Do banks create money?

Franz Von Peppercorn II

This is a follow up from a removed thread where the op said.

Some people seem to be under the false belief that commercial banks create money they don't. They take in deposits and lend out a proportion of those deposits while maintaining minimum capital thresholds on the balance sheet. One of my passions is dispelling myths, this is a myth which needs to be dispelle

(The thread was removed because the poster was a serial re-reg. deleting the original post of a thread deletes the thread).

Franz Von Peppercorn II

My own opinion is that when banks lend money they actually create money that is not there. Its not from savings. Most bank and central bank economists agree with this.

TimeToShine

I would say they fabricate a lack of money by lending that which doesn't exist and charging interest on it.

hmmm

This is Economics 101. Yes banks create money. Their ability to create money is limited by the Central Bank. Central Banks can relax rules which make it easier to create money, or make it more difficult for banks to create money.

Franz Von Peppercorn II

hmmm wrote: »

This is Economics 101. Yes banks create money. Their ability to create money is limited by the Central Bank. Central Banks can relax rules which make it easier to create money, or make it more difficult for banks to create money.

Funny enough although it should be economics 101, it isn’t. Or wasn’t. A textbook I used in school (not university) about 20 years ago gave the “from deposits” argument.

There might be an ideological reason for the persistence of this belief because it justifies preferring savers to wage earners.

BDI

So if I was a bank and had a hundred euro.
How much can I lend out?

Is it 90 or 900.

Franz Von Peppercorn II

BDI wrote: »

So if I was a bank and had a hundred euro.
How much can I lend out?

Is it 90 or 900.

The bank needs about 10% of its loan book as reserves. So if the bank had 100 euro in reserves it can loan up to 900. Iirc.

I’m probably simplifying this a bit.

Beric Dondarrion

BDI wrote: »

So if I was a bank and had a hundred euro.
How much can I lend out?

Is it 90 or 900.

We were taught in leaving cert economics that if a bank has a liquidity ratio of 10% and has 100Euro on deposit it can lend 10 times that amount as only 10% will ever be required in real cash by customers i.e 100Euro. The other 900Euro will be transferred electronically or not at all (or something like that....it's been a few years).

That's why a run on a bank is nightmare for bankers as they can never fully cover all of their customers deposits with real, hard cash.

BDI

Franz Von Peppercorn II wrote: »

The bank needs about 10% of its loan book as reserves. So if the bank had 100 euro in reserves it can loan 900.

I’m probably simplifying this a bit.

So it just increased the amount of currency out there by 900 euro this inturn devalues the euro?

Beric Dondarrion

BDI wrote: »

So it just increased the amount of currency out there by 900 euro this inturn devalues the euro?

But that 900Euro needs to be paid back, the bank only make money on the interest that it generates. This is tied in with the concept of inflation I think which is why inflation eats in to the value of money people have under their mattress etc.

BDI

Beric Dondarrion wrote: »

But that 900Euro needs to be paid back, the bank only make money on the interest that it generates. This is tied in with the concept of inflation I think which is why inflation eats in to the value of money people have under their mattress etc.

So the commercial bank needs to pay the central bank back 900?

Odelay

How can I do this?

Princess Consuela Bananahammock

Central bank creates it, commerical banks are tasked with distributing it. They can ask the central bank for more, but no guarantee they'll get it.

Beric Dondarrion

BDI wrote: »

So the commercial bank needs to pay the central bank back 900?

I'm not up on bank law but my understanding was that the Central bank just make the rules around deposits, liquidity ratios etc. I think they are the lender of last resort as well (if a bank gets in trouble, they will step in to help).

Other than that, banks are responsible for creating most of the money we use today.

gctest50

BDI wrote: »

So the commercial bank needs to pay the central bank back 900?

No no, they just have to say they could pay back 900 if there was some kind of failure ........and that's never going to happen, so it's all grand

Beric Dondarrion

Odelay wrote: »

How can I do this?

Get yourself a banking licence

biko

Money creation in the modern economy
From Bank of England channel

https://www.youtube.com/watch?v=CvRAqR2pAgw

Franz Von Peppercorn II

Princess Consuela Bananahammock wrote: »

Central bank creates it, commerical banks are tasked with distributing it. They can ask the central bank for more, but no guarantee they'll get it.

Most money isn’t created like this. The banks literally create money when a loan is issued.

