The banking system and the way money really works started being researched quite recently (late 2000s). They are some specialists, but a lot of economists (and especially those you can find on TV or read in the generalist press, but not only) are still stuck on the pre-2000 vision where the money banks lend is from deposits.
Seems similar enough to me. That's how.
Practically all prices are determined on the fly. Libor wasn’t the interbank rate, it was one commercial offering, albeit a powerful one. The Fed Funds rate always was and now SOFR are transactionally derived, which is fundamentally different from Libor, which was never anything more than a survey.
This is mere bankster handwaving in lieu of calculating physically intrinsic value for a sufficient number of commodities.
This is a silly comparison. Stars don’t model their fusion output. Particles interact on the fly. There is also no model relating entropy to overnight collateralised borrowing rates.
> calculating physically intrinsic value for a sufficient number of commodities
Interbank funds aren’t a finite commodity.
The sum total positive energy contained in the universe can be calculated and predicted.
>Interbank funds aren’t a finite commodity.
This statement is obviously false and can run into brick walls in practice.
The comparison isn't silly in the slightest. Currencies must be coupled to a finite resource to function; Lest agent A buy all of agent B's gold using practically nothing but chutzpah.
That you think the comparison is "silly" shows limited/magical thinking on the subject.
No, it isn’t, though misunderstanding it isn’t even fundamental to the flaw in your thinking. A couple of banks can create and destroy an infinite amount of money among them with no real effect. JPMorgan credits UBS a trillion trillion trillion dollars at the latter’s JPMorgan account at the same time UBS credits JPMorgan at its UBS account, and then they both undo it a moment later. No real effect. Hell, JPMorgan could create the money with no counterbalance so they could look at it how pretty it is for an indefinite amount of time. Same deal. Regulators won’t be happy, but that’s because of the potential effects of UBS trying to buy the Fed’s balance sheet.
It’s when the interbank market interacts with broader markets that anything real happens.
What need do banks have for that capability where the capability shouldn't clearly be criminalised?
Banks don't legally have that capability.
The point wasn't that banks do this. It's that it would have the same-real world effect (again, outside regulatory action and law enforcement) as me writing you a trillion-dollar IOU.
...How can you not see this?
By this measure, the paper clips I have on my table have zero value to me. I cannot extract energy from them. Same for my phone and computer.
The traditional answer when people go down this path is “what ever the producer and consumer agree the price is based on a currency denominated in joules that can be extracted from an atom”.
By doing so you’ve eliminated all forms of value adding capabilities from your economic system. The paper clip is no more valuable than its unprocessed atomic components, which is clearly not how real value is derived (or your currency is completely divorced from value).
That's a bad criteria if you don't know exactly what you are talking about.
If you know anything about it, you probably are aware it's accounting related rather than technology related.
Precisely. The accounting scandal has as much to do with the underlying technology as the Libor scandal does with our understanding of the mechanics of banking. Nobody informed walked away from the Libor scandal rethinking the fundamentals of banking in the same way chickens didn’t get bioengineered in response to chicken Libor.
Essentially with respect to the banking system, economics has built on a false understanding of how it works (fundamentally the incorrect claim that banks lend out their depositors funds), and never gone back to fix that with a correct understanding. So we have the situation that the Bank of England published a memo reiterating how that deposit money is created through lending about 8 years ago now, but there are still papers being published with the incorrect understanding as a basis.
And now we have the Bank of England essentially proposing to "solve" that problem by introducing a digital form of asset cash. It will be very interesting to see what goes on the other side of the balance sheet for that.
To an extent that 2022 Noble prize in Economic dished out this same trope!
I've not watched the listed course so this shouldn't be seen as a criticism of it, only as context for the theories broadly espoused by Mehrling.
This is fair.
> its describing a system that was dramatically changed by the 2008 financial crisis
Mherling emphasizes the historical development of central banking but I don't think the Money View is describing an outdated system. The MOOC itself came out after the 2008 financial crises and it does reference Quantitative Easing as a response to the European sovereign debt crisis.
[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
Typical arguments against this always end up in "they do lend out their depositors funds" with extra steps.
deposits go to their balance sheets as assets and a liability towards the depositor. Banks do business with their assets and some of that business might put their balance sheet in a position where they can't or won't honor their debt to depositors. At that point whether they "lent out depositor's funds" is philosophical.
