"Broad money is made up of bank deposits — which are
essentially IOUs from commercial banks to households and
companies — and currency — mostly IOUs from the central
bank.(4)(5) Of the two types of broad money, bank deposits
make up the vast majority — 97% of the amount currently in
circulation.(6) And in the modern economy, those bank
deposits are mostly created by commercial banks
themselves."
The information you yourself linked says that 97% of broad money is made up of bank deposits, and that bank deposits are 'essentially IOUs from commercial banks to households'. This supports what I said: that bank deposits are loans from depositors to banks.
A bank can create an unlimited amount of money by issuing a loan: through a simple journal entry, it can create:
- a loan for $1 billion (owed by customer X)
- a deposit account for customer X (containing $1 billion)
But an SPDI can't do that, as it has to have liquid cash for the total amount among all deposit accounts.
Everything you said there agrees with my understanding. The difference is that in aggregate the bank doesn't borrow deposits from its customers, it creates deposits for its customers. It's a subtle distinction. Maybe a more direct way of putting it is that the loanable funds model is observably incorrect.
As you note, creating a deposit is just a balance sheet expansion, limited only by reserve requirements and capitalization and not at all by the presence of any depositors. And currently in the USA there are no reserve requirements and as far as I can tell capitalization is largely a shell game of packaging loans into various financial instruments that satisfy the legal requirements and trading them with other banks.
I didn't know that about SPDIs, thanks. It certainly does diminish the value of the banking license if they can't create USD deposits like a normal bank.
Yeah, the last point you mention is the main thing I was wondering about. I think of 'banking licence' as being synonymous with 'deposit-taking licence', but the SPDI isn't that.
Regarding your earlier statement: "in aggregate the bank doesn't borrow deposits from its customers, it creates deposits for its customers"... I think it's true in aggregate across ALL banks, but less true in aggregate for an individual bank.
Imagine there are 1000 banks in the country. Customer A borrows money from Bank X, which creates a loan and a deposit balance. Presumably, A wants to spend that money (otherwise, why borrow it?), so she transfers it to Customer B, who has a 99.9% chance of banking with a different bank, let's call it Bank Y.
Now imagine this being repeated many many times, across many customers, at each of the 1000 banks. In the end:
- all of the deposits were created as the result of a bank loan, but
- for any individual bank, 99.9% of the deposits came as the result of customers receiving transfers from other banks
The obvious next question is: what, if any, mechanism puts a limit on bank X's ability to lend? If it considers a borrower credit-worthy for a $1 billion unsecured loan, can it just make the loan, even if the loan is much larger than the bank's existing balance sheet? What will happen when the borrower tries to spend some of the money with a customers of bank Y or Z?
> I think of 'banking licence' as being synonymous with 'deposit-taking licence', but the SPDI isn't that.
As I understand it, crypto-currencies are treated by the SEC like commodities, not cash, and your original comment...
> ... SPDIs seems less like banks (which borrow from depositors) than to safe deposit box operators (which provide a place where depositors can keep valuables they don't want disturbed).
... makes sense since in a crypto-currency-as-commodity world the wallets would be treated more like safe deposit boxes than bank accounts.
That's not quite correct. If you apply for a $10k loan from a bank then, once the loan is approved, the bank will simultaneously:
- increase your current account balance by $10k (credit your current account)
- increase your loan account balance by $10k (debit your loan account)
That $10k deposit appeared from nowhere. You didn't 'put the deposit in', and it wasn't transferred from another customer or another bank. And the bank does not need to have $10k sourced from somewhere else.
Of course, when you want to withdraw that that $10k, or transfer it to someone who uses a different bank, the bank will have to come up with $10k from somewhere.
But maybe whatever they are called up to transfer to customers of other banks will be balanced out by transfers from other banks' customers to their own.
> If you apply for a $10k loan from a bank then, once the loan is approved, the bank will simultaneously:
- increase your current account balance by $10k (credit your current account)
- increase your loan account balance by $10k (debit your loan account)
That $10k deposit appeared from nowhere. You didn't 'put the deposit in', and it wasn't transferred from another customer or another bank. And the bank does not need to have $10k sourced from somewhere else.
This is not correct. A bank lends against its cash assets, not against nothing.
Bank accounting works like so: when you deposit $1 at the bank, the bank’s assets increase by $1 (the $1 you just gave it), and its liabilities also increase by $1 (the bank owes you your dollar back when you want it). A bank’s loans are financed by its assets; each dollar it lends is a dollar taken from the asset side of its balance sheet. When a bank lends you $1, it (1) decrements its asset balance by $1, (2) increments your bank account by $1, (3) creates a new asset representing a $1 loan on its own balance sheet, and (4) creates a new liability for you representing a loan of $1 owed.
