@richardjmurphy on Banking

Bliteringly, blindingly, wrong, as usual.

Of course banks handle deposits, but as anyone who has reviewed rates available to depositors for the last few years will know just how contemptuous banks have been of those who wish to use their services for this purpose. There is good reason for that: banks do not (and never have) needed depositors for enable them to make loans. The simple fact is that the money banks lend is created by them out of thin air. It’s offensively easy for them to do so. All that happens when someone asks for a loan is to credit a current account with the amount of the loan and debit a loan account with the same sum. That’s it: that is how 97% of all money in the UK is created, but as is clear, deposits play no part in that process. Instead banks literally create the cash they lend and can get away with this trick so long as people think they’re good for their promise to pay – which they will be so long as, as is now the case, the government clearly considers them too big to fail and explicitly and implicitly guarantees all they do. The insult to the injury is that having made this cash out of thin air they then charge heavily for it – vastly more than they pay for deposits. No wonder an organisation that can costlessly create what it sells is so profitable.

Bob Diamond acknowledges none of this, and the fact that much of the profit he and his colleagues supposedly generate is effectively licenced to them by the fact that the government has failed to claim for itself the right to he profit made on the creation of money; money which only the state can legitimise, but which banks have claimed for thei own benefit and which they have used to speculate at considerable social cost to society at large, as Adair Turner and others have noted.

Dear Lord, the stupid, it hurts.

If a bank just creates money then why do banks have funding needs?

Why, for example, is there an interbank market?

Why did MF Global go bust? It was lending money to southern European governments and surely, it just created the money that it used to buy those bonds?

Why did Northern Rock go bust? If they could just create money then why did people taking their deposits out make it fall over?

Idiot.

The banking system as a whole does credit creation, yes. But each such credit created by an individual bank must be backed by a deposit accepted by that individual bank. Banks no more, as a single bank, create money than I do.

As to that \”profit made on the creation of money\” that\’s seignorage which is a very different thing altogether. It does not refer at all to the creation of credit. It refers to the ability to take 3 p worth of paper, print some nice stuff onit and have it worth £5. And the Bank of England gets all of that.

What does worry is that this nonsense is actually being believed by people. Ignorance is multiplying.

 

78 comments on “@richardjmurphy on Banking

  1. It’s so blindingly simple…why does he not turn the trades unions into banks an all their members would be billionairs

  2. ermmm, no Worstall, you obviously haven’t worked in a bank have you?

    Nor have you understood why the financial markets flatlined.

    Nothing to do with deposits. In fact if you truly think that, you best go back to school, old boy.

    Murphy is entirely right. Most finance transactions are based on confidence, not reality.

  3. Arnald, Richard,

    http://www.khanacademy.org/video/banking-3–fractional-reserve-banking?playlist=Banking+and+Money

    Get your free education here ^^^

    It’s not political. Just one of those nasty hedge fund managers (Boo Hisss) who has now devoted his life to creating free educaitonal resources to the entire world courtesy of organisations run by those nosty capitalists (boo Hiss) like The Gates Foundaiton.

    It’s interesting. I recommend you watch it.

  4. I’m delighted he’s come out and said this.

    The entire Positive Money movement, plus the NEF and now Mr Murphy are campaigning against banks on the grounds expressed here.

    As he puts it:
    “the money banks lend is created by them out of thin air…deposits play no part in that process”

    I’ve been down to Occupy London and this is believed by almost all the protestors down there.

    It is a myth which has simply spiralled out of control.

    Any banking expert care to second what Tim has said, ideally with further elucidation? Can we have the cast iron evidence to end this debate forever?

  5. This is small-time stuff. For the uber-crazy shit, this comment on a BBC news article about the G20 summit wins a prize:

    “Greece can implement its own, real-world solution to the Eurozone crisis, partially by harnessing its solar energy-creating capability. This would help other governments and banks regain confidence in Greece.”

  6. That might be just be THE most uninformed, naive thing he has ever written.

    It’s actually worth saving and printing off to distribute at any events anyone happens to attend where he is particpating.

  7. So, according to the “expert”, the queues of depositors outside branches of Northern Rock had nothing to do with the ensuing panic.
    Pulease, whyfor then did they not allow the good depositors of Northern Rock, Barclay’s, Natwest, etc. free and unhampered access to what was, after all, their own money.
    Could it be that depositors money, which is “real” money has, by law, to be available “on demand” whereas the cybermoney used by banks all over the world has no worth and nothing to underpin that worthlessness?

  8. I think that’s the wrong angle of attack for this one.

    Banks do “create money”, because you can spend their credit at Tesco. “creating money” and “extending credit” are basically the same thing *because we happen to treat bank credit as money*. That is not true for an IOU stamped on a piece of rock by Mr Tim Worstall, Esq.

