Banks are not intermediaries between savers and borrowers. That is not their role in the modern economy. And yet most people cannot get their heads around the fact that this is not the case, including almost everybody in government who somehow think that savers fund lending, which fuels investment. And the answer is no, it doesn’t but let me explain why.
Banks must have deposits (plus their own capital) to match lending. Every day at 4.30 pm. That’s just the way the system works.
Deposits in banks – savings – really do fund lending.
Man’s a loon.
Your money as a saver does not fund bank lending.
Simply not true.
You could be a bit of a matchmaker here, Tim. Just introduce Spud to the Graun tech guy. I’m sure they’ll enjoy nanoseconds of each others edifying company. Or kill each other…
Something thats always bothered me is this – if individual banks can’t create money out of nothing (which they can’t, otherwise they’d be financial perpetual motion machines), how does the banking system as a whole do that?If at 4:30pm on day 1 every financial institution has squared its loans off against its cash deposits, how exactly is there ever enough cash for there to be more net loans over the entire system on day 2? We know banks make more loans over time, where do all the cash deposits come from to cover them at 4:30pm every day?
If you look at the value created in commerce that underlies money, you’d have to ask “What are banks giving borrowers, then?” And “What happened to the created value formed the depositors’ deposits?” Because all money is exchanged for goods or services.
Makes you wonder, for example, what Gordon Brown was thinking when he nationalised Northern Rock. He could’ve just told them to cross out one number on a piece of paper and write a bigger one in crayon.
I know a bloke, used to work in a Scottish retail bank. Other bank’s banknotes are a debt to that other bank, one of his jobs was scurrying around at 4:30pm each day getting rid of other people’s banknotes and exchanging them for their own notes from other banks scurrying around getting rid of theirs, to get rid of the debt.
Lending doesn’t support much business investment. Some 75% of UK bank lending is residential mortgages; most of the rest is commercial mortgages.
Banks don’t lend to companies to help them grow; that’s what equity is for.
jgh,
A banknote is an asset to the bearer, and a liability to the issuer. If Bank of Scotland exchanges its Bank of Ireland notes with Bank of Ireland for their Bank of Scotland notes, then both the assets and liabilities of both banks are reduced (your own note can hardly be counted as an asset).
I guess there must be some technical reason you’d want to pay people to do such zero-sum balance-sheet flummery.
Anyone know how YouTube counts views? Spud is claiming 10s of thousands of views of some of his videos. When I go on his YouTube channel I see 100s maybe low 1000s of views but nothing like his claims.
What’s he seeing that I’m not? Or is he just making it up?
Jim said:
“Something thats always bothered me is this – if individual banks can’t create money out of nothing (which they can’t, otherwise they’d be financial perpetual motion machines), how does the banking system as a whole do that?”
I’m not sure I’ve understood it either, but isn’t it about the velocity of circulation, and which definition of “money” you’re using?
Banks don’t create actual money (‘narrow’ money, is it M0, actual cash). But they circulate it faster, which creates ‘money’ under an extended definition of money that includes bank deposits (‘broad money’ – is it M4?).
So I deposit £100, the bank lends it to Fred, who uses it to buy something from Dave, who deposits it. There’s still only my £100 of actual money, and net there,’s still only £100 (my £100 plus Dave’s £100 deposit, minus Fred’s £100 loan). But on a particular definition of “money” that counts bank deposits but doesn’t deduct loans, there’s now £200 (my £100 plus Dave’s £100).
If I’ve got it right, it’s only on that latter, rather spurious definition of “money” that the banking system “creates money”.
The amount of money around for spending and investment is therefore the underlying amount of actual money (my £100 that I deposited) multiplied by the number of times it circulates, in this case 2 (is that the “velocity of money”? I think so but I’m not really sure).
So the amount of “money “ (in that broad sense) can be increased either by having more actual money going into the system at the same velocity, or having the same amount of money going in but increasing the velocity.
So on one level Murphy is right, the banking system could create more “money” without more deposits, by increasing the velocity. But beyond a certain point increased velocity is risky. So na practical level he’s wrong; for a given level of risk (“velocity”), more deposits mean more lending is possible.
That sort of makes sense to me, but it might be utter bollocks.
“Spud is claiming 10s of thousands of views of some of his videos. When I go on his YouTube channel I see 100s maybe low 1000s of views but nothing like his claims.”
I won’t link to it, but if you go to Spud’s youtube channel and click on ‘videos’ and then select the ‘popular tag, you’ll see that his most popular video has 39k views. And only 16 of his videos (of which there must be a hundred or more) have over 10k views. I would guestimate that the median is about 1.7/1.8m views. To be fair that does include a lot of videos from 3 years ago which have low hundreds of views. Videos made in the last 2 weeks are sitting at 1-5k views, with the odd breakout video getting 10k+.
By comparison a mate of mine gets 5-10k for every video he’s put out over the last 2 months (maybe 20 videos – his channel is all about wild camping and motor bike and cycle trips to places of interest).
https://www.youtube.com/@WiltshireMan/videos
So we are talking very minor levels of audience here, its hardly the Kardashians.
“Banks don’t create actual money (‘narrow’ money, is it M0, actual cash). But they circulate it faster, which creates ‘money’ under an extended definition of money that includes bank deposits (‘broad money’ – is it M4?).”
That’s roughly it. And it’s the whole trick upon which the “banks create money” idea rests.
Banks create redit, obviously. Cerdit is included in he wider definitions of money – M3, M4 etc. Therefore, – Ta Dah! – banks create money. And that’s it, that’s the trick. If we all said no, money is M0 and the other stuff is credit then we’d have the central bank creates money and banks create credit. And you can’t build a decent conspirazoid theory out of that obviousness now, can you?
