| > the origination of the loan and the transfer of settlement funds to another bank are separate operations Correct. The first operation ("writing a number on a computer") can occur regardless of how much money the bank has. But if operation 2 is not possible, then the number that was created in operation 1 is de facto not money. Remember, we're arguing whether the bank needs to have physical banknotes and central bank reserves in order to "create money" when originating a loan. We're not arguing about whether the bank can type in random numbers on a computer - on that point we are already in agreement. The disagreement concerns whether/when those numbers can be considered to be "money". > All "money" is simply an accounting entry. Excluding physical banknotes, yes that is true, but you are implying the reverse of that statement to be true and it's not true at all: all accounting entries are not "money". If I open an excel sheet right now and type in "99999999", that is an accounting entry, but it is not money. Likewise, if a troubled bank has completely ran out of capital and is not supported by structures like the FDIC, and it proceeds to type in "9999999" as an accounting entry for the account balance of the chairman's wife, that is not "money". The chairman's wife will not be able to exchange it to goods and services - hence, it is not "money". > Deposits created by a bank are good for all transactions within that bank. If all people were customers of the same bank (some sort of "central bank" if you will) and all currency were digital, then the bank could indeed create infinity dollars without liquidity risk, because all transactions would occur within their own accounting system with no external settlements. Yes, central banks have the ability to create practically infinite amounts of real money from thin air. The argument doesn't concern the central bank's ability to create money, it concerns a commercial/retail bank's ability to create money in the process of originating loans. > > Follow-up question: if you genuinely believe [a bank which has NO MONEY is able to (in a practical sense) create infinite money out of thin air] to be possible, then why isn't anybody doing that? Surely there are many people working at banks who would like to collude with their friends and family to create infinite money. If you believe that to be possible, why has it literally never happened? > it does happen, fraud in loan origination isn't that rare. Here's a recent example of a banker originating $16m in loans to Paul Manafort in exchange for a shot at working with Trump: Nope, that is not an example of a bank issuing an infinite amount of money while having literally zero money in reserves. That is an example of a bank which has >16M in reserves, then issuing loans for 16M. Nothing weird about that. Completely unrelated to what I was asking for. Show me a bank which has 0 reserves, then issues loans for billions of dollars, and then exchanges those billions to goods and services. You can't do that, because that has never happened, because it's not possible. > But let's imagine that a bank did attempt to operate without any settlement balances. What would that look like? It would originate loans by adding $9,999,999,999 to someone's account, and since they're not the only bank, the person has the choice to spend that money wherever they please and some of that money will end up being withdrawn as notes/coins or transferred to another bank. The originator of the loan would then have to borrow settlement balances sufficient to cover withdrawals in notes/coins and cover interbank settlements. What happens? The central bank, which is the lender of last resort, lends money to all those banks and they have to pay interest on it, but in lending the money, the central bank has created reserve balances No, the central bank would NOT provide a loan in this outrageous, obviously fraudulent instance. Again, you're claiming this to be possible, but it has never happened. > But fundamentally, we could have a banking system that operates exactly as I described where ALL money creation occurred only through the origination of private credit and subsequent lending of reserve balances by the central bank. It would be a horrible economy with massive inequality and instability, but you could do it, if you so desired. The reason we regulate it is to remove some of that instability (removing the inequality, we're still working on!) Now I'm confused. So the example you provided was not supposed to reflect reality? It was just a "we could in theory have a banking system like this"? Yes we could in theory, but in practice we don't. In practice normal banks need reserves in order to issue loans. |
I agree that money is a very ambiguous (and probably not very helpful) term, but insofar as we can consider the M1 money supply measure to be the quantity of money available in the economy at any given point in time (which is what the BoE paper is referring to when it says "money creation"), originating loans definitely creates money[0]. When you get a loan, the money lands in your demand deposit account, it's definitely "money" according to the definition of money being used in the BoE paper.
>> All "money" is simply an accounting entry. > Excluding physical banknotes, yes that is true
Minor point but I would include notes and coins as "entries" in the same accounting system, in the same way as receipts, invoices or cheques. Not really critical to the conversation though ...
> but you are implying the reverse of that statement to be true and it's not true at all: all accounting entries are not "money". If I open an excel sheet right now and type in "99999999", that is an accounting entry, but it is not money.