    The failing is this:

    “money which only the state can legitimise”

    Society created money because monetary exchange is useful and efficient. Society did not need “the state” to legitimise money, because “money” is created through trust between people.

  9. Martin Wolf, chief economics correspondent at the Financial Times, said, “The essence of the contemporary monetary system is the creation of money out of nothing by banks often foolish lending”.

    J.K.Galbraith said, “The process by which banks create money is so simple, that the mind is repelled”.

    Abrham Lincoln said, “The government should create, issue and circulate all the currency needed to satisfy the spending power of the government and the buying power of the consumer.”

    Josiah Stamp, governor of the Bank of England in the 1920s said “The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”

    Graham Towers, former governor of the Bank of Canada said “Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”

    I could go on.

    Tim adds: Yes, you could go on but this is still nothing to do with what Murphy is talking about. The banking system as a whole creates credit, yes, this is the flip side of fractional reserve banking.

    But it just isn’t true that a bank creates for free the money that it lends out. Which is what Murphy is saying they do.

  10. “campaigning against banks on the grounds expressed here”

    Positive Money et al compaign against the *banking system*. There’s nothing wrong with that. Fractional reserve banking + deposit insurance provides a banking system which an awful set of agency problems, moral hazard, etc.

    But Murph is confused if he thinks the Positive Money campaign changes the system with respect to much of what he says.

    Banks can still “create money”, and earn interest margin, under the system Positive Money advocates, with what they call “Investment Accounts”. But the deposits that back those accounts lose the government deposit insurance; they are placed at risk.

  11. “But it just isn’t true that a bank creates for free the money that it lends out”

    The key is “for free”. Banks *do* create money, but it is not “free”; they have to borrow money to create money. And because banks are special, when they borrow money (e.g. by taking deposits), it still counts as money (mostly).

  12. If Murphy had directed his fire at fractional reserve banking, which a number of free market economists in the “Austrian” school have done, or made the argument that banks can multiply credit many times over on a small base of cash deposits, he would be onto something.

    But he muffed it.

    As usual.

  13. But Johnathan
    Surely everyone knows that banks leverage? Obviously Worstall has forgotten. You’re just being a pedant. Oh yeah. This is a pedant blog.

    My bad.

    Tim adds: Umm, Arnald? Could you please try and get with the programme?

    Leverage refers to the relationship between a bank’s capital and its liabilities/assets, not to the relationship between liabilities and assets.

  14. Arnald
    A bank CANNOT create money out of thin air. If it extends credit, it has to finance it from somewhere.
    What Murphy and you are getting mightily confused is in the maturity mismatching aspect.
    I can lend money to the bank, thinking I can get it back immediately, but the bank lends that money to someone else, who thinks they can spend it.
    There is no ‘creation’ of money here, just two people who think they can claim the same amount of money…. and, tell me I am wrong, if everyone everywhere excercises their right to take that money out of a bank at the same time, then, the bank is BUST : no magic money creation there.

    Or is that too pedantic for you?

  15. The Encyclopaedia Britannica puts it quite nicely Vol 12/ p357 /ed 1981
    “In the course of issuing money the commercial banks actually create it by expanding their deposits,but that they are not at liberty to create all they may wish for the total is limited by the volume of bank reserves and by the prevailing ratio between these reserves and bank deposits- a ratio that is set by law,regulation and custom”
    All rather urbanely expressed as opposed to these young Modern Monetary Theory fellows who say that banks create credit with no reference to their own reserves and basically do what the fuck they like, rather shocking to the older sort of Douglasite/Greenshirt monetary reformer,such as myself.
    (Back in his own Samizdat lair J. Pearce once made a fool of himself for mistaking the Greenshirts for some leisure group.)
    Its all up with the purely private creation of credit by the banks,as QE and credit easing has shown that only the State creation of credit is equal to the scale of the present bank- induced crisis.

  16. DBC Reed

    You are just confusing the actions of the banking system, with a single bank itself.

    The net effect is money creation, but an individual bank cannot create money just by the wave of a wand.

  17. This all rather reminds me of virtual particles in quantum dynamics. Perhaps it’s time for a quantum fiscal theory?

  18. Matthew,

    That’s not such a silly idea: banks do exist as a sort of Schrodinger’s Cat experiment. It’s all OK until you open the box to find out whether it is or not, at which point the theoretical probabilities of a bank run collapse and you get to see which outcome (bank run or stable) actually happens.

  19. Ralph, you are wrong here I think. When a bank makes a loan it must find that loan, there must be a liability to match the asset. That may be a retail deposit, or borrowing in wholesale markets, whatever. Money is created because the depositor still has money and now the borrower does too, but it is quite wrong to think money is created in fashion Murphy imagines, without the bank needing to obtain funds. Illustration, again, that this idiot should not be taken seriously by anyone, and the burning embarrassment of the fact that he is.

