Do they? Reserve requirements are almost non-existent. A better way to put it is that banks pretty much have a state-granted privilege for creating money and in the form of loans.
In fact, reserve requirements became meaningless because banks had (and continue to have) so much more in reserves than they were ever required to have under the prior system.
If banks choose to keep lots of reserves (because you’re paying interest on them), it’s hard to change the willingness of banks to lend by changing the reserve requirement, right?
In economic terms, the supply of reserves is meeting the demand curve for reserves in an inelastic region.
So the Fed decided to announce a new approach; the so-called “ample reserves regime” where short term interest rate control would be achieved by administered rates rather than by the reserve requirements of the “limited reserves regime” that went before.
If this sounds very far from the quotidian business of deposit taking and loan making: that’s because it is.
Try this thought experiment. You and I are in a bar. We order drinks but oh no the bar's card machine is down and you don't have cash. No problem I'll lend you a tenner.
1) Am I a bank?
2) Did I first contact the state to check it was ok to create money in the form of a loan to you?
I go back to the bar on another day on my own. Oh no! Their card machine is down again! This time I don't have cash on me. No problem the barman sees me all the time I can have the drink this time and pay up when I next get there and either have cash or their card machine is working.
3) Are they a bank?
4) Did they first contact the state to check it was ok to create money in the form of a loan to me?
The answer to all these questions is obviously no. Credit is created throughout the economy at all levels and it is not a special function perculiar to banks.
A better example would be if you were in the bar alone, and had no money, and instead just wrote an IOU on a bit of paper with your contact details. If we lived in a mythical 100% trustful utopia, then the barman would just accept this as money and so would anyone else in future who the barman needed to pay for anything. But we obviously don't live in such a society so unfortunately no, not anyone can just create money!
The explainer videos I have seen are wildly wrong. I learned this stuff by reading the Basel accords [2], working with banking regulators and central bankers, working on banks' capital reserve models etc. That is to say I know how this actually works because I have been inside the sausage-making process for good or ill - I didn't learn it second-hand from someone who probably also learned it second-hand which is the feel I get from these videos.
Almost any time you see someone "explain" fractional reserve banking it is about 99% probably total bullshit. It's got to the point where "fractional reserve" is almost a trigger phrase for me - I know when I hear it that it is highly likely the speaker doesn't know what they are talking about. Almost like when you hear the word "fiat currency" you know it's very likely someone is going to try to shill you some crypto. An explanation which is not nonsense is here. [3] Fractional reserve banking means the bank doesn't need to keep the full amount of deposits in reserve, but can use some percentage to make loans. These loans are assets the bank has, but as with the example I gave above where you lend to a friend, no additional money is created in this process and when a bank does it, it's not fundamentally any different.
[1] You can find the definitions of M1 and M2 money and a good explanation of what's included in the definition of "money" here https://www.investopedia.com/terms/m/moneysupply.asp
[2] Which are not secret by the way - you don't have to be initiated into the templars or something to understand them. They are boring as all hell to read but otherwise reasonably understandable with a little bit of background https://www.bis.org/basel_framework/
[3] https://www.investopedia.com/terms/f/fractionalreservebankin...
>The fractional reserve banking process creates money that is inserted into the economy. When you deposit that $2,000, your bank might lend 10% of it to other customers, along with 10% from five other customers' accounts. This creates a loan of $1,000 for the customer needing a loan.
>The bank essentially created $1,000 and lent it to the borrower.
The above explanation was always my understanding. Is this a case of semantics?
When a bank gives someone a loan M1/M2 increases (unlike in your loan-between-friends example). The increase in "currency in circulation plus deposits" is the very thing that those numbers try to measure.
You can look at it either way; or indeed you can take a third view, the fractional reserve theory of money, which suggests that the banking system as a whole creates money in aggregate, but not individual banks.
All of these are theories with their adherents and none has yet been proven right or wrong. The only wrong position is a failure to acknowledge that discussion is still open on this point, or to believe that these are anything other than macroeconomic models.
