Comment by nly
1 year ago
Your explanation of fractional reserve banking is somewhat correct, but missing the big picture
Licensed banks can and do write loans at any time without having any deposits to 'lend out'. In doing so they create both the loan (an asset) and a deposit (a liability) simultaneously from thin air. The books immediately balance.
The deposit created is then paid to the borrower and the liability vanishes. The bank is left with only the asset - the one that they created from thin air.
For short term liquidity a bank can always use the overnight lending facility at the central bank. Doing so just makes all their loans far less profitable as this is at a floating daily rate.
In reality the limit to which the money supply grows is not dictated by 'fractional reserves', but solely by interest rate policy and the commercial viability of being able to make loans and demand in the economy.
Not quite. The deposit is paid to the borrower as an advance, and the deposit is transferred to the payee (or the receiving bank if the payee is at another bank)
The liability can never vanish - balance sheets have to balance. Bank liabilities are what we call 'money'. Hence how you are 'in credit' at the bank.
And when we look at the bank assets which back those liabilities, we find that (say) 10% are government-printed money, and the remaining 90% were created by banks.
We don't. What we see is both of those are loans made.
Technically the commercial bank lends to the central bank. That's why they receive interest on it.
That's just a loan like all the other loans on the asset side. The difference is that the interest rate is set by the borrower not the lender.
Holding a deposit is just different name for a particular type of loan.
Not really:
The loan will be accounted to loan book and deposit book on the local(!) banking system level; if the money moves out of the bank, it has to go through central banking money circle - on this level, the loan amount is _NOT_ created, this account can be "filled" only with incoming transactions from other banks (customer deposits!) Thats the reason why a bank needs deposists: to make payments possible, since the number on the central banking account is always smaller than the number of all loans on the local banking system level.
You might want to read this paper from the Bank of England
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
Choice quote from page 1:
"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 deposit"
The part you are talking about is illustrated in Figure 2.
The transfer of central bank reserves between banks doesn't change the fact that once a loan is written new money enters circulation.