    (of course banks can turn one kind of asset, say cash on reserve, into another, a loan, but that asset must have been funded in the first place)

  20. I’m no expert, so do point out (nicely please) where I’ve gone wrong, but it seems Murphy is confusing accounting with reality.

    Yes, when I borrow from my bank, they credit my current account and debit my loan account, and that’s an accounting entry.

    If that were just an accounting entry, then my bank could indeed do that as much as it wanted without needing deposits.

    But those numbers in my current account are only money if I can buy stuff with them (money being a means of exchange). To do that, then either:
    a) I draw cash out of the bank; or
    b) I pay for stuff by bank transfer (debit card, standing order, cheque, whatever).

    So I can buy beer in the pub on my debit card – no cash, just accounting adjustments between my bank account and the pub’s bank account. Again, theoretically the banks could do that as often as they wished.

    But the pub will only accept that as payment if they (and, importantly, their bank) trust my bank to pay up on that promise.

    And that trust depends on my bank’s creditworthiness, which depends in a large part on its bank deposits (equity being relatively small).

    So unless my bank has deposits, it can’t either give me cash or persuade people that its transfers are valid. In that case I can’t spend the numbers in my account, so my account isn’t actually “money”.

  21. Further: it does not matter that rather than acquire funds first and make loans second, banks can loan first and fund second. That just shows us banks have lots going on at once and don’t have to balance the books at each instant. The point remains banks create money using funds not thin air.

  22. I’ve just looked them up (OK, only on Wikipedia), and it’s even worse – the paramilitary wing of the Social Credit party!

  23. Tim,

    This is not quite right.

    Banks no more, as a single bank, create money than I do.

    Consider a single bank that takes a £100 deposit and makes a £100 loan. Now both depositor and borrower have £100 each, and £100 has benn turned into £200. If both depositor and borrower tried to spend it, and bank had no other funds to juggle, there’d be trouble, but I think you can still talk of a single bank creating money in this fashion.

    The difference between you and a bank is that when you borrow £10 from me and lend it to somebody else, I don’t think I still have that £10, but when somebody deposits £10 in a banks they still have £10, to all intents and purposes.

  24. Richard,

    You’re right – the fact that the banks trust each other – or the central bank – (and so much now doesn’t require physical cash) allows the system, as a whole, to “create money”, without allow any individual bank to do so.

    As has been said above, numerous times.

  25. Can someone explain this very simply please?

    If I put £1000 in my bank account what does the bank then do with it?

    Also, what is Murphy having a go at. That our deposits at banks are loaned out or fractional reserve banking?

  26. I don’t know what Ritchie is smoking, I don’t approve of it in the least, and I want some.

  27. Mw, as you imagine, banks use your money to acquire assets, perhaps keeping some of it as cash. Some of those assets may be loans.

  28. “Also, what is Murphy having a go at. That our deposits at banks are loaned out or fractional reserve banking?”

    How the Hell are we supposed to know when it’s clear he doesn’t?

  29. MW,

    I posted a link to a video earlier but based upon the following questions in the comments has largely been ignored so I’ll repeat it again.

    Here’s what happens to your £1000…
    http://www.khanacademy.org/video/banking-3–fractional-reserve-banking?playlist=Banking+and+Money

    The money is ‘loaned into existence’. The video gives a good overview of what M0 and M1 money supply are and this second video explains why it is entirely reasonable that each depositor sees the same money as belonging to themselves…

    http://www.khanacademy.org/video/banking-4–multiplier-effect-and-the-money-supply?playlist=Banking+and+Money

    It also explains the difference between money and wealth and how FRB uses deposits to generate money and wealth.

    The videos are as apolitical as it gets. They merely explain the mechanics of how banking works. Something that should be taught to the 99%.

    Richard Murphy needs to watch and learn.

  30. @Kevin Monk: it all makes perfect sense, although it confirms my feeling that the FR banking system is a gigantic con trick. It allows lots of people to think they have money when in fact they don’t. The banks are engaged in a smoke and mirrors illusion, counting on the fact that not all their depositors will need ‘their’ money at anyone time. If they all do the house of cards collapses.

    Anyone who has seen Its a Wonderful Life should understand how the system works.

  31. It’s very simple really. Stop thinking that banks *lend out* deposits. They don’t – they lend, then they look for funds to settle that lending, which may include retail deposits, interbank borrowing or as a last resort money from the Central Bank through that nice discount window facility that the Bank of England created as an “oops” after Northern Rock fell over. The accounting entries for the loan and associated deposit therefore precede the availability of funds for settlement. During that period in effect money has been “created”.