> The only wrong position is a failure to acknowledge that discussion is still open on this point
Saying that bank lending doesn't increase M1/M2 money supply is wrong. I don't think that discussion is still open on that. It's just how those things are defined. That's the only thing that I asserted.
Right. That is the basic definition of the financial intermediation theory of money. It's actually a predominant view in the literature: for example, the Diamond-Dybvig model is based on the assumption that banks are not special as intermediaries; and it won the Nobel Prize for its authors in 2022.
If money supply is "currency in circulation plus deposits[, etc.]" how does bank lending not increase the "currency in circulation plus deposits[, etc.]" amount?
(Of course lending between friends doesn't: the $100 bill in circulation is the same as before and the friendly IOU is not a deposit nor included in the [, etc.]")
This is not, prima facie a bad theory, right? Go take a look at JP Morgan's balance sheet. The asset and liability sides of the sheet are basically loans and investments (on the asset side) plus deposits and outstanding debt (on the liability side), and these balance.
One may also say that turning up the heater doesn't increase the temperature of a room - because I open the window at the same time.
Anyway, my point was that saying that bank lending is like lending money to a friend and "You now have an asset (the loan) and your friend has a liability (the debt) and the amount of M1 or M2 money in supply has not changed." doesn't make sense.
M1 would change if it was defined as "currency in circulation plus debts between friends" and the "oh, but my friend would sell the debt to the central bank or whatever in the end so there is no change in money supply" argument seems goalpost moving. The original analogy doesn't work and bank lending does increase money supply everything else being equal.
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
Can you not see why there are some who would say "it is obviously wrong to suggest money has been created in the second case, but not the first" or indeed "in neither case has money been created"?
By the way, in case it is not obvious: the fact you don't have a compelling rationale to make me believe your description of the world, and I don't have a compelling rationale to convince you of my view of the world is why there are multiple competing theories.
I am not trying to tell you that you're wrong; just that you're not right.
I'm just claiming that saying that M2 money supply doesn't change in the second case is wrong because it has been defined to measure exactly that. Under the assumption that money has been created in the second case, but not the first - whether we find that obviously wrong or not is irrelevant.
> the fact you don't have a compelling rationale to make me believe your description of the world
I'm only trying to make you believe that the thing that seanhunter wrote is seems incompatible with his own definition of money supply which makes the bank loan situation different from the friend loan situation.
These are macro theories; they don't tell you anything at all about an individual loan - only aggregate behavior of the entire system.
The only think I've been repeating all along is that in your own example
On the one hand, you go to a friend and say "hey, can you lend me $100; I'll pay you back $105 in a year?" and your friend agrees.
On the other hand, your friend puts $100 into a 12 month CD, and the bank pays him a 2% interest rate. The bank then turns around and lends $100 to you as a 12 month personal loan with 5% APR.
In the second case, the friend has given the bank $100 and won't see it back for a year, and will then get $2 interest. The bank then lends you $100 which it won't see back for a year, and will then get $5 in interest.
The cases are economically the same; except in the second case, the bank takes the net interest margin of $3.
The second case, scaled up hugely, is observably what happens in the real world; it's not my theoretical construct. I refer you again to JP Morgan's balance sheet - the extent to which assets (mostly loans) exceed liabilities (mostly deposits) is simply the equity of the bank. That's the whole point of a balance sheet; it balances. If deposits exceed loans then, well, we saw what happens there, right?
You can't break half of the balance sheet off and say "look, these loans are increasing deposits at other banks; M2 has gone up"; that's literally meaningless.
But that's literally the definition of M2. You look at the currency in circulation, the deposits at banks and other things not present in that example and you add them up.
(I'm not sure why would you think that I'm not aware that the balance sheet of a bank is full of deposits and loans among other things, by the way. The whole discussion is about banks taking deposits and making loans!)