[debit loan, credit deposit]
Which creates a loan instrument on the asset side, and creates a matching deposit in the borrower's account. When the borrower repays capital on the loan, the operation is reversed.
Old time banks would have a roughly 1:1 ratio of loans to deposits, these days because banks are also borrowing from other entities, that can ratio can get a bit squirrel.
Here you go: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
It’s a terrific memo. But it was groundbreaking as a public relations piece. Not a theoretical work.
Not sure what you mean by "fundamentally incorrect"? If your bank only has $100 in deposits, you simply can't loan out $101. The money multiplier effect occurs because the lent out money is deposited at another bank rather than stuffed under a mattress.
Banks lend at certain multiples of assets, 10:1.
Money creation takes place here, not as imagined at the treasury.
The typical ratio people talk about here loan:deposit. Bank investors get spooked if that goes over about .8 currently. Prior to 2008 it was closer to .9 but the financial crisis caused people to be more risk adverse. A ratio over 1 implies a bank is lacking liquidity. A 10:1 loan:deposit ratio would be real bad. The industry overall during the pandemic was sitting at around .6, which is one of the reasons the Fed removed the reserve requirement. They wanted to stimulate lending. LTD is not typically part of regulatory control (though in the US there are certain controls to make sure no bank gets to big that hinge on it). Rather its enforced by the market, because equity holders demand it, because they have lower debt precedence.
Bank assets(loans, investments, cash, etc):liabilities (deposits, borrowed money, trading losses, foreign bank holdings, etc) requirements are covered by capital regulations. A bank with greater than 1 a:l would be considered insolvent and depending on the regulatory regime they are part of, might be forcibly put into receivership.
Banks create money through lending, not because they are lending more than they are taking in, but because to the person being lent to, they now have more money. They have both their deposit, and the loan which can be put into circulation now. But they have a corresponding liability to the bank that must be paid over time.
At least you have that going for you
Santander and Lloyds are a little higher than you’d see in the big banks in the US at 1.1 Loan:Deposit but NatWest, HSBC, Barclays, and Standard Chartered all sit in the .6-.9 range which is where banks in the US typically like to be.
Maybe your small banks and credit unions operate dramatically differently than your big banks but that would be surprising. It would also be surprising because the Basel accords make it pretty tough to meet your credit and market risk requirements without using deposits to fund loans.
[0] https://www.spglobal.com/marketintelligence/en/news-insights...
No this is wrong. They can not loan out more than total deposits. The trick is that if you deposit 100, they can loan out 90. It gets deposited with them, so they can loan out another 80 and so on. (Actual numbers may differ). This is how you get the 10x multiplier.
But they can not loan out more than total deposits.
If they could, why even bother with deposits at all?
You bother with deposits for a few reasons a) banks get a lot of power assuming they’ll play a public good in the form of managing deposits and b) they can earn more using the deposits than they have to pay out to depositors.
I then have $100 in assets and $100 in liabilities.
When you withdraw the $100 loan, I borrow from another bank or from the central bank, and give you that money.
I collect deposits because it’s a cheap source of liquidity.
So you either need to borrow the money from another entity (if perhaps you were better at loan origination) ahead of that, or more likely use owner equity to payout the loan.
apropos btw. I've never actually seen a banking system that has a 10% ratio, I think that was Keynes chosing easy numbers. The reserve ratio back in his day was more like 20-25%, these days it is down to about 1-2% in most countries, and being replaced with terms like "required liquidity ratios".
Of course it can. It creates the loan. Capital requirements dictate it must borrow some amount at the end of the day. But when Chase lends you money, it’s literally just increasing numbers in your account.
Edit: I realize now that I forgot to specify that I meant a single $101 loan in my original comment.
No. This is the fundamental misconception alluded to earlier. A bank with $100 of assets and $100 of liabilities can made a $50 loan and wind up with $150 of assets and $150 of liabilities. Deposits are a bank's liability. Every fractional-reserve bank is insolvent in the short run. (This is inherent to leverage.)
More realistic: a 10% reserve requirement. Bank has $100 of assets, of which $10 are reserves, and $98 of liabilities. ($2 equity.) Customer wants to borrow $20. Can the bank make the loan? The answer is yes. It winds up with $120 of assets including $10 of reserves, a deficiency. So it borrows $2 in the interbank markets and winds up with $12 of reserves against $120 of assets. Note that the liability side doesn't even come into play: that's a capital-requirement question, where defining what counts as an asset to what degree is a tomes-thick discussion [1].