    When the loan is physically drawn down, then the imaginary deposit becomes real money. But of course, these days loans aren’t necessarily physically drawn at all. As long as all that happens is electronic transfers, payments can be made without any physical funding. And since all banks can make accounting entries this way, they can lend imaginary money to each other as well. This can go on ad infinitum as long as no-one has to produce any real cash.

    Eventually, of course, someone always asks for real money – usually a depositor who wants their money, or a borrower whose plumber wants payment in cash. That’s when it can all go wrong, of course. If too many people ask for cash withdrawals the bank simply runs out of money. Loans are illiquid assets – they cannot quickly be sold to raise cash. And prior to the Northern Rock disaster, the central bank couldn’t respond quickly enough either.

    The point is that as electronic money becomes the norm, the difference between “real” money and balances created as a consequence of double entry accounting when lending precedes reserves is becoming increasingly blurred. Yes, banks are supposed to keep positive reserve balances at the central bank, and they use the interbank market or central bank liquidity to top these up if necessary. That’s really the only constraint on this money-go-round, and given that the central bank will create money if necessary to meet banks’ reserve requirements it’s a pretty poor one. After all, that’s what central banks are for, innit? The money creation done by commercial banks is backstopped by the central bank. It would be a brave central bank that refused to issue new money to meet demands from commercial banks that have already lent it….

    Oh, and on the subject of interbank lending – the interbank market of course also lends funds from institutional investors, especially money market funds. For some reason we forget that these days more of our savings are in funds than in deposit accounts. And these are electronic entries too. No-one puts physical cash into long-term savings plans, do they? Direct debit or standing order from a current account into which salary is paid by BACS is more like it.

    MW, in answer to your question – the bank MAY use your £1000 to settle lending. Or it may place your £1000 on the international money markets to earn some cash (in which case it will probably be used in the repo market, which is also lending, really). Or it might buy some gilts with it.
    Or it might park it in a reserve account at the Bank of England. It’s hard to say really, and impossible to identify “your” £1000 anyway except as a balance in your account.

    So yes, banks can create money out of thin air, but it doesn’t work quite as Mr. Murphy says.

  32. Fine then Jim, we’ll all go back to barter. I’ll work for 4 kilo of bacon an hour, and not a rasher less.

  33. @Jim and Frances Coppola

    They aren’t so much creating money as moving it around in time. By doing so they allow real wealth to be created, an awful lot of real wealth. Of course if the timing is misjudged, it can go wrong, but without it most of us would not have houses or businesses, nor any of the comforts which other people’s investment has brought us.

    The crisis may have set us back ten years, but without this kind of banking we would never have got beyond 1870.

  34. He’s quite right, banks could operate like this.

    Just not in any regulated country.

    Otherwise, presumably I could become a bank, as could Mr Murphy, at the drop of a hat, and become one of the millionaires he so despises.

  35. DBC

    I now know who the Greenshirts were. Alas, it has not raised my general estimation of your ideas even though we are on rare agreement on FRB!

  36. Frances,

    No, I think it is misleading to say banks create money out of thin air. People make far too much of things being electronic. A bank could sent you a letter by carrier pigeon telling you you have £1000 on deposit with them, and it wouldn’t change anything.

    When banks create an electronic balance of £1000 all they are doing is saying you can come and get £1ooo from them if you want it. I could sent you a letter or do somehing ‘electronic’ saying you have £1000 on deposit at the bank of Luis Enrique, this doesn’t mean I have acquired the ability of magic £1000 out of thin air. Whether I could give you the money depends when you ask for it depends on whether I could fund it, just like is the case with banks. Banks do lend out out deposits, or any other source of funds including BoE supplied loans.

    It does not matter which way round things happen (*) . If banks obtained deposits first before looking to lend it out, they’d still be creating money. Money creation does not rest on the fact they can lend first and find later. Banks are doing it all simultaneously anyway, the are constantly obtaining funds and acquiring assets (lending).

    (*) unless you think that banks will not lend for lack of funds, in a crude way. Sometimes banks will choose not to lend because they don’t want to fund it, but mostly as you say banks can always find funding if they wish to make loans. It is a myth that Econ 101 teaches that banks will need deposits before they can lend, that is simply one way of illustrating the money multiplier.

  37. Frances Coppola says:
    “This can go on ad infinitum as long as no-one has to produce any real cash. ”
    But people do.
    Tesco will accept credit cards but I like decent bread so I walk to the baker and I buy fresh fruit in the market and the newsagent won’t take a credit card for one copy of the FT and nor will the bus driver and how many car parks take credit cards for an hour’s parking?
    So actually its not just that the process is finite – you’re pretty sure that someone is going want some cash this very week.
    Murphmeister claims that you can just set up an equal and opposite pair of debit and credit, whereafter the client goes out and spends the loan and ignores the need for the bank to have £5 in coins or £50 or £500 in notes when the vendor asks for his money. Murphy’s banks would all be in Wonderland and fall over lack the pack of cards when Alice recognises them.

