The baking system as a whole is leveraged about 9:1 based on the previous example. A bank deposit is a bank deposit, regardless of which bank it is at.
"if the banking system as a whole has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the system banking as a whole can make $10 million in loans" [and there will be in the end $11m in deposits in the banking system as a whole, offsetting the $1m in reserves and $10m in loans]
You said
"if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans" [which is wrong unless you assume that every loan remains in that bank as a deposit so the “banking system as a whole” case is recovered]
Of course that bank could get more reserves to be able to make additional loans. But then it could lend much more than $10m if it gets enough deposits/reserves! [One bank =/= The banking system as a whole]
Edit: by the way, I’m curious what is the thing in my previous comment that you find “simply wrong”.
It doesn't help that you're conflating the terms "deposits" and "reserves". Deposits are liabilities of the bank, while reserves are assets held in their account at the central bank.
If the banking system as a whole is leveraged 9:1, that implies each individual bank is leveraged approximately 9:1.
Liabilities : deposit $1m
Assets : reserves $1m
Liabilities : deposit $1m
Assets : reserves $100k, loan $900k
Say you get an additional million in deposits, your bank has now
Liabilities : deposits $2m
Assets : reserves $1.1m, loan $900k
Alternatively, it could get funding from another source like borrowing from banks of issuing bonds. For example
Liabilities : deposit $1m, bond $1m
Assets : reserves $1.1m, loan $900k
> If the banking system as a whole is leveraged 9:1, that implies each individual bank is leveraged approximately 9:1.
One of the main points of the paper under discussion is that this doesn’t happen. Reserves are not a binding constraint on lending.
[0] I don’t know if it makes much sense to talk about whether it is “actual cash”. Maybe my employer took a loan to pay me, maybe not. Maybe it was in cash, maybe by cheque, maybe by bank transfer. Would that change anything?
Only Central Bank reserves and cash are considered "money" in this system. And I'm saying the "money" is leveraged 9:1 in our toy example, whereas you seem to be saying assets must always be greater than liabilities - which obviously I agree with. Since if they weren't, the bank would be insolvent.
"if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans"
What I say is that it can only make more that $900k in loans _if_ the deposits held at the bank grow above $1m. Which doesn’t normally happen when lending because the most likely outcome is that the borrower takes the money out of the bank.
The reserves of the bank go down in that case, don’t you agree? They are just $100k after the $900k loan is made (and transferred away). $100k are the minimal reserves required when a bank has $1m in deposits.
Again, an individual bank is not the same as the banking system as a whole.
And I don’t quite get your remark about reserves. What I called “reserves” could be entirely held at the central bank (or in the vaults!) if the bank wanted to. Do you have an issue with those balance sheets?
My only point was individual banks, can lend up to whatever the reserve requirement is. If it was 10%, $1M in reserves at the central bank means the bank can could make $10M worth of loans. Do we disagree on this point?
It seems like we're arguing about what is actually money.
I agree that bank can lend up to whatever the reserve requirement is. But the next sentence is extremely misleading at best.
For that bank with $1m in deposits and $1m in reserves before any lending that 10% requirement means that it can not let its reserves go below 100k (10% times $1m in deposits) so it can only lend up to $900k out.
I can agree if you say "the bank can make $9m worth of loans provided that the recipients of the loans never get them of the bank [and it ends with $10m in deposits]". That is reasonable (even approximatively true) for the banking system as a whole but is a ridiculous implicit assumption for an individual bank.
I would also agree if you said "a bank with $10m in deposits needs to have at least $1m in reserves".
The bank can make $9m worth of loans (actually the bank can make any amount of loans, maybe even more), and some proportion of that may be transferred to other banks as reserves, and some other reserves will be transferred onto the banks balance sheet from unrelated transactions the bank makes. Then at the end of the day if the bank needs more reserves, it borrows them. The likely amount the bank needs to borrow based on the loans it makes and the cost of that reserve borrowing determines how many loans it will make. If it wouldn’t be profitable to make more, it’ll stop.
At no point does the bank only make 900k of loans so that it is fully covered in case all its loans are transferred out. The whole thesis of the paper is that that way of thinking is backwards.
The amount of reserves can (and will) go up and down for an individual bank as it operates depending on their strategy.
10x the initial reserves has no particular meaning for an individual bank, only for the whole system (and the whole thesis of the paper is that even then the 10x number doesn't really matter).
To go back to your previous point
> For that bank with $1m in deposits and $1m in reserves before any lending that 10% requirement means that it can not let its reserves go below 100k (10% times $1m in deposits) so it can only lend up to $900k out
This just doesn’t make any sense. The whole point of the reserve requirement is to guard against the risk that depositors will withdraw enough money at once to deplete the reserves. The bank needs to meet the reserve requirement of deposits on its balance sheet, not a theoretical future balance sheet. You’re explaining it as if the reserve requirement applies after the theoretical worst possible bank run occurs.
Say the debtor moves all their money to another bank as per your example. Now the bank has 1m deposits and 100k reserves. Now those other depositors also move 100k to another bank, so the bank has no reserves. Uh oh - making that 900k loan actually allowed the banks reserves to drop below the requirement in this theoretical eventuality!
