[luca3v]

This is not exactly how fractional reserve banking works. I think that there is a misconception that if, for example, there is a bank regulation that allows 10% fractional reserve banking, then if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans, with $9 million being "created out of thin hair". In fact, if a bank has $1 million in deposits it can make only $900k in loans.

Indeed, suppose you are a bank and you have $1 mil in deposits, which you keep as reserve with the central bank. Now someone asks for a $900k loan. Now you have $1.9 mil in deposits ($1.9 mil liabilities), and you have $1 mil kept with the central bank in cash, and $900k owed from the guy with the loan (total $1.9 mil in assets, it checks out).

Now the guy with the loan withdraws his $900k to pay for his house or whatever; the bank gives him the $900k from the cash account it has at the central bank. Now the bank has $1 mil in liabilities (the checking accounts of the depositors), $100k in cash with the central bank, and $900k owed from the guy with the loan. Everything still checks out, but now the cash on hand is just $10% of the assets. The bank has reached the fractional reserve limit, and it is not allowed to make any more loans.

[NovemberWhiskey]

This is right, but then the house seller now has $0.9mm in cash. When she deposits it in her bank, that bank can make another loan but only for $0.81mm and so on and so on.

The geometric sum to infinity ends up being 1/reserve_ratio; so if that's 10% in this example, the theoretical money creation is 10x.

[luca3v]

Yes, this is correct! But some people, and perhaps not the grandparent comment, understand the "money creation" point as that money can be replicated infinitely, that is a bank get $1 mil deposit and makes $10 mil loans, and those loans, if deposited, could lead to $100 mil loans and so on

[majormajor]

I'd say that's creating circulation more than creating money.

If you had no bank deposits at all, and nobody ever saved money, saving is outlawed, you gotta spend it, you'd have 1M in total cash in the economy. It would be moving around a bunch, but if you froze the system and counted it, there's 1M available to be spent at any moment in time. Let's compare to 1M deposited in a bank. 900K of it is circulated to the house seller, etc... The total amount circulated follows the geometric sum.

But, if you freeze the system at any moment in time, there is NOT a geometric sum of money in cash or other places immediately available to be spent! Most of this is going to be in accounts with daily withdrawal limits, for instance. We're messing with time here much more than we're creating money - it's a bit of a magic trick, yes, but one that's based on "not everyone is going to want to move all their deposits at the same time, let's take advantage of that to make the system more efficient, at some risk of stability." Not based on infinitely printing money at retail banks. And the risk has, in the better part of the last century, been fine - it's distributed, it's insured, etc. We could have a big discussion about if it's gonna be ok for ever, but first, that's different from this claim of "banks have special privileges to create money that I wish I had."

And the bank still needs to make sure their loans were sensible and low-enough-risk - things have to balance up in the end as people do make various withdrawals at various points in time - and many of those loans also go into accounts at other institutions.

In a world without this sort of banking, you'd still have loans backed by other things, like interest and payment income, like credit cards, but not ones tied at all to deposits - and it should be pretty clear that credit card companies aren't printing money, they're just shuffling it around.

[ubercow13]

>and it is not allowed to make any more loans.

No. From the paper

>In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available.

[IncRnd]

That's just randomly quoting sentences out of context. What you quoted is from the standpoint of a particular central bank, not from the standpoint of an arbitrary lending bank. Absolutely, many lending banks have reserve requirements imposed upon them, just not in the particular country of this paper!

[soVeryTired]

In most counties in the west, reserve requirements don't constrain lending. For example, Canada, the UK, and Australia have a reserve requirement of zero. Fractional reserve banking doesn't really exist anymore outside of economics textbooks.

Capital requirements are what constrain lending in the west (I think the Chinese government does try to control lending in part via a reserve requirement). For example, the "Core Tier 1 Capital Ratio" [0] is extremely important in this regard.

https://www.investopedia.com/terms/t/tier-1-capital-ratio.as...

[IncRnd]

The United States has reserve requirements. The EU has reserve requirements. India has reserve requirements.