  38. Luis,

    It all depends on your definition of money, doesn’t it? In an economy where real items can be purchased entirely electronically, electronic balances “are” money – they aren’t just the promise of money. Broad money does expand (hugely) as a consequence of bank lending.

    Conceptually, it does matter which way round things are done. Lending does not depend on the availability of deposits. In practice, as you say, banks are constantly receiving deposits and granting loans. The point is that there is no connection between the two activities.

    I wish someone would correct all those damn textbooks that teach the money multiplier “deposit £100 leads to lending £1000” myth. It really doesn’t work like that.

  39. john miller says:

    “Just not in any regulated country.

    Otherwise, presumably I could become a bank, as could Mr Murphy, at the drop of a hat, and become one of the millionaires he so despises.”

    But you could. The old village money lender was not limited by the amount of pieces of eight he happened to be in possession of. He could ‘lend’ by guaranteeing a loan for someone else. If the other moneylender was confident he would be good for the money if the borrower couldn’t pay in the future, it wouldn’t matter whether he actually had it when the loan was made.

    There is nothing to stop you, or Mr Murphy, doing that now. The reason you can’t magic the Internation john miller Bank out of thin air (and become a millionaire overnight) is that you have to build up that confidence slowly, starting with your neighbours in the village. It’s not, I think, because of regulation.

  40. John77

    I did caveat that statement for exactly that reason. Banks estimate the amount of physical cash they need on a daily basis, and as long as the cash withdrawals follow a normal pattern they don’t get caught out (well, except for ATMs running out of money over a bank holiday weekend, of course!). Most cash withdrawals are from current accounts, after all – which don’t tend to have enormous balances. It’s when cash withdrawals are ABNORMAL that the whole thing goes pear- shaped – which is what happens in a run on a bank.

    Banks are essentially illiquid even if solvent. Unexpectedly high levels of cash withdrawals can cause bank failure. But this doesn’t have anything to do with the volume of lending, really – especially as mortgages (by far the largest proportion of bank lending) are settled electronically these days. It’s mostly to do with how good banks are at anticipating depositor demand.

  41. So basically, most people are saying that Worstall is

    “Bliteringly, blindingly, wrong, as usual.”

    Haha, especially “Bliteringly”.

    For real, yeah?

  42. Where Murphy IS wrong in this post is in his notion that money creation through lending is costless. Oh no, it isn’t. Even electronic funding comes at a price. Interest has to be paid, not just on retail deposits but on wholesale and interbank ones too. Even central banks charge interest on money they lend to meet reserve requirements.

    Lending is also of course capital-constrained – much more so now than before the financial crash. And capital is increasingly expensive, and banks need increasing amounts of it. The days of cheap loans are over.

  43. Frances,

    Well, the phenomenon of money creation does not rest on which way round things happen.

    I cannot understand why you say deposits have nothing to do with lending. Deposits are one source of funds, often an important one. Why do banks go to the cost of acquiring deposits if they have nothing to do with the business of lending? What do you think banks want deposits for?

    I think the text books say £100 of high powered money can lead to £1000 of broad money. This is true, if it is deposited, lent out, deposited, lent out etc. Even if you dislike the simplified behavioural story, the relationship between H, M, reserves and cash in hand, the textbook multiplier, is correct as a accounting statement.

  44. I think Murphy is very wrong. It is quite wrong to say banks literally create money out of thin air, quite wrong to say deposits – funding – has nothing to do with it.

    A bank may be able to say: “okay, we will lend you £100, your account with us now shows a balance of £100” but the bank must find that £100 from somewhere, it cannot conjour it from thin air, Murphy has quite misunderstood how the banking system create money.

    By the way, when a bank makes a £100 loan funded by a £100 deposit, both borrower and depositor have £100 of money each and money has been created. When that loan is funded by wholesale lending or BoE lending, I’m not sure the wholesale lender or BoE can be thought of as having money in circulation in the same way the balance on my current account can be thought of as money at my disposal. I think the source of funding matters. Thats just an idea I havent thought much on.

  45. I wonder what Murphy thinks banks do with all those deposits in current and savings accounts. I wonder how he thinks banks ever go bust if they can literally create money out of thin air.

  46. What’s funny is Murph’s rant is basically against state controlled money supply & interest rates yet he is big statist, is he not?

    Low deposit rates? They’ve been set so low by state diktat via the B0E.

    Credit creation by banks? Banks are in effect agents to the state who ultimately control the money supply, both directly by outright fiat money creation and indirectly by rate setting.