Point is, a bank does not create money from absolutely nothing when making loans in the way you describe. All loans are financed by the bank’s assets, and a bank cannot originate a larger value of loans than the value of its cash assets. Bank “money-creation” refers to the fact that the total bank account balances in the economy increase when a bank makes a loan; this happens after what I described in the previous paragraph, since the $1 loan now increments your bank account, while nobody else’s bank account balance decreases.
(To see how this works in more detail, imagine the process begins with Alice depositing a one-dollar bill at the bank, and then the bank loaning Bob one dollar. Keep track of the distinction between who has the one-dollar bill and who has a one-dollar bank account balance. The loan proceeds as follows: first the bank gives Bob the one-dollar bill it took from Alice as a deposit, then Bob turns right around and deposits the one-dollar bill back at the bank. The result is that Alice and Bob now both have $1 bank account balances after the loan is made, whereas only Alice did before; the bank still has the one-dollar bill. Summing either bank account balances alone or balances plus dollar bills shows $1 more after the loan was made.)
I remember the Khan Academy course on banking to be useful for understanding what's going on. There's a lot more to it now, and it's closer to the "out of thin air" view these days.
I am having difficulty following your explanation. You described 4 accounting entries:
1. Credit asset account X (which one?)
2. Credit customer's bank account
3. Debit customer's loan account
4. Debit liability account Y
I agree with #2 and #3, which I described in my earlier comment. But:
#4 is already handled by #3
#1 is some unspecified 'asset' account; which one? It can't be cash (as they're not paying out cash) and it can't be a balance they hold with another party (as nothing in this transaction involved anyone but the customer and the bank)
Please take another look. Maybe defining which exact asset and/or liability accounts you believe are affected by each of the entries #1 to #4 will help me understand your point better.
Sorry, re-reading my comment I can see that it is likely only to add to the confusion. (The downvotes suggest so also! Apologies all around.)
I meant to make two points. First, that IMO it is misleading to say that a bank simply creates new money ex nihilo when making a loan, counter to what you wrote ("the bank does not need to have $10k sourced from somewhere else"). There is in fact a bound on the amount of new lending a bank can undertake, one related to its assets, and in that sense the money lent does "come from somewhere." My attempt at a (poorly) stylized accounting was meant to illustrate what sort of thing makes up a bank's cash assets and how they relate to lending, but I'll try a new approach below. Second, I was trying to clarify what "bank money" means, to explain how it gets created, as much of the broader confusion in this thread seems to be around what "[bank] money-creation" really entails.
Let me try to make my first point again. In modern banking systems, fractional reserve has been mostly replaced by capital requirements, which limit a bank to holding an amount of (risk-weighted) assets no greater than some multiple of its capital. A bank's capital is its assets less its liabilities, which we'll write A - L. Let's call the regulatory capital multiple M, then capital requirements essentially say that A <= M(A - L). When a bank makes a new loan, its assets and liabilities increase equally in the way you described. That means that for a loan of X, if the lending bank is not already bounded by capital requirements, that the capital adequacy inequality becomes X + A < M(A + X - (L + X)) = M(A - L). That is, the left side of the inequality increases but the right side of the inequality is unchanged, so the capital requirement binds more tightly. In particular, it must be that the loan amount X < M(A - L) - A; in other words, new loans are constrained to be less than the excess of regulatory capital over pre-existing assets. So a bank cannot just create arbitrarily large new loans; loans are constrained by capital, the positive component of which is assets. That's where loan money "comes from": a bank's assets.
The second point I meant to make about bank money-creation was not directed at your comment specifically. But I wanted to point out that "bank money" simply means the sum of all bank deposits, and that it, too, is constrained to be a finite number. In this sense also banks cannot poof into existence arbitrarily large loans (with corresponding deposits) in the way I read your comment to imply.
> The obvious next question is: what, if any, mechanism
> puts a limit on bank X's ability to lend? If it
> considers a borrower credit-worthy for a $1 billion
> unsecured loan, can it just make the loan, even if the
> loan is much larger than the bank's existing balance
> sheet? What will happen when the borrower tries to spend
> some of the money with a customers of bank Y or Z?
The answer is, of course, the capitalization requirements you described above mean that (i) no, it can't make arbitrarily large loans, and (ii) the bank should hopefully have enough liquid assets to satisfy redemption of demand deposits.
"Broad money is made up of bank deposits — which are essentially IOUs from commercial banks to households and companies — and currency — mostly IOUs from the central bank.(4)(5) Of the two types of broad money, bank deposits make up the vast majority — 97% of the amount currently in circulation.(6) And in the modern economy, those bank deposits are mostly created by commercial banks themselves."
The information you yourself linked says that 97% of broad money is made up of bank deposits, and that bank deposits are 'essentially IOUs from commercial banks to households'. This supports what I said: that bank deposits are loans from depositors to banks.
A bank can create an unlimited amount of money by issuing a loan: through a simple journal entry, it can create:
- a loan for $1 billion (owed by customer X)
- a deposit account for customer X (containing $1 billion)
But an SPDI can't do that, as it has to have liquid cash for the total amount among all deposit accounts.