[NovemberWhiskey]

That is not how fractional reserve banking works, people - or, to me at least, it gives a wrong impression.

Say we are in a fractional reserve banking system, where the required reserve is 10%.

I deposit $1M at the bank. My bank can now lend $900K to you. You can now deposit $900K back at your bank. Your bank can now lend $810K to someone else, and so on and so on.

The geometric sum of this is "1/reserve_ratio"; so if there's a 10% reserve ratio, then the initial $1M deposit can lead to $10M of loans outstanding. No single bank is loaning out more than is being deposited with it.

[RobertoG]

That's not how it works.

Banks lend and then try to find reserves, after the fact, because they have legal requirements. No bank loss a good lending business because they have not reserves enough.

When a bank make a loan, there are two possibilities: they have enough reserves, then they don't need to do anything.

Or they don't have enough reserves, so they have to borrow them from other banks or from the central bank.

If they borrow them from other banks they are creating demand for reserves in the inter-bank market. That makes the interest rate go up.

The central banks don't try to control the quantity of money, but the interest rate. If there are a lot of demand for reserves and the Central Bank don't add reserves to the system the interest rate will go up. So, the Central Bank add or retire reserves in order to keep the interest rate in the range they want.

The quantity of money is decided by the demand of lending in the economy.

The Central Bank can choose to try to control the quantity of money or the interest rate, but not both. All modern Central Banks try to control the interest rate.

[mgraczyk]

This used to be true, but hasn't mattered for a long time. The reserve requirement is zero for most (all?) US banks.

https://www.federalreserve.gov/monetarypolicy/reservereq.htm

[NovemberWhiskey]

It doesn't matter because no banks have been anywhere near the reserve requirements that were previously in effect. The change to the "ample reserves" regime is just a tacit admission that lending is not functionally limited by reserve ratios in the U.S. at the moment.

[mgraczyk]

Yep that's what I meant by "hasn't mattered for a long time".

[NovemberWhiskey]

I'm sure you know, but (based on discussions that took place at the time of the announcement back in 2020) I know a lot of people who leapt directly to the assumption that the removal of the reserve requirement was so that banks could "create even more money out of thin air than they were previously allowed to do".

I hope you don't mind me clearing that misconception up, even if it's not for your benefit!

[danielmarkbruce]

The capital requirements result in something similar. In the end, a loan by JPM of $100 is backed by about $90 of deposits and about $10 of JPM equity. In practice JPM has more capital than that, but there is some adjustments to the loan amount given the risk of any loan etc.

So, JPM needs more equity if it wants to ramp up it's loans.

[tibanne]

Strange that private companies are allowed to create money from nothing don't you think?

[mgraczyk]

It's strange if you have a particular conception of money. If you think of money as a social technology used to improve aggregate well being, then it's just a property that empirically makes sense. Private banking, with effective regulation, has proven to be a fairly effective way to stabilize the business cycle and unblock growth

[cryptica]

Sure, it helps to improve the aggregate well being of those who participate in the fake economy at the expense of those who participate in the real economy... Great for crooks!

[JumpCrisscross]

> it helps to improve the aggregate well being of those who participate in the fake economy at the expense of those who participate in the real economy

This is financial Luddism. Just because something is unfamiliar doesn’t mean it’s bad.

Private money creation is necessary for a growing, dynamic economic condition. (The problem is simpler in a static or simply cyclic economy.) Growth is heterogenous. To preserve price and bank stability, you want money created where it’s needed and not in excess where it’s not. In times past, this was largely geographic: banks in the West created money faster than banks in the agrarian South. Today, the divisions are more complex: a bank serving tech companies probably creates more deposits than one serving aging manufacturers.

Centralising this function in a state apparatus has been proposed. But the central bank would have to run and then implement an economic model. Decide where and for whom to create money. This is central planning. It has a poor track record. (This is also the argument against bank concentration [1].)

[1] https://fred.stlouisfed.org/series/DDOI01USA156NWDB

[cryptica]

The way the banking system works now, it mostly creates money where it's not needed. That's why there is such high inequality which keeps growing. New capital is just deployed to chase old capital. It creates anti-competitive moats which prevent money from going where it's really needed and where it could be used most efficiently. It makes bureaucracy viable and economic efficiency non-viable.

The vast majority of people who benefit from bank loans are not value creators, they are rent-seekers. Value creation necessarily requires taking calculated risks and banks these days aren't willing to take any risk.... They need full collateral. It's all about existing collateral. In the short term, the safest investment you can make is to build a moat around your existing investment... But if everyone in the economy is busy building moats (because that's the only activity which is sufficiency safe for banks to fund), there will be nobody remaining to do useful stuff which moves the economy forward.

[User23]

It’s the defining characteristic of a banking license. Like any license it permits activity that would otherwise be illegal. In this case, creating new dollars.

[howeyc]

That's how it has been for a while, as the bank of England paper explains.

The key is that the bank is "on the hook" for being able to get that money back eventually. So they don't just loan indiscriminately.

[hgomersall]

"On the hook" right up until the point they're about to go bust, then they hand over responsibility to the government to rescue them from their rampant speculation.

[SilasX]

But “eventually” can mean “now, as an easy loan from the central bank/lender of last resort”, which trust the solvency of the bank’s loans.

[drexlspivey]

So basically all commercial banks are free to issue unlimited loans (and create unlimited new dollars)?

[User23]

Basically, yes. There are “capital” requirements, but as far as I can tell that’s basically just laundering their loan business by trading equity with peer banks, which are of course largely based on loan performance.