    TBTF? Well the state is not bound to help out insolvent banks, it chose to shaft the taxpayer in doing so.

  47. Hang about, Francis. This;

    “As long as all that happens is electronic transfers, payments can be made without any physical funding. And since all banks can make accounting entries this way, they can lend imaginary money to each other as well. This can go on ad infinitum as long as no-one has to produce any real cash.

    Can’t be right, can it? Becuase electronic bank transfers, like cheques, are settled with central bank reserves.

    Lets say I buy a loaf of bread from Mr Baker, at $10, and pay for it with my VISA electron. Then Mr Bakers (buisness) account is credited with that $10. All well and good, and accountingy.

    Except that to settle that my bank has to transfer $10 from its reserve account at the central bank to the central bank reserve account of Mr Bakers bank.

    So, let’s say that $10 was a loan. My bank still needs $10 worth of assets (central bank reserves) to make that loan “spendable”. So they still need to have accquired funds to purchase the central bank reserves to action the transaction.

    The point being that electronic transfers are still very much “drawing down” against the loan.

  48. Luis

    I did say that retail deposits were one way of funding lending, actually. But banks do not “match” loans with funding deposits, except in very large structured deals. We’re really looking at this at much too low a level – which was partly Tim’s point.

    Retail deposits aren’t the only source of funds and may not be the most important one. Northern Rock was lending huge amounts of money funded almost entirely by interbank borrowing. It failed when it couldn’t do this any more because the interbank markets froze after the collapse of Bear Sterns.

    Unlike Murphy, who ignores the funding issue completely, I am not arguing that funding is irrelevant. But there is no direct relationship between the activity of deposit-taking and the activity of lending. The money multiplier is misleading in implying that a bank must first have a deposit in order to lend.

    Matthew

    I think you’ve missed the point I was making. Of course electronic transfers are “drawing down” against the loan. Did you not read what I said about central bank reserve accounts and how they are funded?

  49. Frances,

    Okay, but who thought loans were matched with deposits? Who imagined my bank goes around saying “who wants to borrow mr enriques’s £100”? Who ever thought that loans are always 100% funded by deposits?

  50. Frances
    Take away the idiots here that don’t understand how words work to make points without pictures. You are making proper wotsits.

    However, the finance industry is able to disguise the true source of ‘funding’ through a myriad of tricks, which, in themselves can be sold.

    The notion that ‘banks’ create money from ‘thin air’ is very realistic.

    Explain please, all you wise ones, how the financial disaster a few years ago was allowed to happen. Please bear in mind that markets are apolitical and non-affiliated (yeah right) and that those in control of such socially destructive decisions were rightly renumerated for their actions.

    Please bear in mind that, apart from nitpicking, you haven’t got a fucking clue. That is, apart from ploughing on relentlessly with failure.

  51. Luis,

    Well, no-one who knows anything about banking thinks that, of course. But people whose knowledge of fractional reserve lending is limited to Econ 101 do think that. And there are an awful lot of those people. So yes, I am constantly encountering people who genuinely believe that loans are only funded by retail deposits, who genuinely believe that their £1000 is split into 10 lots of £100 and lent out. Their number is only exceeded by the morons who think their deposits are locked safely in a vault and banks conjure the interest they pay on them out of thin air. Astonishing, what people believe.

  52. @Arnald: RM said in his piece the following:

    “There is good reason for that: banks do not (and never have) needed depositors for enable them to make loans. ”

    This is, as many above have stated, totally untrue. For a loan to be created, there must either be a deposit or some money borrowed from elsewhere by the bank (a deposit being really a loan from a private individual, repayable on demand or after a fixed notice period). Admittedly the loan may precede the deposit, but the two must match on a reasonable time scale.

    Banks cannot create assets (loans) from thin air without a liability (deposit or interbank loan) to match. It is not, and cannot be, done either.

    If it can be done, why are you not out there doing it, and raking in the cash hand over fist?

  53. Arnald,

    The financial disaster a few years ago was at least partly a failure of funding. Banks could not fund their obligations when the repo markets froze after the collapse of Bear Sterns. They had massively over-lent and were dependent on very short-term wholesale funding. So creating lending without ensuring that reserves are available to fund it is risky. That’s why ignoring the funding issue is not a good idea.

  54. Sorry Francis, still feeling my way around this topic. I guess I didn’t really understand what you’d written.

    Seriously though, the central bank will just create reserves without demanding some form of corresponding asset from the bank? That seems a bit mental.

    I mean, the other sources of funding don’t seem all that bothersome to me. Interbank lending, etc.., are all backstopped by actual savings at some point. So it doesn’t make much odds if it’s actually deposits or whatever, I would have thought.

