FTX tapped into customer accounts to fund risky bets, setting up its downfall

The answer seems to be “a few business days, usually next next business day” but that likely won’t appease the tinfoil hat crowd. https://www.fdic.gov/consumers/consumer/news/cnfall14/miscon...

> The first operation ("writing a number on a computer") can occur regardless of how much money the bank has. But if operation 2 is not possible, then the number that was created in operation 1 is de facto not money. Remember, we're arguing whether the bank needs to have physical banknotes and central bank reserves in order to "create money" when originating a loan. We're not arguing about whether the bank can type in random numbers on a computer - on that point we are already in agreement. The disagreement concerns whether/when those numbers can be considered to be "money".

I agree that money is a very ambiguous (and probably not very helpful) term, but insofar as we can consider the M1 money supply measure to be the quantity of money available in the economy at any given point in time (which is what the BoE paper is referring to when it says "money creation"), originating loans definitely creates money[0]. When you get a loan, the money lands in your demand deposit account, it's definitely "money" according to the definition of money being used in the BoE paper.

>> All "money" is simply an accounting entry. > Excluding physical banknotes, yes that is true

Minor point but I would include notes and coins as "entries" in the same accounting system, in the same way as receipts, invoices or cheques. Not really critical to the conversation though ...

> but you are implying the reverse of that statement to be true and it's not true at all: all accounting entries are not "money". If I open an excel sheet right now and type in "99999999", that is an accounting entry, but it is not money.

Well, they sort of are. I mean, any liability denominated in the state's unit of account is, in some way, money. This is the crux of Minsky's "Heirarchy of Money"[0]

For Minsky, there is nothing special or elusive about money. In fact, he says, "everyone can create money; the problem is to get it accepted" (1986, p. 228)[1]

> Likewise, if a troubled bank has completely ran out of capital and is not supported by structures like the FDIC, and it proceeds to type in "9999999" as an accounting entry for the account balance of the chairman's wife, that is not "money". The chairman's wife will not be able to exchange it to goods and services - hence, it is not "money".

Right, but banks are supported by those structures. That's what makes them banks. As we saw in 2008, the government went to extroardinary lengths to insure that even the most recklessly issued loans didn't result in banks becoming insolvent. Bill Black is definitely worth a listen to on this topic[2].

>> Follow-up question: ... Nope, that is not an example of a bank issuing an infinite amount of money while having literally zero money in reserves. That is an example of a bank which has >16M in reserves, then issuing loans for 16M. Nothing weird about that

Well, we don't really know what the reserve position of that bank was, and $16m was probably a relatively small amount relative to the overall capital position, but this is definitely an example of someone going outside of what would be considered normally regulated procedure (regulation being the only thing that separates "good" loans from "bad" loans) for personal gain which is why I thought it was relevant to your point.

>> But let's imagine that a bank did attempt to operate without any settlement balances ... No, the central bank would NOT provide a loan in this outrageous, obviously fraudulent instance. Again, you're claiming this to be possible, but it has never happened.

When a bank receives its license, it can immediately start both taking deposits and issuing loans. Banks lend money to each other all the time, and most loans from the central bank are against collateral such as government securities and other very liquid forms of capital[3] however the central bank will, under some circumstances, lend money to banks against the assets they have themselves created through loan origination[4].

So while my little thought experiment about "starting from $0" is not quite accurate, it's not that far off!

>> But fundamentally, we could have a banking system that operates exactly as I described ... > So the example you provided was not supposed to reflect reality? It was just a "we could in theory have a banking system like this"? Yes we could in theory, but in practice we don't. In practice normal banks need reserves in order to issue loans.

My example was intended to show you how banks hold reserves in order to make their loan operations more profitable. The point was that even if you started off with all banks at $0 in reserves and funded the entire operation using only central bank loans, you would end up with a system similar to what we have now where the primary reason banks need reserves is to increase profitability. It may be the case that a bank that had no reserves at all would go bust because it wouldn't be able to compete with other banks, but it's certainly not the case that they all need to attract reserve deposits equal to the amount of loans they want to originate. They only need sufficient reserves to satisfy net flows of funds and, because they're banks, they have access to the types of credit facilities they need in order to satisfy short term liquidity shortfalls.