““Banks don’t create actual money (‘narrow’ money, is it M0, actual cash). But they circulate it faster, which creates ‘money’ under an extended definition of money that includes bank deposits (‘broad money’ – is it M4?).””
OK, so how does the amount of credit money rise, if the banks need to balance their books every 4:30pm? Don’t they need more deposits to balance things up? I can see how the above would work over a longer period of time, but as every financial institution has to stop the merry go round at close of business and balance the books, where does the extra cash come from every day?
The cash doesn’t change. The amount of credit does. And the deposit of a credit in a bank is a deposit suitable to match a credit loan out by that same bank.
Very, very, little of the “money supply” is cash or from hte BoE. In normal times (ie, no QE) maybe 2 or 3%.
This may help…. (or not!)
Suppose we have a single bank, with £1,000 capital (ie money available to lend.) Tom, Dick & Harry each ask for a loan of £500. The bank puts the money in their accounts. It has thereby created £500 “extra”, “out of thin air”, but being the single bank, the money either stays in their account, in which case it cancels out, or is paid to Adam, Bertie and Charlie, for goods or services, who pay it into the bank, restoring everything to equilibrium.
The amount of credit a bank can create is limited by the amount it needs to retain to satisfy any customer who wants to draw cash out of the system to hide under the bed. This percentage is set by the Bank of England and can be raised or lowered to increase or decrease the supply of credit.
Though there are many banks, the principle remains the same, that credit in one account is matched by an increased balance in another. The banks are interconnected through the banking system. If they happen to be short come 4.30, they can borrow from the BoE, who are able to lend because some bank somewhere else will hold the balancing amount.
Remember also, that “money” is “destroyed” when it is repaid to the bank, as the credit creation is reversed.
I doubt this would be enough for banking exams, but I’d like to think it is vaguely useful for a layman’s understanding.
Redit? Cerdit? Tim has had even more of the output of the Bushmills distillery than I have had today!
Put together a balance sheet of assets and liabilities for your own household accounts and it becomes clear. Remember to include all your assets, the tenner you lent your make a year ago which will probably become a “bad debt” included.
“Though there are many banks, the principle remains the same, that credit in one account is matched by an increased balance in another. The banks are interconnected through the banking system. If they happen to be short come 4.30, they can borrow from the BoE, who are able to lend because some bank somewhere else will hold the balancing amount.”
Yes, but in your example the amount of money and credit are in balance throughout the system. Yes the BoE may act as the intermediary to lend the bank who needs cash at the end of the day, but thats only because another bank has more than enough at 4:30. So my point remains – how does credit go up and up if cash available at 4:30pm doesn’t to maintain each and every banks ratio of cash to loans? If every bank in the system decides to create some new net loans on a Monday, where does the extra cash come from at 4:30pm to balance the books, money that wasn’t anywhere in the system on Friday?
“o my point remains – how does credit go up and up if cash available at 4:30pm doesn’t to maintain each and every banks ratio of cash to loans?”
It’s not “cash to loans”. It’s “deposits to loans”. A deposit can be that credit the bank has conjoured up by making a loan…..
Fractional Reserve Banking
Lloyds (or Barclays or Midland or NatWest) only has to hold cash equal to 8% of customer deposits. So when my pension arrives in my Lloyds account Lloyds can lend Jim 92% of that to buy a milking machine and the milkmaid sighs in relief, takes a couple of days off to recover and then get a cushy job as a cashier in the local Tesco. The milking machine manufacturer pays 15.12% VAT and deposits the other 76.88% in its Barclays account. Barclays lends 70.72% to a cheese factor which buys half of the milk from Jim whose wife spends it on advertising her B&B on airbnb (a few years ago the stats showed that famer’s wives, in aggregate, made more from B&B for walkers than their husbands did from farming) and airbnb deposits that with HSBC/Midland – at this stage we have already added treble my pension to bank deposits …
@john77: so what happens when you want to spend your pension then? Lloyds hasn’t got it, or rather its got 8% of it. The rest is spread to the 4 winds. What then?
Jim
I understand that this is what’s called a run on the bank.
Their fraud is exposed and the government is forced to print huge sums of money to avoid a total collapse of the economy.
@Jim
If you were the only depositor at the bank and they’d lent out your money and then wanted it back, the bank would have to sell some of their assets (i.e. the loans that they have made) in order to give you your money back. But the whole point of a bank is that they don’t have a single depositor, they are aggregators and not everyone is going to want all their money out at once.
Yes, bank runs happen, but they’re bad for the economy as a whole, so provided a bank is illiquid and not insolvent, the central bank will step in.
Jim said:
“so what happens when you want to spend your pension then? Lloyds hasn’t got it, or rather it’s got 8% of it. The rest is spread to the 4 winds. What then?”
They hope that only 8% of people want to do that on any day (net anyway; some of your spending will have been deposited back into the bank accounts of the people who sold the stuff you spent it on).
If more want to, then Lloyds has to borrow, either interbank overnight (from any banks who have got more cash than they need that day) or from the Bank of England (who will lend if the bank has assets – loans – worth lending against).
If more people withdraw than they can borrow to cover, that’s a run on the bank and it’s Northern Rock all over again.
As I’ve mentioned in other comments, I find it helps if you look at the creation of value in commerce that underlies money. Production & consumption have to balance. So you can’t “create money”in those terms. You’d be creating an entitlement to consume for which there wouldn’t be production. It’s all an illusion produced by the monetary book-keeping process.
bloke in spain said:
“As I’ve mentioned in other comments, I find it helps if you look at the creation of value in commerce that underlies money.”
True. Creating money but not value just causes inflation. There’s still the same amount of stuff, just more money chasing it.