    Oh, and I’m a different Matthew to the one commenting up the thread, by-the-by. The last post was me, but not the earlier ones.

  55. Frances

    I still think the simple story of banks taking deposits and making loans is the right way to introduce the basics to students. Any decent teacher should emphasise the simplification and talk about how banks are more complex than that, and modules beyond 101 should expand on it, but perhaps after most graduate, all they can remember is the simple story.

  56. Tim is right, and Murphy is wrong. But Murphy and the many vituperative commenters above are only slightly wrong.

    For a bank to lend money, it has to have the money. It can borrow it wholesale, or it can use deposits. That’s all.

    The point about monetary expansion and bank credit, which Murphy is close to but strictly wrong on on this point, is where the deposits come from. If the Guardian borrows a hundred quid from a bank to pay Murphy for an article, they’re down a hundred quid. BUT… what does Murphy do with the hundred quid? First off, he leaves it in his current account. Therefore, the bank gets it straight back, and can lend it again. Which it will (most of it, anyway).

    (Of course, may not be exactly the same bank, but it all goes around, the principle is the same)

    Hence all the stuff about manufacturing credit, etc., etc. All basically true.

    HOWEVER, please notice that none of that actually contradicts Tim’s post. Because, for every £100 of credit that is produced this way, there really is £100 of deposits — in this case Murphy depositing (or just leaving) his £100 from the Guardian in his bank account. If nobody deposits their money in the bank, none of this works.

    The wholesale lending is still on the same basis, except when it comes from the central bank, which can do weird things. But note Tim expressly covered that.

    LPUK, back when I was paying attention, constructed a policy that would have allowed “real” money to be deposited and lent out, but not money that had already been lent out once. I don’t think it was a particularly sensible idea, but I can see what they were getting at.

    If you really want to curb this, which might not be a terrible idea, the area to concentrate on is probably maturity transformation.

  57. Jim

    No-one matches loans and deposits like that in practice. Assets and liabilities balance at the bank balance sheet level, but not below that. And there are a number of ways of managing the liability side of the balance sheet to balance the loan books. Deposits are only one way, and since they are senior debt they are arguably not the most important. In the event of loan default, tier 1 and 2 capital take the hit first – hence the recent emphasis on capital buffers.

    If you are talking about funding, then there is question of timing here. Accounting entries for a loan are made irrespective of availability of funds, and only the drawdowns of a loan have to be funded. If a loan is drawn in several tranches, therefore, the full amount of the loan will be recorded as an asset from the start, with an offsetting created deposit (liability), but funding will only be obtained as and when each tranche loan is drawn down. It’s a risky strategy, I agree – you could argue that banks should obtain full funding for a loan from its start date – but that’s not what they do.

  58. Matthew,

    Central bank demands collateral, of course…which is why banks buy good quality securities!

  59. @ Frances Coppola
    I didn’t say nor mean to imply that you were stupid – just that there was a crucial difference between your explanation and Murphy’s nonsense and it should not be assumed by idiots like Arnald that your post means that “Murphy is entirely right”. The Bank of Murphy would collapse after one day when someone wanted to buy a loaf of bread.

  60. Before Gordon Brown transferred bank supervision from the BoE to the FSA, there hadn’t been a run on a UK bank in more than a century.
    [Dick Van Dyke is American and was cast as a Cockney sweep because Americans dominate the film industry – there have been a lot of runs on American banks.]
    The financial crisis a few years ago (the disaster is yet to happen when the Eurozone crashes) was due to the confluence of several factors of which greed in Wall Street was not actually the worst, appalling though it was. Bad legislation by Clinton and Brown, stupid greed by Californian realtors (estate agents) and insolvent homebuyers and gross (it would be libellous to say “criminal” so I won’t) negligence by rating agencies were more significant.

  61. “LPUK constructed a policy that would have allowed “real” money to be deposited and lent out, but not money that had already been lent out once.”

    How would they tell?

    I borrow a fiver from the bank, and buy beer with it. Tim withdraws a fiver from his bank account (which is in credit), and buys beer with it. The pub deposits both fivers in their business bank account. Short of having two sets of notes in circulation, how does the pub’s bank know that Tim’s fiver can be lent out, but mine can’t?

  62. John77

    No, you’re right. I have reached the conclusion that what Murphy actually knows about banking could probably be written on a postage stamp, and as he writes considerably more than that about it, it is nearly all fantasy. This post does have faint glimmers of reality, but totally ignoring funding is a major error – especially as funding was SUCH a crucial issue in the last financial crisis and is becoming so in this one too.