That's why we have reserve and capital requirements. Leveraged banking doesn't work without supervision.
1: https://www.federalreserve.gov/monetarypolicy/reservereq.htm
- The reserve ratio. This is the amount of reservable (read deposited) cash that is required to be held by the bank in cash equivalents compared to the amount of deposits on their books. This is typically (for instance in the US) a regulatory capital requirement of a central bank to its member commercial banks. But note its only a second order limit on what the bank can loan out as the loans (or investments, or CDS' or bitcoin) on the books are not part of the equation. What this _really_ does is increase the cost of capital of deposits, making them more expensive for the banks to use for other activity. Prior to the pandemic many types of reservable deposits already had 0% ratios and the headline amount was 3%. This is the _least_ important limit on bank balance sheets for loans.
- Another is the regulatory asset:liability capital controls. Banks can be subject to many different regulators, and they all have a variety of balance sheet rules (and those rules encompass many other things like risk processes and other operations) but always banks must keep more assets on the books than liabilities. But! Thats not a stop to lending, because loans are assets, instead thats to ensure depositors are made whole. The stop to lending is the actual balance of assets is also regulated. Those balance of assets are scored both against market risk and credit risk. Too many loans on the books without enough cash will blow those limits up and get them in trouble with their regulators.
- The loan to deposit ratio. This is explicitly what it sounds like, the amount of money loaned compared to the amount of money deposited. In the US this is not actually part of any regulatory regime limiting the amount a bank can loan*. Instead it is a market based limit that the owners (investors/shareholders) of the bank keep track of to understand how liquid the bank is and how safe the bank is as an investment. This is important because depositors have senior claims in the case a bank goes belly up. Currently, investors look for a .8 loan to deposit ratio. During the pandemic the industry was sitting at around .6, which is one of the reasons the Fed removed the reserve requirement. They wanted banks to put more deposits to use in lending so they made it cheaper to do. Banks with high loan to debt ratios very frequently go out of business so have extremely expensive fund raising costs, therefore its something they take pretty seriously.
If you are curious what the lending amounts look like in practice, the last number is probably the easiest to understand and get access to. As I said, the industry sits well below 1:1 on loans to deposits. You can find some that approach 6 to 1 or even sometimes higher but those are typically distressed banks. The central bank reserve requirement is much more lenient than that and always has been.
* Loan to deposit ratios are a part of some regulations about bank size, but only as benchmarks.
See my above example for why capital ratios, which consider asset quality and liabilities, are superior to reserve requirements.
"Transfer" loses its colloquial meaning at this level of banking granularity.
Interbank transfers involve two components: a message and settlement. If our aforementioned bank's customer "transfers" their $20 to another bank, the message would go across SWIFT or CHIPS or whatever, and then the sender's bank would credit the recipient bank's account at the sender's bank. (The intrabank case is trivial.)
If the customer asks for their $20 in cash or to be transferred via Fedwire, on the other hand, the latter being both a messaging and settlement system, run risk emerges. The bank needs to borrow against or sell assets to generate liquidity. (The Fed extends daylight overdraft protection [1], but that's a specific case of its lender-of-last-resort duty.)
But the bank becomes insolvent only when it is forced to fire sell assets or recognize their dubious value. Not when it extends the loan. Nor even when the customer demands their cash. At both those times, the balance sheet balances. It's just exorbitantly levered.
None of this says a bank should do this. Just that it can. In a system where deposits are loaned out, this cannot happen. In our system, where loans create deposits, it can. The former is the toy model we teach in school.
[1] https://www.investopedia.com/terms/d/daylight-overdraft.asp
In the long term... any bank that is careful not to have too many insolvent loans is guaranteed an inflow of money from the capital and interest repayments - some of which will be on their books, and some will be coming from money deposited at other banks, effectively transferring the asset cash back.
It's actually quite an elegant system at this level. Horribly fragile with respect to losses on loans though.
Why not? I think the assumption here is that money is like a physical commodity. If we were talking about apples then of course your statement would be correct. But we're not.
When a bank "lends" you $100 it just creates two entries: one in your current account that says +$100 and one in your loan account that says -$100. The latter is called a liability. There is nothing physical. In fact, the only thing that "exists" are the entries in the ledger. The money is completely abstract and appears only between the time the loan was created and the loan being paid back.