Comment by dghlsakjg
3 days ago
That’s not how banking works. Banks cannot lend “10–100× their assets.” Loans are assets. Deposits are liabilities. What limits lending is capital, not reserves, and leverage is tightly regulated at roughly 10× equity, not 100×.
The interest math is wrong too. Banks pay interest on deposits, absorb defaults, cover operating costs, hold capital, and meet liquidity rules. Net margins are about 1–3%, not 50–500%.
Fractional reserve banking does not mean infinite money or risk free profit. It means deposits are not 100% cash backed (because they have loaned out a portion of your deposit).
This is a popular myth, not “doing the math”.
What you’re describing only works in an absurd edge case where people borrow money just to park it and pay interest without spending it. That’s not fractional reserve banking, that’s a broken thought experiment.
> What limits lending is capital, not reserves, and leverage is tightly regulated at roughly 10× equity, not 100×.
I'm with you in principle. But alas there's lots of regulation that muddies the economic waters. Eg reserves do limit lending in some places at some points in time.
> What you’re describing only works in an absurd edge case where people borrow money just to park it and pay interest without spending it. That’s not fractional reserve banking, that’s a broken thought experiment.
Yes, indeed. People usually get a loan to spend the money (ie invest it). Otherwise, why bother with the expensive loan?
It can be difficult to figure out whether the theoretical limit is 10x or 100x in my mind because there isn't a reserve ratio federally (well, there is one, but it's zero) , and the other regulations surrounding that aren't so cleanly understood in a neat formula.
Extremely simplified:
When I deposit a dollar, the bank records a $1 deposit liability. If the bank makes a $1 loan, it creates a new $1 deposit for the borrower.
If that dollar is spent and redeposited, deposits increase even though the amount of base money has not. It looks like multiplication, but what’s really happening is that loans and deposits are expanding together on the balance sheet.
The bank is not creating wealth out of nothing. It now has matching assets (loans owed to it) and liabilities (deposits owed to customers), backed by capital that absorbs risk.
With reserve ratios effectively zero, lending is constrained by capital requirements and risk management, not by reserves. Banks cannot recirculate a single dollar endlessly without sufficient capital.
The bank of England has some incredible articles that explain this that have been circulated on HN before. Really fantastic reading for those wanting to understand the mechanics.
https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...
They don't create wealth out of nothing. They capture, and potentially create, wealth by offering financial services including lending. The differences between the positive interest paid to depositors and the loan interest, after covering risk and other costs, is the wealth they've captured/created for themselves.
I don't think anyone is under the illusion that credit expansion itself creates wealth in the sense of more dollars moving around means more wealth.
I think the relavent point here is that this form of credit expansion does expand the numerical value of deposits ("create money") which has asymmetric advantages to the bank. Due to having a central bank, the banks are basically acting as arms of the federal government when they do this. The payoff the banks get from this is capturing the interest differential on these expanded credits as well as benefitting from the Cantillon Effect whereby they usually have prioritized access to new money entering the economy.
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Reserves matter even if reserve ratios are zero. If Bank A lends too much money, then when its customers spend that money, a lot of it will end up deposited at other banks. These banks will then ask Bank A for reserves (as in, central bank money) to clear the inter-bank transfers, which Bank A will need to borrow from the central bank, at a cost.
> It can be difficult to figure out whether the theoretical limit is 10x or 100x in my mind because there isn't a reserve ratio federally (well, there is one, but it's zero)
I know what you're thinking of here, but it doesn't mean anything like what you think it means.
So the US used to have a rule that every bank hand to have a certain percentage of its assets stored in its account at a Federal Reserve bank; it is this percentage which was gradually reduced to 0 by I think 2020. Note that only the funds in that account meet the requirement; a literal pile of cash contributes not a single cent.
The way banks are primarily limited nowadays is via capital adequacy ratio, which is essentially that you need to set aside a particular pile of capital that can be raided to guard against assets falling in value to 0. It's complicated because this pile of capital doesn't come from the money a customer deposits in their account (which needs to be held as an asset to offset the liability a depositor represents), but rather from income the bank makes in other ways. If a bank sells $1 million worth of shares, they get to issue ~$20 million more loans.
If a bank gets $1 million worth of new deposits, they get to issue... $0 more loans. Well, maybe less: if a bank gets $1 million worth of new bitcoin deposits, that probably reduces its capital ratio because bitcoin is such a risky asset.
>If a bank gets $1 million worth of new deposits, they get to issue... $0 more loans.
Then it doesn't make sense for a classical deposit-lending bank to pay interest on those new deposits. They can't generate revenue from the new deposits since they cannot touch them to perform lending , and they are now a liability because they must perform banking services to the depositor, regulatory compliance, and insure against the risk something accidently happens to the money. Under your scheme maybe they could go park it at the fed and get interest that way but even that is technically a loan; they are giving up the notional money in exchange for interest in hopes they can collect it at a later time.
Lots of places, eg Canada, never had a legally mandated reserve ratio.
Fractional reserve banking has economic limits, even when there are no legal limits.