Reply to post: Re: We already have this

Re: We already have this

Mike Bell,

You've mis-read that Wiki article, partly as it's very badly written. Particularly the table on lending. It also confuses bank capital and bank reserves. Banks are in fact regulated to maintain two main types of assets:

1. Cash (or very liquid) reserves - which is money they use every day to cover normal withdrawals, plus stuff they can access if there's a run on the bank.

2. Capital. This is money the bank owns (or its shareholders do). This is to cover losses on loans - so that even if say 5% of the people they've loaned to default, they can cover the losses without taking from savers' accounts. From memory minimum capital adequacy ratios in the UK are something like 7% - but the Bank of England stress tests last year meant you had to have over 10% to pass - and if you didn't you had to sell more shares or bonds to get there.

The thing that the loonies who don their tinfoil hats and scream about FRACTIONAL RESERVE BANKING fail to understand, is the bank balance sheet.

Banks aren't legally allowed to just loan money. They have to have it first. If you save £100,000 with the bank, there are 2 transactions in the bank's ledger. They get £100k of cash (an asset) and a £100k liability (the balance on your account). These match, so the bank's books balance.

Banks pay interest on cash on deposit (well not much at the moment...). This means that they must make a profit on that money, or they can't cover the interest. So they loan some of it to someone else at more interest than they're paying their savers. At that point they have created another 2 transactions, £90k of the £100k saved goes to someone else (debited from the cash ledger) and they gain a new asset - which is the loan to this person of £90k. The books now balance again.

Here's a simplified balance sheet:

CREDIT ------------- DEBIT

£10,000 ---------------------------- operating cash (part of deposit from person A)

£90,000 ---------------------------- mortgage debt owed by person B

--------------------------- £100,000 savings account balance (owed to person A)

£100,000 --------------£100,000 - totals balance

Some explanations get very confused by a couple of things. The counter-intuitive bit that if I've got cash in the bank then they have a corresponding liability in that they owe me that cash. And the rather weird terminology that gets used about money. Basically we use various definitions of money when talking about the money supply. Almost no-one uses M0, which is the actual notes and coins printed/minted by the government - most calculations for the purposes of dealing with inflation use M3 (there's M0, M1 to M5 each includes everything in the earlier ones, plus some extra). M1 includes bank current account deposits as money-equivalents, plus notes and coins not held in bank vaults (that Wiki article explains this badly). I can transfer cash out of my current account to someone else's in order to settle a debt - thus the bank has probably created some M1 money when it lends cash at the same time as holding an account for me. However this is complicated, as I'm unlikely to have all of my money in a current account if there's lots of it - savings accounts aren't measured in M1, plus banks also may borrow from the markets in order to lend (also in ways that don't add to M1). Finally the money they lend out won't all make its way back into banks as deposits in current accounts, and therefore will not all create M1 either. What "money" means in different circumstances is a very confusing topic all to itself...

The short version is, it's bloody complicated. But no, banks don't have a license to print money. They don't get the money they actually do "sort of print" anyway, because everything they do has to have an entry on both sides of their balance sheet. Plus money doesn't quite mean what it ought to mean.