Yes, it creates credit that people think is money. I suspect that's a big problem with it. People think their money is in the bank. Instead the bank is just extending them some credit that they can pass on to others when they "purchase" something.
This says otherwise.
https://fred.stlouisfed.org/series/TOTRESNS
Lots more real evidence here https://fred.stlouisfed.org/categories/123
And in Canada, Australia, etc, they are zero:
* https://en.wikipedia.org/wiki/Reserve_requirement#Countries_...
"As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions."
It's not like banks suddenly loan out all the money. The Fed page has a FAQ and you can look up related papers.
From the FAQ: "For many years, reserve requirements played a central role in the implementation of monetary policy by creating a stable demand for reserves. In January 2019, the FOMC announced its intention to implement monetary policy in an ample reserves regime. Reserve requirements do not play a significant role in this operating framework."
People see the change, which is a good move for good reasons, and flip out, just like goldbug times or when CPI get adjusted and so on. A simple way to look at it for a long time there has been a idea battle between what's called endogenous and exogenous money creation (somewhat overview of the debate [1]), and over the past 50 years, most central banking systems have evolved as market needs evolved, to allow banks to lend beyond reserve requirements as long as they soon replenish, which was done via overnight lending windows through central banks. The practical effect is there has not been a "reserve requirement" except in name only for decades. Banks can lend whatever they want, and only have to borrow back to the old requirement which is simply an inefficiency.
This is summed up in one sentence on the Wikipedia article on reserve requirements as "Under this view, reserves therefore impose no constraints, as the deposit multiplier is simply, in the words of Kydland and Prescott (1990), a myth" [2]
Under the new system, the Fed changed other rates to account for this bookkeeping trick, with the same net effect on the banking system, but under simpler and more transparent accounting. They're not idiots.
So, since this was the reality of banking, the FED changed how things are tallied. Just like when CPI changed some terms to handle changes in reality, changes that were well documented, for good reason, people not reading carefully got upset and were sure they got cheated somehow.
So setting the old rate to zero and adopting the new methods for monetary control are the same pattern: terms change, in practice things are actually better off, but people used to the old term are upset and mischaracterize it as some a sign of financial calamity or underhandedness.
It's not. When people dig this out during an unrelated bank issue as some smoking gun it's worth stopping the nonsense in it's tracks in the same vein as COVID or climate or goldbug nonsense.
[1] https://www.sciencedirect.com/science/article/pii/S109094431...
When you decrease the reserve requirement, you're unlocking reserves that were previously locked up to back your deposits so that they can be loaned out to other customers, who will then promptly either directly or indirectly end up depositing their loaned amount into the banking system again, where the part that remains after the reserve requirement once again gets loaned out, deposited back in, etc.
In effect, because you're making this money go around, you're increasing the total supply of money, because these deposits are the money supply, and there can and often is more than a $1 net increase in overall deposits for each $1 deposited with a bank. Another way to state it is like so: you deposit $1, bank loans out $0.90, someone else deposits that $0.90, their bank loans out $0.81, so on and so forth for $10 of net deposit generation for a $1 initial deposit at 10% reserves held.
Of course, individual banks can elect to lock up more reserves than necessary, which would negate this effect.
Banks create money from nothing to lend out:
> Therefore, if you borrow £100 from the bank, and it credits your account with the amount, ‘new money’ has been created. It didn’t exist until it was credited to your account.
> This also means as you pay off the loan, the electronic money your bank created is ‘deleted’ – it no longer exists. You haven’t got richer or poorer. You might have less money in your bank account but your debts have gone down too. So essentially, banks create money, not wealth.
* https://www.bankofengland.co.uk/explainers/how-is-money-crea...
> This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
* https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
Money is a psychological construct of humans to facilitate trade and the exchange of goods and services. Some societies don't (didn't) even have money/currency: everyone kept a mental 'tally' of who gave or took things, and there were social expectations of giving "gifts" for repayment. Physical tokens (bones, shells, gold, paper, etc) came later.
This primer from the Bank of England is very clear: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...