatorily approved option, not throw it all in the latest crypto ICO [1] https://www.ufbdirect.com/ https://www.ufbdirect.com/
  • sonthonax 4y ago
    Banks usually have a regulatory requirement to keep a portion of funds in the Federal Reserve.
• Negitivefrags 4y ago
  This is a concept called a Narrow Bank. Basically it’s a bank that puts all its deposits directly with the Fed. There have been attempts to start such a bank in the past and they have been denied a banking charter.
  • qubex 4y ago
    Narrow Bank is the same as Thin Client.
• Jerry2 4y ago
  Yes, that's how it works. There's this amazing animated movie from 2011 that explains how banking works and the history of banks: "The Collapse of The American Dream Explained in Animation" [1] It has almost 10 million views. [1] https://www.youtube.com/watch?v=mII9NZ8MMVM https://www.youtube.com/watch?v=mII9NZ8MMVM
• rocqua 4y ago
  It's not quite right that banks don't loan out their depositors money. They need depositors to be able to make loans. Stashing depositors money at the Fed keeps the bank from making loans. Stashing money at the Fed is possible by the way, and effectively does destroy the money (or rather, takes it out of the economy). Banks can deposit money at the Fed earning exactly the interest rate that the Fed controls. This effectively takes that money out of the economy. That is generally rather bad, because it stifles growth. But in case of inflation, it can sort of help. That is part of why the Fed interest rate helps regulate inflation. But generally speaking, you want loans to be made! It helps good and productive ideas get of the ground. It is core to Western economies. Hence the Fed is quite scared of narrow banking. They want to be the 'borrower of last resort'.
  • imtringued 4y ago
    >They need depositors to be able to make loans I've never asked my loans to be paid out in cash or transferred to another bank. When people say commercial banks create/issue money they mean that cash/central bank reserves have become irrelevant other than as a rudimentary payment method or network to transmit between banks. If you wanted to make the point that banks lends existing deposits you would have to basically argue that people never wire money and always pay with cash and deposit their cash paychecks manually and pay taxes in cash. Curiously, my government points me at major banks and their ATMs when I want to pay my taxes in cash.
    • makomk 4y ago
      Presumably you didn't just keep that money sitting in your own bank account though - you used it to buy something or pay someone, and their account was often at another bank. If a bank issues too many loans where the money ends up at other banks without counterbalancing transfers of money in, it eats away at the reserves they have available to settle those transfers with and that's how deposits actually limit banks' ability to make loans. The Bank of England article that someone linked further down explains this in more detail (page 18 in the PDF): https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
• pharmakom 4y ago
  Creating money out of nothing is a mechanism to get large projects off the ground. Without it, it would be difficult to fun infrastructure, R&D, etc. like most mechanisms, it can be used in good and bad ways.
• andrepd 4y ago
  > when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. The bank also needs to pay the loan back by an agreed uppn time (which destroys the money). Why can't I do that with the central bank directly? Why the rent-seeking middleman?
• s_dev 4y ago
  >The bank also needs to pay the loan back by an agreed uppn time (which destroys the money). Perhaps you can clarify by what you mean by 'destroyed'. To my knowledge once the bank has 'created' the money it will always exist in the system. However it has devalued all other money by a small amount which we understand today as 'inflation'. So it's not clear to me what you mean by destroyed.
  • qubex 4y ago
    “High-powered money” is that which is created when the central bank lends to commercial banks. As it is a claim on the central bank’s assets, when it is returned to them it ceases to exist (as the central bank doesn’t need extra paper to dispose of its own assets).
  • kasey_junk 4y ago
    The destruction mechanism is the same as the creation mechanism but in reverse. An asset is removed from the lendee in the form of a debit against their deposits thus destroying outstanding cash.
  • nradov 4y ago
    When a borrower defaults then some fraction of the outstanding balance is destroyed.
• meh8881 4y ago
  > From what I understand, when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank Nah it’s simpler. You put a dollar in the bank. The bank loans 80 cents to Bob. Bob puts 50 cents of that 80 cents in the bank. The bank loans out some of that. Even without going beyond Bob, the same dollar is now in the bank twice. That’s what people mean by money being created.
  • deleted 4y ago
    [deleted]
  • bannedbybros 4y ago
    [dead]
  • bombcar 4y ago
    And this cannot be "controlled" for because money is fungible, and if you do try to "prevent" it Bob just puts his 80 cents in another bank which does the same thing, and it all loops around. Certificates of Deposit are supposed to be the thing that "helps" a bank balance the "short duration" deposits with "long duration" loans - but when interest rates are so low the CDs are not worth bothering with. I wonder if we'll see a maximum interest rate on "cash accounts" or something in the near future to try to balance it.
    • marcosdumay 4y ago
      It can absolutely be controlled. That's what reserve requirements do. It's just out of fashion for central banks to control it. (For several reasons that exist, but I'm not sure are good ones.)
      • bombcar 4y ago
        Reserve requirements (unless they go to 100%, but then you can't loan at all off deposit accounts) don't prevent the bank from "loaning out money already loaned" but they do help reduce the chance of a run.