Comment by derriz | Hacker News Reader

Comment by derriz | Hacker News Reader

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The document you linked does not contradict my claim. Your document describes the role of banks in the M2 money supply NOT how individual banks work.

I can assure you that what I describe IS how real world banks work. You can look at the balance sheet of any retail bank and it will spell this out clearly. I've worked in retail banks and have some hands one grasp of their day to day operations.

Your confusion is a common one - you mistake the process that results in the creation of M2 money with the day-to-day operations of retail banking.

Modern retail banking is a very simple business - they borrow funds (from depositors, other banks, sometimes central banks, commercial loans, etc.) and then lend out the SAME funds while keeping some back in liquid assets (cash, deposits in central banks, short term government notes, etc.) in reserve. The trick is to charge more interest on what you lend out than you pay on what you borrow while managing the risk and cash flows involved when you have a mixture of terms (expiries) of borrowings and lendings.

I think I've given a reasonable summary in my posts of how banks work. I've studied the balance sheets of retail banks and have been exposed to their day to day operations so please don't simply disagree with me and point me to a document on M2 money creation - if you think I've stated something untrue, then highlight it and describe where I'm wrong.

Banks are not merely intermediaries between savers and borrowers. Loans create money, but only loans that are not used to repay other loans result in an increase to the money supply. The following text comes from an ING Bank research note, quoted by The Economist [1]:

"Banks do not view the creation of money as an objective itself. It is a by-product of the banking sector’s business operations. However, it is of great economic and social relevance.

Not every loan ultimately results in new money. The majority of new lending is used to redeem existing loans. Money is only created to the extent the gross lending exceeds the value of the existing loans being redeemed."

That note refers to the "great economic and social relevance" of these banking operations. Here's Professor Richard Werner talking about this at length. [2]

Here's Perry Mehrling (who teaches Coursera's Economics of Money and Banking) weighing in [3]. He explains that it's a nuanced issue but clearly agrees that the "credit creation view" is important and quotes a Group of 30 report:

“In a barter economy, there can rarely be investment without prior saving. However, in a world where a private bank’s liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet.”

[1] https://www.economist.com/buttonwoods-notebook/2014/06/11/wh...

[2] https://www.youtube.com/watch?v=N-FDdHj7rPk

[3] http://www.perrymehrling.com/2016/01/great-and-mighty-things...

Again banks' role in the creation of M2 money does not reflect how individual retail banks operate.

Just because you have a model that seems to describes the behavior of flock of birds doesn't mean that the model is useful when discussing the anatomy and wing-aerodynamics of individual birds.

You've posted a bunch of links describing the various forms of money and the role of banks in modern (post 18th century) M2 money creation. I know all of this material but it's not relevant to the operations of individual retail banks.

OK, so if each individual retail bank only lends out pre-existing, deposited funds, where does the increase in the money supply come from? Bear in mind that money created as a by-product of bank lending makes up the vast majority of the total money supply in various modern economies (97% in the UK [1]).

[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

The increase occurs because of the different definitions of money. If you define money as the sum of amounts available in demand account at banks (with is roughly what M2 is), then lending from a bank increases this number as the borrowed money ends up in the account of the borrower or in the accounts of the people the borrower spends the money with.

This fact means that retail banks "create money out of nothing" only when money is defined as the sum across all banks of the amounts available to customers on demand. No individual bank "creates money out of nothing", individually they borrow money and lend a fraction of it out; they have balance sheets which balance - i.e. ignoring shareholder equity, for every asset (money owed to them by a borrower), there must be a liability (money they owe to lenders including depositors). The M2 money supply counts the latter but does not deduct the former from the sum; as a result, the M2 money supply has a direct relationship with the total size of retail banking balance sheets.

M2 is an economic statistic and it's behavior tells you nothing about how individual banks operate.

OK, how does that gel with a report from S&P [1] that says:

“Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”?

Also Prof Werner's analysis, he reaches the same conclusion.

[1] http://positivemoney.org/2013/08/repeat-after-me-banks-can-n...

That statement is misleading or reflects a misunderstanding on the part of the author.

"Credit" is an accounting concept. Balance sheets are accounting artifacts. The way the bank records it's transactions is a model, not reality. For example, lots of intangibles can have accounting entries created for them for various purposes, but these don't create reality.

Btw, a big problem when discussing bank operations are that the terms "debit" and "credit" can be confusing as their roles are relative to the bank not the customer. Even "asset" and "liability" can be confusing. An Irish media finance and economics professor, Brian Lucey, mixed them up and suggested that a troubled bank could be fixed if it sold its deposits which is impossible - deposits are a liability for banks, not an asset.

Reality is much more simple. Bank lending starts when a customer asks for a loan. Assuming the loan application meets all risk requirements, etc. AND sufficient funds (reserves) are available on the bank's balance sheet, the loan can be issued and the funds transfered to the customer. Reserves are reduced as part of this process but an asset is created for the bank (the loan) so the balance sheet remains the same size.

>> the funds transfered to the customer

Well, that's the crux of it right there. You are disagreeing with several authoritative sources who say that no such transfer happens, and in general the loaned funds are created out of thin air.

Standard & Poor's: “Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard)”

Group of 30: "... banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet."

Richard Werner: "...each individual bank creates credit and money newly when granting a bank loan."

Banks are subject to constraints. They need to retain enough capital to absorb losses on their loan book, and they need to retain enough reserves to cover withdrawals and clearing requirements. They are free to create money "out of thin air" insofar as they meet regulatory requirements associated with those constraints. [1]

You wrote: "I've worked in retail banks and have some hands one (sic) grasp of their day to day operations."

I suggest that your experience does not encompass the whole sector, and that may be the source of your confusion.

[1] https://www.goodreads.com/book/show/13144133-where-does-mone...

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