[soVeryTired]

I never claimed they didn't. I claimed the reserve requirements didn't constrain lending.

[ubercow13]

Well yes, this article is about the UK. But the paper is quite clear that in practice, it is not any reserve requirement that effectively determines how many loans a bank will create. I am guessing this applies equally to other modern economies even if they have such a limit?

It's one sentence but the context is that the whole paper is arguing against the textbook explanation of fractional reserve banking GP stated - the "two common misconceptions" stated in the introduction.

[kgwgk]

> it is not any reserve requirement that effectively determines how many loans a bank will create

But according to that article it may be, because that bank will need to increase reserves to expand lending and acquiring them has a cost.

“But that does not mean that any given individual bank can freely lend and create money without limit. That is because banks have to be able to lend profitably in a competitive market, [……] whether through deposits or other liabilities, the bank would need to make sure it was attracting and retaining some kind of funds in order to keep expanding lending. And the cost of that needs to be measured against the interest the bank expects to earn on the loans it is making,“

[louloulou]

You should read the article, because it seems you're the one with the misconception.

how it works -> "if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans"

not how it works -> "if a bank has $1 million in deposits it can make only $900k in loans"

[kgwgk]

What the article says is that to lend out more than $900k it has to increase it reserves (maybe borrowing from other banks). Not that it can lend out $10m with just $1m in deposits.

“By attracting new deposits, the bank can increase its lending without running down its reserves, as shown in the third row of Figure 2. Alternatively, a bank can borrow from other banks or attract other forms of liabilities, at least temporarily. But whether through deposits or other liabilities, the bank would need to make sure it was attracting and retaining some kind of funds in order to keep expanding lending.”

[louloulou]

>through deposits or other liabilities

This is entirely the point. The money created goes back to the bank as deposits and new money is created on top of this.

i.e. 0.9^0+0.9^1+0.9^2+0.9^3+... = 10

[kgwgk]

The money created doesn’t necessarily go back to the bank. When you take a loan you use the money for something, not to keep it in an account at that bank.

It will typically end in another bank. Then the bank that gave you those $900k still has just $1m in reserves and cannot lend anymore. Unless it gets some deposits or additional funding from another bank (maybe the one where those $900k ended).

It seems we all agree that “if a bank has $1 million in deposits it can make only $900k in loans.” In the aggregate banking system there are now $900k more, some bank may use the reserves created by that deposit to lend $810k, etc.

That’s not the same as

how it works -> "if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans"

which is wrong.

[louloulou]

I'm afraid you're simply wrong and need to do some more research. There's no magical point in time where money is "in use". It is always credited to someone's bank account at any given point in time.

The baking system as a whole is leveraged about 9:1 based on the previous example. A bank deposit is a bank deposit, regardless of which bank it is at.

[kgwgk]

You didn’t say

"if the banking system as a whole has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the system banking as a whole can make $10 million in loans" [and there will be in the end $11m in deposits in the banking system as a whole, offsetting the $1m in reserves and $10m in loans]

You said

"if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans" [which is wrong unless you assume that every loan remains in that bank as a deposit so the “banking system as a whole” case is recovered]

Of course that bank could get more reserves to be able to make additional loans. But then it could lend much more than $10m if it gets enough deposits/reserves! [One bank =/= The banking system as a whole]

Edit: by the way, I’m curious what is the thing in my previous comment that you find “simply wrong”.

[iso1210]

> The money created doesn’t necessarily go back to the bank

Very little will be kept in a matress or burnt. Almost all will go back to a bank.

$1m in Bank A

$1m in bank B

Charlie borrows $900k from Bank B, gives to Dave, puts into Bank A

Eric borrows $900k from Bank A, gives to Felicity, who puts it in bank B.

[kgwgk]

"A bank" is not the same as "the bank".

In your example, the money borrowed by Charlie from B does later go back to bank B.

But if you remove the last transaction it doesn't.

Hence, it doesn't necessarily happen.