[lowkey]

Both you and the author, while correct about many details, are completely wrong about the business model and economics of retail branch banking.

To be precise you are off by 100x or two orders of magnitude on the profitability of depositors to the branch. What you both missed is the biggest open secret in banking - the fractional reserve model.

Fractional reserve references the fact that banks don’t merely loan out depositor funds at a 3-5% spread. Instead they are required to keep at most 3% of depositor funds on—hand while they loan out the other 97% at a very profitable spread between interest charged on loans and interest paid to depositors.

For this reason every $1000 taken in by a branch allows them to make on average $97,000 in new loans. They pay the depositor 1% in interest on the $1000 deposit while charging 4-7% interest on approximately $97,000 in loans for a rough profit of almost $3,000-$6,000 for every $1000 deposited. Where does the $97,000 come from? It comes in the form of bank credit - literally numbers added in the bank’s computer.

This is one of the mechanisms of money creation. The other being sourced by the Federal Reserve when they purchase securities on the open market with money they create out of thin air. This is also what causes inflation, despite what politicians wish you to believe.

Banks do not operate as non-profits. They wouldn’t operate retail branches unless the economics warrant it, which they very much do.

[stephen_g]

That’s not actually how real banks work though - “fractional reserve” is only an economic textbook model.

Most countries don’t, and have never had reserve requirements. The limits to lending are firstly capital (share capital, retained earnings etc.), which banking regulations allow banks to lever up to a certain level, and secondarily liquidity, which they need to be able to pay out withdrawals, transfers etc. Deposits don’t come into it apart from that they are a certain kind of cheap liquidity for inter-bank transfers.

Deposits themselves are a liability of the bank, and since lending creates new deposits on the balance sheet, “lending from deposits” would create more liabilities from existing liabilities, which doesn’t really work with the accounting.

[lowkey]

I’ll admit my Google Foo is currently failing me but when last I checked fractional reserve requirements were a very real requirement up until the last couple of years.

Do you have a source to support your claim that they only apply in economic textbook theory and not in reality.

Could you perhaps help explain, ideally with a numerical example, how it currently works in practice?

[stephen_g]

A great resource is from the Bank of England (UK central bank) themselves: https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m... (click through to the main PDF).

Key quote:

> "Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits."

Here's a rundown of what it means by economist Steve Keen who specialises in this kind of stuff: https://www.quora.com/What-is-fractional-reserve-lending/ans...

As Keen explains from accounting first principles, fractional reserve could work if banks gave out loans in cash, but not how modern banks work today.

What I'm referring to about capital is formalised in the Basel III regulations - see https://en.wikipedia.org/wiki/Basel_III - since we've established that banks don't lend out of deposits, they actually have to cover any delinquent loans from their tier-1 capital (shareholder's equity) - that's what they're leveraging when they lend, not deposits. I can attest to this myself - I've never heard of any bank saying "oh sorry, we couldn't make any more loans because we needed to wait for some more people to make deposits", but as a bank shareholder I have more than once had a letter saying "we need to raise more capital through a new share offering tranche or else our lending projections show we may not be able to meet our capital adequacy ratios" (especially around the time when things were transitioning from Basel II to Basel III because the ratios increased).

[eru]

> I’ll admit my Google Foo is currently failing me [...]

See https://en.wikipedia.org/wiki/Reserve_requirement#Countries_...

> [...] reserve requirements were a very real requirement up until the last couple of years.

Mostly only in the US.

The whole Wikipedia entry is worth a look.

If you want to read more than you ever wanted to know, check out the works of George Selgin.

[lowkey]

Notably all other countries have a similar fractional reserve banking model even if the details may vary. Specifically, the money loaned out by the bank is created out of thin air in the form of bank credit and does not come out of any account. The banks in every country have no cost of goods for the money they lend out. They are authorized by government charter to create this money out of thin air. This is true whether they have reserve requirements or not.

[eru]

I am afraid you are misunderstanding the situation.