    Oh, and I agree with you about regulation. Much of the problem in America – which as you say has had far more bank runs, and indeed more and worse financial crises, than the UK – is the fragmentation of regulation. So what did we do? We fragmented our regulation too. No surprise that regulation then became ineffective. Fragmentation in the banking system can’t be avoided, but fragmented regulation prevents proper identification and management of systemic risk.

  63. @Richard — it was complicated and not terribly practical; I think it involved two separate currencies or something. Note when I describe it as “not particularly sensible”, that’s in the same way that landing an airliner with no undercarriage is “difficult”.

  64. Somewhere in this quoteless farrago,where assertions are made without any reference to any published authority , is a recommendation about how students should be taught : the simple narrative of how money is created.
    However the simplest and most accurate story is not helpful to the argument that banks are our
    gentlemanly friends or the comforting myth that the banking system may create money but not an individual bank : Banks start off (in Lombardy)holding and lending gold but people doing journeys don’t want to carry it ,so ask for notes which can be converted back to gold on arrival.Soon the banker realises his customers are using the notes as money and leaving the gold in his vaults.So he fixes a reserve ratio of say 10% (in practice more like 3%) in case anybody comes along and asks to redeem the notes in gold (Our bank notes still say Promise to pay: for redemption in silver).
    So a single bank increases 100 ducats in gold
    to 1000 ducats in notes (All money)
    Ralph Musgrave ‘s quote above from Galbraith goes onto describe how the monopoly Bank of Amsterdam learned from Lombardy (Italy did n’t exist) to lend out customers’ money while still allowing them to draw on their accounts .
    “The original deposit still stood to the credit of the original depositor.But there was now also a a new deposit from the proceeds of the loan.Both deposits could be used to make payments ,be used as money.Money had thus been created out of nothing”JK Galbraith “Money whence it came,Where it went”publ 1975 ,p 19 .
    (Not that anybody on this blog will be arsed to read it,most being unused to the disciplines of the Humanities in ploughing through difficult books and quoting from those that appear relevant.So much easier to run an equation [Black/Scholes is a lulu] As I’ve said before :half our problems are down to the Two Cultures Debate being de facto won by the wrong side.)

  65. DBC Reed

    If I can find it I will read it!

    That’s an excellent description of what I was trying to describe….the way in which the process of LENDING creates new deposits. That’s how money creation works. Because of that there is an element of self-funding in lending, as these new deposits can’t be distinguished from “real” deposits (as @Richard points out). They are drawn down by the borrower, who spends them – but that money ends up in another bank (or even the same one) as a real deposit which can be used to fund more lending.

    And that’s why I object to the money multiplier myth. It simply isn’t how lending works, and therefore should not be taught to students.

  66. DBC

    Are you really complaining I haved added no citations in blog comments? FFS.

    I can’t see you have added anything to the discussion other than another retelling of the same story. Galbraith is wrong to say money has been created out of nothing; in his account money has been created using the original deposit, just like the text book account.

    Frances

    The money multiplier isn’t a myth, it’s the ratio of one kind of money to another. And it is taught that the process of Lending creates new deposits. There is no distinction between new deposits and real deposits, whatever that may mean.

  67. The money multiplier is derived by manipulating accounting identies. It should not be regarded as a function with constant parameters that policy makers can use to set the money supply. Last time I was a TA on 1st year macro we had an exam question that specifically asked about how the relationship between H and M depends on banks’ willingness to lend. If you think the money multiplier theory says that increases in H mechanically lead to proportionate increases in M, you fail that question.

  68. Again, if money is created out of nothing, what is all the pissing about with deposits for in Galbaith’s account? Banks use money to create more money. It is not correct to say banks require nothing to create money.

  69. Luis

    It would be more helpful to teach how loan accounting works. Accounting entries for loans are a debit to customer loan account and a credit to customer deposit (current) account. Both of those are on the balance sheet, so the bank’s assets AND LIABILITIES are both expanded by the amount of the loan. That deposit can then be drawn in cash or transferred to another account at the same or a different bank. When that happens, for the lending bank there is a reduction in its liabilities – a debit to the customer deposit account. This is what has to be funded – in exactly the same way as any other sort of deposit withdrawal or payment from a current account in credit. If the drawdown is in cash then the bank has to have physical cash available to meet the demand. Other forms of settlement don’t require physical money, so the funding gap only needs to be addressed in aggregate at the end of the day by borrowing to meet reserve requirements. If by chance people have put more money into the bank than has been drawn, of course, the bank’s reserve account is in credit and it will lend that money out instead of borrowing.

    So yes, the new deposits created as part of the lending process do have to be funded – which is what we were discussing. And there is a cost involved in that. It is that funding requirement, and the cost, that was completely ignored in Murphy’s post. Banks certainly can’t “invent” money to plug that settlement funding gap.

    I’m sorry, all, if I didn’t make this clear enough earlier.

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