In fact, there was a spectacular neobanking collapse in Australia recently:

"Xinja failed in part because it started taking deposits before it made loans. That meant it had to pay interest to customers before it was generating income."[5]

Banks don't need a certain level of reserves or even highly liquid government securities to satisfy capital adequacy requirements. If you look at the documentation around commencement of a bank and capital adequacy standards[6][7] you'll find a story that is much more complicated than simply "reserve funds". They look at all sorts of financial instruments able to "absorb losses" or "commitment of funds". These mean that you can have investors who have pledged to step in to satisfy liquidity requirements or provide collateral/security for loans from other banks and/or the central bank.

There is a difference between the "capital adequacy" requirements placed on banks and the imagined "reserve requirement". Bill Mitchell sets it out clearly:

"To understand why reserve requirements do no constrain lending you have to understand how a bank operates. Banks seek to attract credit-worthy customers to which they can loan funds to and thereby make profit. What constitutes credit-worthiness varies over the business cycle and so lending standards become more lax at boom times as banks chase market share (this is one of Minsky’s drivers).

These loans are made independent of the banks’ reserve positions. Depending on the way the central bank accounts for commercial bank reserves, the latter will then seek funds to ensure they have the required reserves in the relevant accounting period. They can borrow from each other in the interbank market but if the system overall is short of reserves these horizontal transactions will not add the required reserves.

In these cases, the bank will sell bonds back to the central bank or borrow outright through the device called the “discount window”. There is typically a penalty for using this source of funds. At the individual bank level, certainly the “price of reserves” may play some role in the credit department’s decision to loan funds. But the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend.

So the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. The bank expands its balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank."[8]

In other words, banks issue as much credit as they can to as many credit worthy customers as they can find, and separately look for ways to satisfy any regulatory requirements. It is the case that regulatory requirements will inform lending criteria but it's nowhere near as simple as "x% of reserves".

[0] https://fred.stlouisfed.org/series/M1SL

[1] https://www.levyinstitute.org/publications/the-hierarchy-of-...

[2] https://www.youtube.com/watch?v=WQBIfSWDx9s

[3] https://www.rba.gov.au/publications/bulletin/2017/dec/2.html

[4] https://www.rba.gov.au/publications/bulletin/2020/sep/pdf/ma...

[5] https://www.afr.com/companies/financial-services/xinja-s-col...

[6] https://www.apra.gov.au/sites/default/files/2021-08/Guidelin...

[7] https://www.apra.gov.au/sites/default/files/2021-08/APS%2011...

[9] http://bilbo.economicoutlook.net/blog/?p=9075

I think that's the most prudently argued response I've got on HN.

It sounds like we are mostly in agreement, but we disagree on:

1. When something should or shouldn't be called "money"

2. Will the bank - in practice - lose its money-printing ability if it behaves extremely bad

Regarding point 1, I guess we're going to just agree to disagree.

Regarding point 2, it's up to you to provide a single counter-example and prove me wrong. Theoretical arguments won't cut it here.

I'll answer some individual points below:

> I agree that money is a very ambiguous (and probably not very helpful) term, but insofar as we can consider the M1 money supply measure to be the quantity of money available in the economy at any given point in time (which is what the BoE paper is referring to when it says "money creation"), originating loans definitely creates money[0]. When you get a loan, the money lands in your demand deposit account, it's definitely "money" according to the definition of money being used in the BoE paper.

The BoE paper wasn't describing the case where a troubled bank with 0 capital makes up infinite amount of demand deposits. If such a case were to happen in practice, automated systems might initially report the amount of circulating money as infinite, but very soon someone would "correct the error".

> When a bank receives its license, it can immediately start both taking deposits and issuing loans.

This might be as it is written in Australian law, but in practice no bank is going to receive a license if it has 0 capital when starting up. Sure, it doesn't need deposits to start lending, but it still needs reserves.

> Banks lend money to each other all the time, and most loans from the central bank are against collateral such as government securities and other very liquid forms of capital[3] however the central bank will, under some circumstances, lend money to banks against the assets they have themselves created through loan origination[4]. So while my little thought experiment about "starting from $0" is not quite accurate, it's not that far off!

