| > Regarding point 1, I guess we're going to just agree to disagree. I actually agree with you really, I think the term money is terrible and leads to all sorts of misunderstandings about how the world works. But in the sense of the word being used in that BoE paper, bank loans create "money" as in "money supply" as it is measured in official documents. > 2. Will the bank - in practice - lose its money-printing ability if it behaves extremely bad I absolutely agree that bad behaviour will (in an ideal world!) lead to the loss of a banking license (although recent events point to the contrary, "To Big To Fail" and all that -- I think that banks should have gone bankrupt and people should have gone to jail after 2008!) But, with regulation as it stands currently, not having enough reserves to remain liquid prior to originating a loan isn't bad behaviour. In some cases banks can have a negative balance as long as it's not negative for a sustained period of time (regulations differ between jurisdictions). Capital adequacy is not the same as a reserve ratio! > If a bank issues a huge loan that the customer intends to withdraw from the bank, that can cause a short term liquidity shortfall. So if you're saying the bank needs sufficient reserves to cover for potential short term liquidity shortfalls, then I suppose we are in agreement over the main question in this debate. I think the key here is the sequence of events, which is subtle but crucial. Banks don't first take deposits equal to the amount of loans they wish to originate, and then subsequently go looking for people to whom they will originate loans with those reserves as a guarantee of their ability to ensure liquidity to satisfy net flows of funds. They originate the loans and then separately go looking for whatever funds they need to satisfy their liquidity. Capital requirements are far more complicated than simply having a reserve ratio. They can be things like commitments of funds subordinated to demand deposit liabilities. In other words capital can be a potential source of liquidity, rather than actual reserves sitting in your account. They also borrow from each other and from the central bank, including with self securitisation. > I'd be to happy to accept a single counter-example where a bank with 0 reserves issues >999999999 dollars to a family friend who then exchanges it to goods and services It doesn't have to be fraudulent in order to fit what the BoE is saying. It just needs to be the case that banks aren't constrained by their deposits, but rather their capital which can take many forms. Reserves make their operations more profitable, and if they're unprofitable enough for long enough, they'll go bust. But the statement "banks lend out reserves" is demonstrably wrong. > In practice banks are constrained in their loan-making by their reserves, even if you have 9 research papers that claim otherwise "in theory". I've provided reference documentation from the RBA (that's Australia's central bank) and APRA (Australia's financial regulator), and the original paper is a document produced by BoE which is the UKs central bank, so I think this is a little more than a purely theoretical argument! I've also discussed this personally with Sean Carmody[0] who works for APRA and has a long history of working in banking with extensive experience particularly in liquidity risk management. I'm not making it up! EDIT: Also if you're interested, this whole lecture series is very good (gotta skip over the start with the host economist talking he rambles on a bit) but in particular lectures 6&7 address banking structure and regulation based on the work of Minksy https://www.youtube.com/playlist?list=PLnw-449iRxO-BbfN55FdO... [0] https://www.apra.gov.au/apras-executive-and-governance |
It is indeed wrong, but nobody here has made such a statement. Saying "banks lend out reserves" implies that when a bank issues a loan worth $X, their reserves are immediately reduced by $X. I've been pretty clear in my statements that their reserves are not reduced until the customer withdraws $X to another bank (which does not always happen, and even when it does happen, other customers from other banks transfer funds back into this bank, so the net flow is not always negative as multiple banks keep issuing loans and money is shuffled between banks).
> banks aren't constrained by their deposits, but rather their capital which can take many forms
Sure! I like this way of putting it.
Now, a bank which has a high amount of capital can in practice issue more loans than a bank which has a low amount of capital. And one way of increasing the bank's capital (and thus improving the bank's ability to issue loans) is increasing the bank's reserves. So there's some kind of positive correlation between a bank's reserves and its ability to issue loans, right? You mentioned yourself that a bank has to have sufficient capital to survive short term liquidity events, and issuing a large amount of loans increases the probability of such events.
> I've provided reference documentation from the RBA (that's Australia's central bank) and APRA (Australia's financial regulator), and the original paper is a document produced by BoE which is the UKs central bank, so I think this is a little more than a purely theoretical argument!
The sources you've provided describe the "general case" of banks making loans as part of normal business proceedings. The documents do not describe the extreme case of a bank issuing infinite money to the chairman's wife. I don't believe that the writers had this extreme case in mind at all when they were writing these papers. You're making the argument that the same mechanisms that enable the general case would equally apply to the extreme case. I don't believe that, and I don't believe all of the writers of those papers would agree with you either. Even if the writers are sometimes using inappropriately strong expressions like "there is no relationship between customer deposits and loan issuance", I don't believe they mean that literally (and if they do mean that literally, then I'm going to argue that the papers are wrong).
Let's go back to the concrete example: A bank is known to have lost ALL of its capital and is known to have billions in liabilities that it will never be able to pay off. The bank then issues a $10B loan to the chairman's wife. The chairman's wife then exchanges that $10B to physical yachts and aeroplanes. You believe that this can happen in practice, because you believe that the central bank would provide the reserves needed to settle the transfers, even though the central bank is aware that the bank is acting with malice and committing fraud. You believe that this behavior might "lead to the loss of a banking license", but you don't believe it might prevent yacht-buying and aeroplane-buying before the loss of banking license occurs? If I understood your position correctly, then we disagree here, and I'd be happy to change my position when a single counter-example is presented. If something like this has never happened in history, then I don't believe it can realistically happen in the future either.
The reason why I'm bringing up this extreme case is to demonstrate that clearly there is some connection between the bank's... I'm going to say capital... and its ability to issue loans. This connection also exists in less extreme cases, but it's easier for me to demonstrate with this extreme example.