First, government authorisation is irrelevant. Shadow banking has the same effects. See https://en.wikipedia.org/wiki/Shadow_banking_system And so do grey or black market operations. Or offshore banks (that don't fall under the local government's authorisation.)

Second, even in the absence of any minimum legal reserve requirements, why do banks need reserves at all? Among other uses, banks need reserves for two main reasons:

* Cash withdrawals

* Net settling of money transfers with other banks

Now you are right that a bank can in principle create a loan/deposit pair out of thin air: they just adjust their ledger that you have now have 100$ dollars in your current account, but also that you owe them a 100$. Voila: money from nothing.

Now here's the problem: debtors are seldom content to let the loaned funds gather dust in their accounts. Typically, they spend them. Either by withdrawing cash or by transferring the money to some other person's account.

Chances are that the other person's account is with a different bank.

Both the withdrawal and the transfer diminish the reserves of our bank.

(On the flip side: both cash deposits and your customers receiving a money transfer into their account, increases your bank's reserves.)

In summary: yes, in the instant of creation, loans create money out of thin air. But as soon as the debtor spends the loaned funds, reserves (and thus deposits) are required.

And that's why even in the absence of legal reserve requirements, banks have to attract deposits.

Does this make sense?

See also https://www.alt-m.org/2017/09/06/the-bagging-rule-or-why-we-...

[gamegoblin]

How does your model explain that reserve requirements are now 0%? Why haven’t the banks created infinite money?

The loanable funds model that you describe is no longer accurate (though it is still taught by courses using outdated textbooks, e.g. the classic “Macroeconomics” by Mankiw. Newer textbooks, e.g. Core Econ do not teach the loanable funds model. It is incompatible with empirical data.

[1] https://www.federalreserve.gov/monetarypolicy/reservereq.htm

[lowkey]

I simplified for the sake of the audience since it does, I’m sure you would agree, seem absurd that the current reserve requirements are near 0% which only makes my argument stronger. Technically, though the reserve requirements are still >0%. There are limits as exhibited by other required ratios that must still be preserved. But effectively with near 0% reserve, the benefits of holding deposits are only amplified.[0]

[0] https://en.wikipedia.org/wiki/Fractional-reserve_banking

[gamegoblin]

I’m mainly arguing against the idea that banks take in money as deposits and lend out that same money as loans. In modern economies, this is not actually how it works (Though it used to be true! Just not anymore.)

“Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits”

I highly recommend reading the whole paper from The Bank of England, it shows that much of what is taught in outdated macro textbooks is wrong.

[0] https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

[majormajor]

This article has always bugged me because I get hung up here:

> When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage.

That's certainly not how it worked for me in the US. My bank account went down dramatically in the process of buying a house because I had to wire the down payment to an escrow company, and the bank gave either the escrow company or seller the rest of the funds (I assume, I had no visibility into the process. But at no point did me-as-borrower get an increase in my deposits!

Is that super meaningful? I wouldn't think so, except for that if the seller wants cash, or wants to deposit that money in a different bank (or puts it into the stock market, or whatever) then it requires my lending bank to have something other than just numbers in their own internal database - they have to convince that other institution that they're good for the money they just lent out. And that's the part where I'd assume consumer deposits would come back into play - unless the banks have another source of currency on hand.

[gamegoblin]

Think of a car loan, then, in which case the bank can just increment the number in your deposit account (until you spend it on a car).

The bit of information your second paragraph alludes to is the fact that all banks have accounts at the Federal Reserve. The Fed has the single database that the banks use to clear with each other. And the Fed and other regularity agencies audit the banks to make sure their internal databases are consistent, their loans are backed by assets of sufficient quality, etc.

This video by an economics professor is accessible to all and explains this to a certain extent in general. https://m.youtube.com/watch?v=4xgHbW2A9KE

Something to note is that in the US (and most modern economies), the federal government creates a 1:1 exchange rate between private bank money (e.g. money created through loans) and central bank money (numbers in the Fed database and physical cash) via deposit insurance (e.g. FDIC in the US).