Does that mean the bank shouldn’t have made the loan? No, because the reserve requirement applies to their current balance sheet. When the bank had 1m deposits and 1m reserves, it could make 9m loans. At this point it has 10% reserved (designed to guard against the eventuality that those debtors all withdraw their money). If the bank makes 900k loans and they are withdrawn, it has 1m deposits and 0.1m reserves. It is now in exactly the same situation as the previous example (scaled down). The bank doesn’t need to wait for this unlikely event to happen to allow its reserves to drop to 10%, it can just make the extra loans in the first place.
> This just doesn’t make any sense. The whole point of the reserve requirement is to guard against the risk that depositors will withdraw enough money at once to deplete the reserves. The bank needs to meet the reserve requirement of deposits on its balance sheet, not a theoretical future balance sheet.
What part doesn't make sense precisely?
A) The bank has $1m in deposits
B) It has to meet the reserve requirement (10%) for the deposits in its balance sheet ($1m)
C) The reserve requirement is $100k
D) The rest are excess reserves
The balance sheet looks like this:
Assets Liabilities
$100k Required reserves $1m Deposits
$900k Excess reserves
Sure, this is the balance sheet now:
Assets Liabilities
$100k Required reserves $1m Deposits
$900k Loans
That's the whole point of fractional reserve! You have enough reserves to cover a fraction of the deposits amount. If the bank has no excess reserves it will be in breach as soon as some depositor decides to get some of their money back and it will need to get more reserves to remain in compliance.
> The bank doesn’t need to wait for this unlikely event to happen to allow its reserves to drop to 10%, it can just make the extra loans in the first place.
The unlikely event that the people who take loans sends the money elsewhere? What would be unlikely is that they didn't.
Yes exactly, by making 9m loans, the bank has a fraction (10%) of reserves to cover the deposit amount (10m).
> The unlikely event that the people who take loans sends the money elsewhere? What would be unlikely is that they didn't.
You are assuming that 100% of deposits created by loans will be immediately withdrawn. The thing that doesn’t make sense is that you’re treating deposits created from debt as special. The bank needs reserves of 10% of all its deposits.
Why are you considering the eventuality that the loan holder buys something but not that the saver buys something? They are both equally irrelevant as they are eventualities factored into the 10% requirement.
Say there is only one current account holder at the bank with 1m savings. Then the bank gives that customer a 900k loan. Now the customer buys a house. Why do you assume the house will cost 900k? They might buy a 1.2m house, in which case the bank is stuffed, as it only has 1m reserves. There is nothing special about the 900k.
Because people take loans for something? It could be to invest, definitely not to keep it untouched in a current account.
Do you know of a single case of someone who took a loan for the sake of it, leaving the deposit created untouched at the lending bank, and paying interests for the privilege of having that deposit?
(The eventuality that the saver buys something is why banks keep reserves, with minimums set by regulators in some countries. To allow for a fraction of those depositors to buy something without the whole setup collapsing immediately.)
Edit: and for what it's worth, this "eventuality" is also seen as a basic scenario in the paper under discussion. That's what Figure 2 is about:
"The house buyer takes out a mortgage... ...and uses its new deposits to pay the house seller."
"The mortgage lender creates new deposits... ...which are transferred to the seller’s bank, along with reserves, which the buyer’s bank uses to settle the transaction. But settling all transactions in this way would be unsustainable: [...] the buyer’s bank will in practice seek to attract or retain new deposits (and reserves) [...] to accompany their new loans."
The whole premise of the paper seems to be that this way of thinking is backwards (in terms of the order and causality of events) and not really relevant to modern banking.
Another toy example - there are two banks in the banking system with 1m deposits and reserves, and they are let loose making loans at the same time. Why would they only create 900k of loans? The situation is symmetrical, they can expect the net reserve transfer between them to be small if they make similar amounts of loans. In what way is the 10% reserve requirement limiting them to making 900k of loans in this scenario?
As for the other question, it's clear from the beginning that things can be said about the banking system that are not necessarily true for any individual bank. That paper says as much "Figure 1 showed how, for the aggregate banking sector, loans are initially created with matching deposits. But that does not mean that any given individual bank can freely lend and create money without limit."
So long!
Ok, then this is NOT how it works -> "if a bank has $1 million in deposits the bank can make $10 million in loans"
I can agree with either of the following formulations:
"if a bank has $1 million in deposits the bank can make $10 million in loans as long as the loans remain as deposits in the bank"
"if a bank has $1 million in deposits the bank can make loans for any amount that it wants as long is it can comply with the reserve requirements"
"Reserve Requirement Example As an example, assume a bank had $200 million in deposits and is required to hold 10%. The bank is now allowed to lend out $180 million, which drastically increases bank credit. In addition to providing a buffer against bank runs and a layer of liquidity, reserve requirements are also used as a monetary tool by the Federal Reserve. By increasing the reserve requirement, the Federal Reserve is essentially taking money out of the money supply and increasing the cost of credit. Lowering the reserve requirement pumps money into the economy by giving banks excess reserves, which promotes the expansion of bank credit and lowers rates."
Do, by all means, double check this. It's been quite a while since my studies so I had to work this out on the fly. I am generally more comfortable researching what I think I know then going over it again, and again, and again...... But I'm pretty sure that's right. It's in that deposits are liabilities and loans are assets things where, in working it through, I got that "oh!" moment.
It is an interesting thing, though. Because if you unwound all the deposits and all the loans in the economy, there would be no money in the money supply. All of it is dependent on loans and the money supply grows in response to the economy increasing. As the economy increases, there is a demand for more money. That demand results in more loans that results in an ever increasing supply of money.
It still weirds me out. But then, I do engineering, not money.