[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.