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| Source: Jalopnik |
What I love about Nick Rowe? His analogies. This is from Bank runs, keynesian multipliers, monetarist cold potatoes at Worthwhile Canadian Iniative:
Car banks. Suppose the Jalopnik devil waved a wand and made cars a fungible asset. All cars are suddenly identical, and will always be identical. Car banks spring up. You give your car to the car bank. In return, the car bank pays you rent/interest, and promises to pay you one car on demand. Since most of the time most people don't need a car, car banks become fractional reserve car banks. There's no profit in having cars sit idle. Owning the bank's promise to pay you one car on demand is as good as owning a car, provided the bank can always deliver on that promise.
I read that, I know we're talking about money and banking. But it helps to think of it in terms of cars. It's like seeing with fresh eyes. But here's something:
Since most of the time most people don't need a car, car banks become fractional reserve car banks. There's no profit in having cars sit idle.
That's the "loanable funds" thing. The car bank gets to loan out the cars to other drivers because it *has* the cars, because we deposited them in the car bank.
Yeah, it works with cars. It works with cars, because a bank cannot create a new car simply by lending it out. It has to actually have a car before it can lend it. That's not true for money. Banks create money by lending it out. (Actually I'm starting to mull that one over. But I'm not ready to talk about it yet.)
Banks create money by lending it out, so they don't need to get our deposits in order to lend. I understand that.
So I have to ask, again: Why do banks want our deposits?
12 comments:
Thanks Arthur!
Compare these two imaginary quotes.
"Banks don't lend reserves! Because when one bank makes a loan and has less reserves as a result, those reserves don't disappear from the system. They just end up being held by another bank."
"People don't lend money! Because when one person makes a loan and has less money as a result, that money doesn't disappear from the system. It just ends up being held by another person."
Okay, the second one ("people don't lend money") is obviously false. ("Obviously" after about three readings.)
And reserves are to banks as deposits are to people so I'm thinking we think the first one ("banks don't lend reserves") is similarly false.
But I don't think that's the argument that is made by the accounting-types. I think they say the money banks lend is newly created by the act of lending. And they say reserves have nothing to do with it; I have a lot of trouble with that.
But it's all quite confusing to me. If a bank creates money by lending, can that money then become reserves by being deposited with the Fed? I don't see why not... but this is the kind of feedback that should make a lot of noise in our economy, and I don't think we hear that noise.
And (as I ask in the post) what good are deposits to banks if they can't make money by lending them out? All quite confusing to me.
Thank you Nick.
Arthur: " I think they say the money banks lend is newly created by the act of lending."
They do say that. But it isn't strictly speaking correct. If a bank makes a loan by lending central bank currency, for example, that doesn't create money. And if a bank buys a computer, by writing a cheque drawn on itself, which the computer seller then deposits in his account, then they have created money without making a loan. If the bank simply adds $100 to the chequing account of its favourite charity, as a gift, that bank has created money.
Creating money creates money.
The big difference between a car bank and a real bank is that you can't drive an IOU for one car.
So I have to ask, again: Why do banks want our deposits?
When you move a deposit from bank A to bank B, final settlement of that transaction involves a transfer of reserves from A to B.
Generally speaking, this is a less costly way for bank B to obtain additional reserves from other banks than going to the federal funds market to borrow them from other banks.
When rates were higher, it was a lot cheaper so you might even get a free toaster.
But it's all quite confusing to me. If a bank creates money by lending, can that money then become reserves by being deposited with the Fed?
When a bank creates deposits through lending, it is not creating reserves. It is writing IOUs for reserves. The exact same way writing personal checks creates IOUs for deposits.
Even though I can create checks I can't just write them and take them to the bank to increase my deposits. If I want more deposits I have to obtain them from someone else.
Banks create deposits when they lend but when they want more reserves they can't just take those deposits to the fed to increase their reserves. They have to obtain those reserves from someone else. Avenues for obtaining reserves include selling assets to the central bank, borrowing from the central bank, borrowing from other banks, receiving from other banks in settlement of deposit transactions.
