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A simple explanation of how money moves around the banking system (2013)

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Re: A simple explanation of how money moves around the banking system (2013)

#11

Post by mgraczyk »

tibanne wrote: post #8
mgraczyk wrote: post #7

Earlier quoted context omitted.

This used to be true, but hasn't mattered for a long time. The reserve requirement is zero for most (all?) US banks. https://www.federalreserve.gov/monetarypolicy/reservereq.htm

Strange that private companies are allowed to create money from nothing don't you think?

It's strange if you have a particular conception of money. If you think of money as a social technology used to improve aggregate well being, then it's just a property that empirically makes sense. Private banking, with effective regulation, has proven to be a fairly effective way to stabilize the business cycle and unblock growth

Re: A simple explanation of how money moves around the banking system (2013)

#12

Post by mgraczyk »

NovemberWhiskey wrote: post #10
mgraczyk wrote: post #7

Earlier quoted context omitted.

This used to be true, but hasn't mattered for a long time. The reserve requirement is zero for most (all?) US banks. https://www.federalreserve.gov/monetarypolicy/reservereq.htm

It doesn't matter because no banks have been anywhere near the reserve requirements that were previously in effect. The change to the "ample reserves" regime is just a tacit admission that lending is not functionally limited by reserve ratios in the U.S. at the moment.

Yep that's what I meant by "hasn't mattered for a long time".

Re: A simple explanation of how money moves around the banking system (2013)

#14

Post by OscarCunningham »

User23 wrote: post #3
marcodiego wrote: post #2

The simplest explanation: - You invest in the bank - The bank loans your money to someone else at high interest rate - The bank gets paid, keeps most of the profit and uses a small part of it for your investment.

Simple, but completely wrong. The bank never loans your money. When it wants to originate a loan it creates new deposits from nothing.

Except that the people who are loaned money withdraw it pretty quickly, and then the bank does need cash from deposits (or from inter-bank lending, but the net amount of that is zero).

Re: A simple explanation of how money moves around the banking system (2013)

#15

Post by irq-1 »

_n_b_ wrote: post #13

If this genre appeals to you, the Bits About Money newsletter ( https://bam.kalzumeus.com/archive/ ) has a lot more content along these general "how finance really works" themes. The article about mortgages, in particular, is great.

FYI Bits About Money is by HN user https://news.ycombinator.com/user?id=patio11

Re: A simple explanation of how money moves around the banking system (2013)

#16

Post by NovemberWhiskey »

mgraczyk wrote: post #12
NovemberWhiskey wrote: post #10

Earlier quoted context omitted.

It doesn't matter because no banks have been anywhere near the reserve requirements that were previously in effect. The change to the "ample reserves" regime is just a tacit admission that lending is not functionally limited by reserve ratios in the U.S. at the moment.

Yep that's what I meant by "hasn't mattered for a long time".

I'm sure you know, but (based on discussions that took place at the time of the announcement back in 2020) I know a lot of people who leapt directly to the assumption that the removal of the reserve requirement was so that banks could "create even more money out of thin air than they were previously allowed to do".

I hope you don't mind me clearing that misconception up, even if it's not for your benefit!

Re: A simple explanation of how money moves around the banking system (2013)

#17

Post by metadat »

User23 wrote: post #3
marcodiego wrote: post #2

The simplest explanation: - You invest in the bank - The bank loans your money to someone else at high interest rate - The bank gets paid, keeps most of the profit and uses a small part of it for your investment.

Simple, but completely wrong. The bank never loans your money. When it wants to originate a loan it creates new deposits from nothing.

The reality is actually significantly worse than what parent comment posits. Money gets created out of thin air frequently in banking, it's quite the scheme / sham.

Learning more about how the financial system works is usually upsetting, and in surprising ways. The entire business has a certain ring and scumbag scent to it.

Re: A simple explanation of how money moves around the banking system (2013)

#18

Post by SilasX »

howeyc wrote: post #9
tibanne wrote: post #8

Earlier quoted context omitted.

Strange that private companies are allowed to create money from nothing don't you think?

That's how it has been for a while, as the bank of England paper explains. The key is that the bank is "on the hook" for being able to get that money back eventually. So they don't just loan indiscriminately.

But “eventually” can mean “now, as an easy loan from the central bank/lender of last resort”, which trust the solvency of the bank’s loans.

Re: A simple explanation of how money moves around the banking system (2013)

#19

Post by RobertoG »

NovemberWhiskey wrote: post #6
User23 wrote: post #3

Earlier quoted context omitted.

Simple, but completely wrong. The bank never loans your money. When it wants to originate a loan it creates new deposits from nothing.

That is not how fractional reserve banking works, people - or, to me at least, it gives a wrong impression. Say we are in a fractional reserve banking system, where the required reserve is 10%. I deposit $1M at the bank. My bank can now lend $900K to you. You can now deposit $900K back at your bank. Your bank can now lend $810K to someone else, and so on and so on. The geometric sum of this is "1/reserve_ratio"; so i…

That's not how it works.

Banks lend and then try to find reserves, after the fact, because they have legal requirements. No bank loss a good lending business because they have not reserves enough.

When a bank make a loan, there are two possibilities: they have enough reserves, then they don't need to do anything.

Or they don't have enough reserves, so they have to borrow them from other banks or from the central bank.

If they borrow them from other banks they are creating demand for reserves in the inter-bank market. That makes the interest rate go up.

The central banks don't try to control the quantity of money, but the interest rate. If there are a lot of demand for reserves and the Central Bank don't add reserves to the system the interest rate will go up. So, the Central Bank add or retire reserves in order to keep the interest rate in the range they want.

The quantity of money is decided by the demand of lending in the economy.

The Central Bank can choose to try to control the quantity of money or the interest rate, but not both. All modern Central Banks try to control the interest rate.

Re: A simple explanation of how money moves around the banking system (2013)

#20

Post by hgomersall »

howeyc wrote: post #9
tibanne wrote: post #8

Earlier quoted context omitted.

Strange that private companies are allowed to create money from nothing don't you think?

That's how it has been for a while, as the bank of England paper explains. The key is that the bank is "on the hook" for being able to get that money back eventually. So they don't just loan indiscriminately.

"On the hook" right up until the point they're about to go bust, then they hand over responsibility to the government to rescue them from their rampant speculation.
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