Well, I'd say it's far off. We're comparing "normal bank issuing loans more or less prudently" to "bank with 0 capital issuing infinite money to the chairman's wife". I would argue that your typical central bank is willing to bail out most cases in the former category, while refusing to bail out any case in the latter category.

> It may be the case that a bank that had no reserves at all would go bust because it wouldn't be able to compete with other banks, but it's certainly not the case that they all need to attract reserve deposits equal to the amount of loans they want to originate.

I'm obviously not claiming that banks need reserve deposits equal to the amount of loans they originate. I'm saying that banks need some deposits to issue loans, and I'm saying that any one individual loan is never going to be larger than the amount of reserves held by the bank. The sum of all loans might be larger than the amount of reserves held, but no single individual loan is going to be.

> They only need sufficient reserves to satisfy net flows of funds and, because they're banks, they have access to the types of credit facilities they need in order to satisfy short term liquidity shortfalls.

If a bank issues a huge loan that the customer intends to withdraw from the bank, that can cause a short term liquidity shortfall. So if you're saying the bank needs sufficient reserves to cover for potential short term liquidity shortfalls, then I suppose we are in agreement over the main question in this debate.

> loans are made independent of the banks’ reserve positions [...] Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank."

I'd be to happy to accept a single counter-example where a bank with 0 reserves issues >999999999 dollars to a family friend who then exchanges it to goods and services. Just a single example of this, and I will say I was wrong. Without a single documented case of this happening, you are essentially claiming "this could happen in theory". That's different from "this is how the world actually is today". Many things could theoretically happen in the world, but they don't, and that's not how to world is. In practice banks are constrained in their loan-making by their reserves, even if you have 9 research papers that claim otherwise "in theory".

I don't know how to say this clearly enough: It's a Ponzi because you can't buy anything except other currencies with it.

Like sure, you can't steal it from me, but you can sure as hell prevent me from acquiring goods/services with it (Governments all around the world have done an amazing job of that whether they tried to or not), so it's only worth something insomuch as you can turn it into fiat.

And it's only worth what it is in fiat because people believe that in the future it will be able to buy goods and services, despite no evidence that it will be able to do that.

> It is indeed wrong, but nobody here has made such a statement

Really? The very first comment I replied to was:

"banks at least tell you they are loaning your deposits out"

My response:

"Side not but that’s not really how banking works. Banks create deposits when they originate loans and separately look for the assets they need in order to satisfy any regulatory requirements and net flows of funds for inter bank settlements."

Your initial response:

"No, when you take a loan out of a bank, the bank doesn't "create deposits" that it loans to you. The bank loans you existing deposits"

Are you saying there's a distinction between "banks loan you existing deposits" and "banks lend out reserves"? They seem to be the same statement to me ...

> Now, a bank which has a high amount of capital can in practice issue more loans than a bank which has a low amount of capital. And one way of increasing the bank's capital (and thus improving the bank's ability to issue loans) is increasing the bank's reserves

Yeah that's one way they can do it. Those reserves would then almost always be swapped for bonds unless there's more money to be made by loaning them to other banks (which is how the central bank sets and defends the interest rate).

> So there's some kind of positive correlation between a bank's reserves and its ability to issue loans, right? You mentioned yourself that a bank has to have sufficient capital to survive short term liquidity events, and issuing a large amount of loans increases the probability of such events.

You could, if you wanted to, have a bank that capitalised entirely with reserves, but it's way more profitable to attract reserves, lend them out to other banks who have attracted less reserves, and buy bonds with said reserves. You can use the loans you made yesterday to another bank as collateral to borrow at the discount window, for example, if you find yourself in your own liquidity crunch.

So I'd say a more accurate statement is that there is a positive correlation between a bank's ability to attract reserve deposits and its profitability, both due to additional loan origination capacity and due to low capital costs. But reserves are only one piece of the puzzle.

