[zizee]

From what I understand, when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).

Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.

I guess this is sort of what happens with banks buying bonds from various government bodies, but the banks are managing a mix of bond maturity durations.

If bank runs are a worry, why not do away with this flexibility for the banks?

[meh8881]

> From what I understand, when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank

Nah it’s simpler.

You put a dollar in the bank. The bank loans 80 cents to Bob. Bob puts 50 cents of that 80 cents in the bank. The bank loans out some of that.

Even without going beyond Bob, the same dollar is now in the bank twice. That’s what people mean by money being created.

[bombcar]

And this cannot be "controlled" for because money is fungible, and if you do try to "prevent" it Bob just puts his 80 cents in another bank which does the same thing, and it all loops around.

Certificates of Deposit are supposed to be the thing that "helps" a bank balance the "short duration" deposits with "long duration" loans - but when interest rates are so low the CDs are not worth bothering with.

I wonder if we'll see a maximum interest rate on "cash accounts" or something in the near future to try to balance it.

[marcosdumay]

It can absolutely be controlled. That's what reserve requirements do.

It's just out of fashion for central banks to control it. (For several reasons that exist, but I'm not sure are good ones.)

[bombcar]

Reserve requirements (unless they go to 100%, but then you can't loan at all off deposit accounts) don't prevent the bank from "loaning out money already loaned" but they do help reduce the chance of a run.

[marcosdumay]

They don't prevent money multiplication, they control money multiplication.

If a country has reserve requirements that are larger than the banks safety margins, the central bank has complete control on the size of M1.

[Negitivefrags]

This is a concept called a Narrow Bank.

Basically it’s a bank that puts all its deposits directly with the Fed. There have been attempts to start such a bank in the past and they have been denied a banking charter.

[qubex]

Narrow Bank is the same as Thin Client.

[xyzzyz]

Fed hates that and fights this tooth and nail. See, for example:

https://johnhcochrane.blogspot.com/2018/09/fed-nixes-narrow-... https://johnhcochrane.blogspot.com/2019/03/fed-vs-narrow-ban...

[em500]

Cochrane's speculates a bit about the Fed's motives near the end. He doesn't think they're outright evil, in cahoots with the incumbent commercial banks, etc. He thinks it's a misguided attempt to cross-subsidize the lending activities at the current commercial banks. If the super safe narrow bank draws away a lot of the common depositors, the commercial bank will need to get more other (more expensive) funding sources (bonds and other loans) which can make mortgages, business loans etc more expensive.

edit: It was Scott Sumner, commenting on Cochrane's blog, who speculated that the motive might be cross-subsidizing the normal bank lending activities: https://www.econlib.org/why-does-the-fed-oppose-narrow-banki...

[dgb23]

Am I reading this right? They expected this mechanism to be too efficient for regular, already established banks to compete?

So a safer, more efficient mechanism for banking is declined in order to keep the established banks competitive?

Isn't that sort of outrageous?

[em500]

You're in good company if you find that outrageous. But the (speculative) reasoning is not so much to keep them competitive, but to keep borrowing cheap. In the real world, lots of people want to borrow money for 3, 5 or 10 years for their business or 10, 20, 30 years for their mortgage (and preferably at fixed rates), while very few people want to lend out money for such long terms at fixed rates. So the way banks handle this is pool together lots of small short terms loans like deposits and count on the observed regularity that they usually don't withdraw their money simultaneously (SVB notwithstanding). If the relatively stable and cheap small deposits are all going to narrow banks, how are the lending banks going to fund the longer term loans?

[dgb23]

My understanding so far is that these deposits are often overburdened. In part due to speculative investments.

From a perspective of someone who understands very little of these matters, it seems like responsibilities are shuffled around and the whole structure is unclear.

There are other ways to solve the problem you describe right? For example credit unions come to mind.

I usually look things up on this site, as it seems to discuss financial matters neutrally and explains them so I can understand them: https://www.investopedia.com/terms/c/creditunion.asp

[imtringued]

The narrow bank restricts the Fed's ability to hawkishly raise the interest rate. It won't be able to get away with gross market Vs policy mismatches anymore. I mean think about it, the Fed makes an unintended policy error and raises the interest rate far above what banks can pay, everyone goes to the narrow banks. If the interest rate is too low nobody goes to the narrow bank. So the Fed essentially would have to perfectly choose the optimal interest rate which it probably can't do. It always overshoots or undershoots.

[TheOtherHobbes]

Which is ok, because that's just the market punishing the Fed for poor decisions.

[prox]

In r/askeconomics this was exactly the answer by the leading answers.

https://www.reddit.com/r/AskEconomics/comments/11vtl1c/what_...

[dageshi]

They hate it for good reason.

The narrow bank would be safer than US Treasury Bonds. In a financial crisis similar to 2008 this would amplify chaos as money drained from all other investment classes into the narrow bank at a time when the government probably needs low interest rates on their debt to solve things.

[tasubotadas]

Crazy. How did the story with narrow bank end?

[fuoqi]

You can be your own narrow bank by directly investing into short-term bonds or by buying a money market fund.