Well, they sort of are. I mean, any liability denominated in the state's unit of account is, in some way, money. This is the crux of Minsky's "Heirarchy of Money"[0]
For Minsky, there is nothing special or elusive about money. In fact, he says, "everyone can create money; the problem is to get it accepted" (1986, p. 228)[1]
> Likewise, if a troubled bank has completely ran out of capital and is not supported by structures like the FDIC, and it proceeds to type in "9999999" as an accounting entry for the account balance of the chairman's wife, that is not "money". The chairman's wife will not be able to exchange it to goods and services - hence, it is not "money".
Right, but banks are supported by those structures. That's what makes them banks. As we saw in 2008, the government went to extroardinary lengths to insure that even the most recklessly issued loans didn't result in banks becoming insolvent. Bill Black is definitely worth a listen to on this topic[2].
>> Follow-up question: ... Nope, that is not an example of a bank issuing an infinite amount of money while having literally zero money in reserves. That is an example of a bank which has >16M in reserves, then issuing loans for 16M. Nothing weird about that
Well, we don't really know what the reserve position of that bank was, and $16m was probably a relatively small amount relative to the overall capital position, but this is definitely an example of someone going outside of what would be considered normally regulated procedure (regulation being the only thing that separates "good" loans from "bad" loans) for personal gain which is why I thought it was relevant to your point.
>> But let's imagine that a bank did attempt to operate without any settlement balances ... No, the central bank would NOT provide a loan in this outrageous, obviously fraudulent instance. Again, you're claiming this to be possible, but it has never happened.
When a bank receives its license, it can immediately start both taking deposits and issuing loans. Banks lend money to each other all the time, and most loans from the central bank are against collateral such as government securities and other very liquid forms of capital[3] however the central bank will, under some circumstances, lend money to banks against the assets they have themselves created through loan origination[4].
So while my little thought experiment about "starting from $0" is not quite accurate, it's not that far off!
>> But fundamentally, we could have a banking system that operates exactly as I described ... > So the example you provided was not supposed to reflect reality? It was just a "we could in theory have a banking system like this"? Yes we could in theory, but in practice we don't. In practice normal banks need reserves in order to issue loans.
My example was intended to show you how banks hold reserves in order to make their loan operations more profitable. The point was that even if you started off with all banks at $0 in reserves and funded the entire operation using only central bank loans, you would end up with a system similar to what we have now where the primary reason banks need reserves is to increase profitability. It may be the case that a bank that had no reserves at all would go bust because it wouldn't be able to compete with other banks, but it's certainly not the case that they all need to attract reserve deposits equal to the amount of loans they want to originate. They only need sufficient reserves to satisfy net flows of funds and, because they're banks, they have access to the types of credit facilities they need in order to satisfy short term liquidity shortfalls.
In fact, there was a spectacular neobanking collapse in Australia recently:
"Xinja failed in part because it started taking deposits before it made loans. That meant it had to pay interest to customers before it was generating income."[5]
Banks don't need a certain level of reserves or even highly liquid government securities to satisfy capital adequacy requirements. If you look at the documentation around commencement of a bank and capital adequacy standards[6][7] you'll find a story that is much more complicated than simply "reserve funds". They look at all sorts of financial instruments able to "absorb losses" or "commitment of funds". These mean that you can have investors who have pledged to step in to satisfy liquidity requirements or provide collateral/security for loans from other banks and/or the central bank.
There is a difference between the "capital adequacy" requirements placed on banks and the imagined "reserve requirement". Bill Mitchell sets it out clearly:
"To understand why reserve requirements do no constrain lending you have to understand how a bank operates. Banks seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share (this is one of Minsky’s drivers).
These loans are made independent of the banks’ reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these horizontal transactions will not add the required reserves.
In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds. At the individual bank level, certainly the “price of reserves” may play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend.
So the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. The bank expands its balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank."[8]
In other words, banks issue as much credit as they can to as many credit worthy customers as they can find, and separately look for ways to satisfy any regulatory requirements. It is the case that regulatory requirements will inform lending criteria but it's nowhere near as simple as "x% of reserves".
[0] https://fred.stlouisfed.org/series/M1SL
[1] https://www.levyinstitute.org/publications/the-hierarchy-of-...
[2] https://www.youtube.com/watch?v=WQBIfSWDx9s
[3] https://www.rba.gov.au/publications/bulletin/2017/dec/2.html
[4] https://www.rba.gov.au/publications/bulletin/2020/sep/pdf/ma...
[5] https://www.afr.com/companies/financial-services/xinja-s-col...
[6] https://www.apra.gov.au/sites/default/files/2021-08/Guidelin...
[7] https://www.apra.gov.au/sites/default/files/2021-08/APS%2011...
[9] http://bilbo.economicoutlook.net/blog/?p=9075