I would say that reserves within a bank's capital mix are similar to tyres and car safety. Having bald tyres is really unsafe, and having better tyres improves your car's safety, but there are tonnes of other ways to drive safely and there's a point at which you're over spending on tyres that won't make any difference to the overall safety of the car (don't you just love car analogies?)

> The sources you've provided describe the "general case" of banks making loans as part of normal business proceedings.

Yes agreed.

> You're making the argument that the same mechanisms that enable the general case would equally apply to the extreme case.

Not really, the part where I used "starting from scratch" as an example was to highlight that reserves increase profitability of a bank and that while, due to regulation, banks can't just start with "nothing" (they need some way to satisfy their liqudity requirements, aka capital), but the system we end up with a little while after "starting from scratch" is very similar to what we have now. The crux of the matter is that reserves increase profitability. It is almost certainly the case that a bank that always has to borrow to satisfy all liquidity requirements will go broke, so regulators don't let that happen, but also a bank which over capitlises reserves relative to loan origination (Xinja being the extreme example of that) will also fail.

The genesis of this thread was the notion that banks "lend out deposits", that's what I'm arguing against.

> but you don't believe it might prevent yacht-buying and aeroplane-buying before the loss of banking license occurs?

Well, actually probably not! Like, they couldn't do it twice, but banks are allowed to have negative reserve balances for a time. If they had been found to be fraudulent then they should go to jail (would they though?) but on the actual day that this happened, the yacht transaction would probably actually succeed. Of course, if the owner of the yacht could be traced back to the fraud committed as a willing participant then that yacht could well be siezed as part of the estate and so on, proceeds of crime and whatnot.

But if some dude really flipped and just typed in the numbers, they could do it, but it would wind up very quickly.

However there are not-too-dissimilar tactics used in banks such as appraisal fraud and liars loans. If you listen to Bill Black's recipe for control fraud it's more or less what you're describing[0], just a little slower and a little more "book cookey".

His book "The Best Way to Rob a Bank is to Own One" has many examples of control fraud. Sure it's a little more deceptive than just opening a spreadsheet and typing in the numbers, but they're totally faking capital levels in order to obtain liquidity to satisfy net flows of funds, resulting in tremendous short term profits and eventual collapse.

> The reason why I'm bringing up this extreme case is to demonstrate that clearly there is some connection between the bank's... I'm going to say capital... and its ability to issue loans. This connection also exists in less extreme cases, but it's easier for me to demonstrate with this extreme example.

Right so what you could say is there's definitely a "credit limit". If you typed in $9,999,999,999,999 into the spreadsheet and then tried to spend it all externally (meaning that none of the people you were buying from had accounts at the same bank, OR you tried to withdraw all that money as notes and coins) then that would set off some sort of warning: either you'd be trying to borrow too much too quickly from too many people, or your account would be so negative overnight that the Fed would give you a call and be like "ummmm ... no". This is pretty similar to what things might look like if you or I tried to spend too much too quickly on our AMEX card.

But "having reserve deposits" is not a pre-requisite for originating a loan. Banks can (and do!) get away with somewhat subtler forms of control fraud over a period of time that is not really that long (2 - 3 years, say) during which time executives can stash an enormous amount of cash and just leave the mess for the regulators to clean up.

There certainly are people who advocate for 100% reserve banking and an end to private credit such as Positive Money[1] but their policies are not very practical and (as per the lecture series I linked to earlier) some private credit creation is probably a good thing to have in an economy. The problem is how dominant the financial system itself (which is, ultimately, just a record keeping system) has become in terms of GDP. We need to make finance boring again!

[0] https://www.youtube.com/watch?v=ClfBxWPkBKU

[1] https://positivemoney.org it's worth noting that while I do, in general, not agree with much of what PM has to say my understanding is that they were actually quite instrumental in lobbying to get the BoE to produce the paper to which I originally linked. In their case they were motivated to "expose the reality" and shock everyone into demanding 100% reserve banking but I don't think anyone was actually all that shocked by it, except David Graeber who wrote about it https://www.theguardian.com/commentisfree/2014/mar/18/truth-... and, as luck would have it, was where I first learned about MMT in the comments section when someone linked to this youtube video https://www.youtube.com/watch?v=bTZGU9s0idM