[rocqua]

That has massive fee friction, does not eliminate counter party risk entirely, and earns different (lower?) rates than the Fed offers.

[chrchang523]

I don’t know how long this will last, but I started doing this recently with Vanguard’s VUSXX (short-term Treasury) fund when I realized it had significantly higher after-tax yield than high-interest savings accounts without the hassle of manually rolling over T-bills, and it looks like many other people have been moving in this direction.

[guepe]

If you buy t-bills yourself fees are low, and brokers aren't banks - so risk of money being stuck there is low.

It's a bit of work but very manageable. 10/10 recommend, you earn more than a savings account.

[ac29]

Fees on buying treasuries are zero if you buy them directly from the treasury or any of the large brokers (Vanguard, Fidelity, etc).

[SOLAR_FIELDS]

I’m curious about this as well, because the top comment (TNB takes over an existing bank that already has this account) seems like a perfectly viable alternative. Given that they had the resources to get to this point in the first place, was there a reason why this wasn’t an option?

[xyzzyz]

It’s dead.

[blitzar]

Funnily enough, this concept is the central bank digital currency - CBDC business model, with extra steps.

[rocqua]

It's not quite right that banks don't loan out their depositors money. They need depositors to be able to make loans. Stashing depositors money at the Fed keeps the bank from making loans.

Stashing money at the Fed is possible by the way, and effectively does destroy the money (or rather, takes it out of the economy). Banks can deposit money at the Fed earning exactly the interest rate that the Fed controls. This effectively takes that money out of the economy. That is generally rather bad, because it stifles growth. But in case of inflation, it can sort of help. That is part of why the Fed interest rate helps regulate inflation.

But generally speaking, you want loans to be made! It helps good and productive ideas get of the ground. It is core to Western economies. Hence the Fed is quite scared of narrow banking. They want to be the 'borrower of last resort'.

[imtringued]

>They need depositors to be able to make loans

I've never asked my loans to be paid out in cash or transferred to another bank. When people say commercial banks create/issue money they mean that cash/central bank reserves have become irrelevant other than as a rudimentary payment method or network to transmit between banks.

If you wanted to make the point that banks lends existing deposits you would have to basically argue that people never wire money and always pay with cash and deposit their cash paychecks manually and pay taxes in cash. Curiously, my government points me at major banks and their ATMs when I want to pay my taxes in cash.

[makomk]

Presumably you didn't just keep that money sitting in your own bank account though - you used it to buy something or pay someone, and their account was often at another bank. If a bank issues too many loans where the money ends up at other banks without counterbalancing transfers of money in, it eats away at the reserves they have available to settle those transfers with and that's how deposits actually limit banks' ability to make loans. The Bank of England article that someone linked further down explains this in more detail (page 18 in the PDF): https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

[fuoqi]

>when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest.

Commercial banks can not create loans out of thin air during normal operation. They either have to use depositors' money or share holders' capital. In other words, bank's liabilities (e.g. user deposits) should not exceed its assets (loans to users, securities, reserves at Fed, etc.). There are games which can played with how assets worth is measured (e.g. mark-to-market vs. mark-to-maturity), but otherwise the rule must be followed by banks.

>Why can we not have a similar system for deposits? A bank takes a deposit, the fed "destroys" the money, but pays interest to the bank. When the depositor wants to withdraw their money, the fed/bank recreates the money.

When a bank receives a deposit, it has to decide what to do with it. It can either loan it to someone (either directly or by buying bonds), invest (e.g. by buying stocks), pay it as a dividend to share holders (assuming it has far more assets than liabilities), or keep it in bank's reserve account at Fed. In the later case it gets payed roughly the key interest rate. This is why rate hikes suppress inflation (at least in the near term), banks instead of deploying their capital into the economy deposit it at Fed, thus temporarily removing it from circulation. It also means that cost of loans in the wider economy rises accordingly, since banks will not loan without a sufficient premium to the Fed's rate.

[sumedh]

> Commercial banks can not create loans out of thin air during normal operation.

Commercial banks create money, in the form of bank deposits, by making new loans. 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.

At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.

[the_optimist]

This is outright incorrect. https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

[fuoqi]

What exactly is incorrect in my explanation? Are you saying that bank's liabilities can exceed its assets for a prolonged time? Or that reserves at a central bank do not pay interest? The second order effects (such as loan at one banks creates deposit at another, meaning M2 gets essentially "printed"), which are important for monetary policy and regulation, are not relevant when we view operation of a bank in isolation.

[neilwilson]

It's entirely 180 degrees backward.

Banks operate by discount. You take a thing to the bank, the bank values it and then a financial asset is created which the bank buys by creating an advance of its own liabilities against it. The bank then books the assets (the mortgage) against the advance. The bank's balance sheet is expanded.

The individual then 'pays' people with the advance - which does nothing other than change the ownership on that advance. When the payment process is complete we stop calling it an advance and start calling it a deposit.

You don't even need somebody else's money to start a bank. The Bank of England was started by issuing shares to subscribers and booking them on the asset side as nil paid.

A deposit 'moving' to another bank is really the destination bank taking over the deposit in the source bank, or delegating that to the central bank via a centralised clearance process.