Franz Von Peppercorn II

BDI wrote: »

So the commercial bank needs to pay the central bank back 900?

The banks don’t owe that money to the central bank. The lendee they loan it to too obviously owe it to the banks.

kippy

Franz Von Peppercorn II wrote: »

The banks don’t owe that money to the central bank. The lendee they loan it to too obviously owe it to the banks.

So where do the banks owe the money too? Aren't there interbank lending rates?

Don't the EU central bank pump money into the economy via central banks etc?
Isn't the EU rate a key rate?

kippy

Franz Von Peppercorn II wrote: »

Most money isn’t created like this. The banks literally create money when a loan is issued.

This doesn't tie in with the narrative that comes from most bank in relation to rationale for interest rates.....

BDI

So in 40 years time(mortgage) there will be about 9 times the amount of money in the economy as there is now?

KyussB

This goes even further than what is discussed in the thread:
Reserves are not actually the limit on bank lending - that's called the 'money multiplier' theory - the reason it is not the limit, is because if banks overlend and end up short on reserves, and if they fail to borrow from other banks, then the central bank will never refuse to lend to the bank, as a last resort.

So, in practice, reserves are not the limit - the central bank will always facilitate a bank which overlends and can't shore up reserves on the interbank (getting loans from other banks) market.

The real limit is collateral requirements. The value of assets (e.g. houses) tied to loans. This is far looser and more murky than reserve requirements.

Basically what it means though, is that lending is not determined by central banks (known as the 'exogenous theory of money') - it is determined internaly by the performance of the economy (the 'endogenous theory of money').

Franz Von Peppercorn II

BDI wrote: »

So in 40 years time(mortgage) there will be about 9 times the amount of money in the economy as there is now?

Loans are being repaid back all the time. It’s not like we are starting the system right now with banks able to loan 9 times reserves. Most of that is already out there.

Franz Von Peppercorn II

kippy wrote: »

So where do the banks owe the money too? Aren't there interbank lending rates?

Don't the EU central bank pump money into the economy via central banks etc?
Isn't the EU rate a key rate?

1) The banks create the money for the loans they issue.
2) they don’t owe that to anyone. It’s new money.
3) they can also take loans out, like anybody else, from other banks.
4) they can also get loans from the CB. That’s rare though.

screamer

How do they create the money though? Create a loan yes, but the actual physical money they don’t create that. It has to be paid over to whoever is borrowing it, so I disagree that they create money. They create loans and fund them out of existing cash that people have on deposits which they basically take a punt on, that there won’t be a run on the bank with everyone looking for their money back. So create a savings account, it has a balance but the cash is gone, loaned out.

BDI

screamer wrote: »

How do they create the money though? Create a loan yes, but the actual physical money they don’t create that. It has to be paid over to whoever is borrowing it, so I disagree that they create money. They create loans and fund them out of existing cash that people have on deposits which they basically take a punt on, that there won’t be a run on the bank with everyone looking for their money back. So create a savings account, it has a balance but the cash is gone, loaned out.

That’s the point. Put all the money in the world on a calculator. For arguments sake say it’s 100.
There is only actually 10 in cash.

Franz Von Peppercorn II

screamer wrote: »

How do they create the money though? Create a loan yes, but the actual physical money they don’t create that. It has to be paid over to whoever is borrowing it, so I disagree that they create money. They create loans and fund them out of existing cash that people have on deposits which they basically take a punt on, that there won’t be a run on the bank with everyone looking for their money back. So create a savings account, it has a balance but the cash is gone, loaned out.

No they don’t use existing cash on deposit, although that’s what was often taught in school.

Junkyard Tom

There are people who self-identify on boards.ie as 'financiers' who decry the 'magic money tree' in political discussions as if money isn't created out of thin air.

The Central Bank of England shook the magic money tree in the wake of the 2008 downturn and it created half-a-trillion GBP.

moonage

Yes, when a loan is made the money comes into existence out of thin air.

It then has to be paid back with interest and if there is a default the house, car, business etc can be repossessed. What a con!

BDI

Junkyard Tom wrote: »

There are people who self-identify on boards.ie as 'financiers' who decry the 'magic money tree' in political discussions as if money isn't created out of thin air.

The Central Bank of England shook the magic money tree in the wake of the 2008 downturn and it created half-a-trillion GBP.

Yeah but it leads to devalue of the currency.