Another way to think about it...
If you go to the bank for a mortgage, whose account gets debited when the bank credits the deposit to be transferred to the seller?
If banks lend out other people's money, then just whose money is being lent out? When two non-banks lend money, one most literally give up their dollars for a period of time.
When a bank creates a deposit through lending, no other deposits are affected.
Nick wrote:
"if a bank buys a computer, by writing a cheque drawn on itself, which the computer seller then deposits in his account then they have created money without making a loan."
In order to do that (legally) the bank has to first earn that money by taking interest or fees from some depositors account. When a bank loan is made no money is taken from any depositors account.
"if a bank buys a computer, by writing a cheque drawn on itself, which the computer seller then deposits in his account then they have created money without making a loan."
NOw this depends doesn't it? Lets assume that Chase has no excess reserves above that required by law:
Lets say that Chase wants to buy some computers from Dell for $1 million.
If Dell banks at Chase, then Chase simply credits Dell's account. These are brand new bank deposits that Chase didn't get from somewhere else. Now since Chase created $1 million in new deposits on its balance sheet, it would have to acquire $100,000 in reserves from the Federal Funds market to cover the legal RR.
Now if Dell banks at BofA, then Chase would have to transfer $1 million in reserves to BofA to clear its check to Dell as BofA doesnt accept Chase money, only Govt money for clearing.
If a banks operational spending is viewed as creating money then a banks operational earnings must likewise be viewed as destroying money.
If a bank's operational creation of money exceeds its operational destruction of money on a chronic basis, the regulators will declare the bank insolvent and shut it down.
To be allowed to operate the bank must consistently destroy more money than it creates by its operational expenditures and receipts.
Jim:
"If a banks operational spending is viewed as creating money then a banks operational earnings must likewise be viewed as destroying money."
You describing the situation too broadly. When a bank transacts with its own customers, then clearly its creating money via crediting that bank account. But this is not true when it buys goods and services from people that bank elsewhere.
Chase bank is clearing its own Chase bank checks to its own Chase bank customers. No reserves are transferred at the time of the transaction. Chase must only acquire 10% worth of reserves over the two week Lag RR enforcement window.
Loans create deposits, not reserves.
Reserves at commercial banks consist of deposit accounts with Federal Reserve Banks and vault cash.
http://www.federalreserve.gov/monetarypolicy/reservereq.htm
Art
‘Loans Create Deposits’ – in Context
http://monetaryrealism.com/loans-create-deposits-in-context/
This explanation in the link may help sort out these issues.
From the post
"There is potential for confusion if ‘loans create deposits’ is embraced too enthusiastically as the defining characteristic, without considering the full life cycle of loans and deposits. Indeed, we shall see further below that ‘deposits fund loans’ is as true as ‘loans create deposits’ and that there is no contradiction between these two things."
Hope this helps in sorting this out.
Banks need deposits to fund loans only because the regulatory system imposes that constraint (by fiat).
Sen William Proxmire got Congress to strengthen that constraint in 1977 with the Community Reinvestment Act (CRA). This was in response to the fact that in the 50's and 60's deposit taking institutions were routinely taking deposits in urban blue collar neighborhoods and making most of the credit that those loans "funded" available to suburban white collar neighborhoods (where the bankers happened to live). If a banker is allowed to take deposits in one community and make loans in another, then the bank becomes a mechanism for systematically transferring wealth from the pockets of the depositors into the pockets of the bankers (or their country club buddies) and the bank charter becomes nothing but a license to steal.
CRA requires regulators to rate deposit taking institutions on how good a job they do in lending back to the same community from which the bank gets deposits because without regulatory system imposing the requirements for meeting the "convenience and needs" of depositors the banks have no real interest in the financial welfare of depositors or any real need for their deposits.
Glass–Steagall was another law founded on the understanding that deposits are a flow into banks and loans are a flow out of banks and the pump that generates the flow is bank lending and without careful regulation of lending that pump will not be used for public purpose but will be used to inflate the banking system.
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