Bank capital, either equity or notes, is convincing somebody with a deposit to swap it for another liability that has less security.

Much of the problems we have with banking and the view against it is because of the persistence of the Monetarist view that they pick up bag of coins from somebody and pass them on to somebody else. There are no bags of coins, and there is no passing them on. Never has been, never will be.

[fuoqi]

>You don't even need somebody else's money to start a bank. The Bank of England was started by issuing shares to subscribers and booking them on the asset side as nil paid.

We discuss commercial banks. The Bank of England is quite far from your run of the mill commercial bank, to say the least. Try to start a commercial bank without any capital, it will be a fun exercise.

As I've said in the post, there are various make-believe games which can be played with assets. My favorite example is the irredeemable gold certificates owned by the Fed.

Your systematic view is certainly valid, but it does not matter much for day-to-day operations of most banks. They do not care about how the system was kick started. For them reserves at a central bank play role of bag of coins, even though, as you said, there are no real coins, just pairs of assets and liabilities spread out between different balance sheets.

>Much of the problems we have with banking and the view against it is because of the persistence of the Monetarist view

Oh, so the current debacle is mostly fault of monetarists? Got it. And here I thought that the "temporary" make believe games introduced after GFC, lax regulation, irresponsible fiscal and monetary policy had something to do with it... /s

[neilwilson]

"Try to start a commercial bank without any capital, it will be a fun exercise."

It's precisely the same. You issue shares to subscribers and mark them as nil paid.

That is capital - because you have a call on their resources - much as the names of Lloyds of London capitalise the insurance market.

Reserves are irrelevant to banking. Here in the UK we didn't even have reserves until 2005 yet we'd been operating a central banking system for 300 years at that point.

This obsession with central bank reserves is a peculiarly American concept.

Loans create deposits, and the central bank simply accommodates the simulation of money moving around the payment system.

There is no control function from central bank reserves. It's a complete myth. If the central bank tries, monetarist style, then the payment system breaks, fires break out and they have to back off. Hence the Bank Term Funding Program.

There comes a point when the belief in bags of coins and fixed amounts of money has to die.

[rocqua]

Perhaps the statement 'banks cannot create loans out of thin air'?

A bank can, with some capital buffer, borrow money from the fed, loan it out to someone else, and earn an interest spread.

Deposits help here because you pay a depositor less money than you pay the Fed, but they aren't crucial. And the Fed does have the advantage of not demanding it's money back at random.

Though perhaps I am wrong about how easy it is to carry a negative balance with a central bank? I imagine it is fine as long as the balance sheet looks good.

[makomk]

Creating loans and the money associated with them out of thin air doesn't cause the bank's liabilities to exceeed its assets though: they're simultaneously creating an asset (the loan) and a liability (the money deposited from the loan) which exactly cancel out.

[dgrin91]

If I'm a bank why would I want to get X% interest from the Fed when I can instead get X+Y% interest from some other investment option[0]? Yes the risk is higher, but typically only marginally so. Obviously you have big failures like SVB & others, but the reality is that those aren't common.

It also lets the bank pass on the increased rates to customers. The current fed interest rate is ~4.5%, but there are banks out there right now where you can get >5% in a savings account[1]. Your system would remove that option for consumers.

[0] Other option being some regulatorily approved option, not throw it all in the latest crypto ICO

[1] https://www.ufbdirect.com/

[sonthonax]

Banks usually have a regulatory requirement to keep a portion of funds in the Federal Reserve.

[s_dev]

>The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).

Perhaps you can clarify by what you mean by 'destroyed'.

To my knowledge once the bank has 'created' the money it will always exist in the system. However it has devalued all other money by a small amount which we understand today as 'inflation'. So it's not clear to me what you mean by destroyed.

[qubex]

“High-powered money” is that which is created when the central bank lends to commercial banks. As it is a claim on the central bank’s assets, when it is returned to them it ceases to exist (as the central bank doesn’t need extra paper to dispose of its own assets).

[kasey_junk]

The destruction mechanism is the same as the creation mechanism but in reverse.

An asset is removed from the lendee in the form of a debit against their deposits thus destroying outstanding cash.

[nradov]

When a borrower defaults then some fraction of the outstanding balance is destroyed.

[andrepd]

> when someone takes out a loan, a bank doesn't lend out depositors' money. Instead money is "created" by the bank (on behalf of the fed), and the bank needs to pay the fed interest. The bank also needs to pay the loan back by an agreed uppn time (which destroys the money).

Why can't I do that with the central bank directly? Why the rent-seeking middleman?

[pharmakom]

Creating money out of nothing is a mechanism to get large projects off the ground. Without it, it would be difficult to fun infrastructure, R&D, etc. like most mechanisms, it can be used in good and bad ways.

[Jerry2]

Yes, that's how it works. There's this amazing animated movie from 2011 that explains how banking works and the history of banks: "The Collapse of The American Dream Explained in Animation" [1] It has almost 10 million views.

[1] https://www.youtube.com/watch?v=mII9NZ8MMVM

[mrfox321]

It give banks far too much leverage.

If they took large losses or lent out too much, inflation would skyrocket.