[majormajor]

Sure, though it's rare that you'd borrow money without intending it to leave the bank (cases like paying off higher-interest stuff with lower-interest borrowing aside), but that aside, yeah, all the bits about how the banks have to have their accounts reconciled with the Fed and backing assets and all is really the core of my disagreement with the "banks can basically just print money infinitely" claims. Which I've sometimes seen people cite that BoE article as support of leaning on that "they just add a number in their computer when you take out a loan" bit. If it were that simple, I'd love to just make myself a bank and print myself some money, after all. ;)

My understanding is also that these discussions of "money" ignore things like investments or non-liquid assets, which I think is another big source of fuzziness. E.g. borrowing against other assets, including stock, that might have appreciated incredibly rapidly which gives you more purchasing power (the ability to "spend more money") without requiring anyone else to actually have given you money for anything specific.

[jkulubya]

There’s no reason (other than cost and your current wealth and bank risk management) why you couldn’t get a personal loan for the full purchase price of the house, and pay the seller the cash price. You’d then see your bank account balance go up by the house’s cost, withdraw the cash and then pay the seller.

I’m not sure what bank would give a normal person that kind of money unsecured but you could secure it with e.g. another house you own. Most people don’t have a spare house, so the banks optimise the process for the everyday scenario where the buyer doesn’t need to see their bank balance go up. But money is still being created in there somewhere

[lowkey]

> I’m mainly arguing against the idea that banks take in money as deposits and lend out that same money as loans.

We are in full agreement on this point. Banks never lend out even a fraction of depositor funds. Instead, they have been given a monopoly right by the government to create bank credit as a money equivalent out of thin air.

If you or I did this it would be considered fraud but when banks do it, it is legal.

[lowkey]

> How does your model explain that reserve requirements are now 0%?

> Why haven’t the banks created infinite money?

Reserve requirements are not the only constraint limiting bank’s ability to lend. The banks are also limited by the number of qualified borrowers who are seeking a loan. Qualified borrowers must have sufficient collatoral and/or income coverage to service the loan as well as a need to borrow funds. Banks can’t sell more loans than qualified borrowers are buying.

[55555]

You’re claiming banks make 5k in profit for every 1k in deposits. Chase has 2.3 trillion in deposits. Why don’t they have 10+ trillion in annual profits?

[lowkey]

Chase is limited in that they can only lend to well-qualified borrowers who wish to borrow from Chase on terms Chase deems sufficiently profitable.

In other words they are limited by the demand for loans by well-qualified borrowers. Well qualified is defined as borrowers with sufficient collatoral, income/debt, and credit history.

[majormajor]

I think you're making a different point than the original article. Yes, retail banks operate in an economically profitable way. But that's not to say that branches are required. There are retail banks without any branches. They can still do all the lending you mention. The author is attempting to answer the question of why those haven't put the ones that spend money on branches out of business. He also alludes at a followup around "semi-public infrastructure deployed as commercial real estate projects which are funded by private capital."

However: "Instead they are required to keep at most 3% of depositor funds on—hand while they loan out the other 97% at a very profitable spread between interest charged on loans and interest paid to depositors."

So if you bring in $1000 a 3% requirement means $30, and you can lend $970. Where do you get $97,000? Say the bank wants to loan money to home purchasers. "Numbers added in a bank computer" aren't gonna pay the bills for the people on the other side of those home purchases who are going to want cash or money in their own bank, not just yours.

Are you assuming a recursive process? Lend $970, have it redeposited by the person the borrower pays, lend out another $940, etc? But that only works if the money keeps getting redeposited at which point it's not entirely fair to characterize that as the "original" deposit only, and my understanding is that that's the (somewhat hypothetical) "money multiplier" which I've always seen as 1/r which would be 33x for 3% not 97x anyway. And in practice, that doesn't get reached.