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How a Trillion-Dollar Market Remains Hidden in Plain Sight

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Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#11

Post by downandout »

jackgavigan wrote: post #8
userbmf wrote: post #5

Market lenders aren't banks. They cannot use fractional reserve banking. If they take in $100 they loan out $100. A bank takes in $100 having loaned out $10K to satisfy reserve requirements 10% (likely less but keeping it simple). So if most lending moved to market lenders we would see a collapse in the money supply.

If the bank's reserve requirement is 10%, wouldn't it only be able to lend out $90 of the $100 it had taken in deposits?

Kind of, sort of, but not really. The $90 that was lent, at some point, winds up back in a bank, where that loan is now a new deposit. Then 90% of the $90 can once again be lent out. Now that original $100 deposit = $171 in loans. And on it goes, until that $100 deposit is roughly $1000 floating around in the economy. This is called the "money multiplier".

Here's a chart that shows the expansion potential of money at various reserve requiements: http://en.wikipedia.org/wiki/Fractional_reserve_banking#medi...

This also shows how banks make so much money, and why there are both laws and services designed to encourage people to keep their money in banks. A $100 deposit generates slightly less than $1K in loans. At only 5% interest, the banks will realize $50 in interest per year on the ~$1K in loans enabled by that single $100 deposit.

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#12

Post by grayclhn »

userbmf wrote: post #5

Market lenders aren't banks. They cannot use fractional reserve banking. If they take in $100 they loan out $100. A bank takes in $100 having loaned out $10K to satisfy reserve requirements 10% (likely less but keeping it simple). So if most lending moved to market lenders we would see a collapse in the money supply.

No, you would need a larger monetary base to support the same size economy. But printing more money is easy.

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#16

Post by justinsb »

Animats wrote: post #6

Peer to peer small lending is easy. Peer to peer small debt collection is hard. That's why the low end of lending is so expensive.

I remember reading the T&Cs for one of these 'marketplace lenders'; they would do collections for the lender, if the borrower was 60 days late (which doesn't even seem that late). But the lender would get nothing, setting up a huge conflict of interest for the marketplace: they could make a lot more money on a loan in default than a successful loan.

Wild West indeed.

Edit: Yuk.. "Currently, Lending Club charges investors... 18% of the amount recovered if the loan is 16 or more days late and no litigation is involved". In other words: an automated-payment screws up, Lending Club sends a letter to the borrower, who fixes the problem: Lending Club takes 18% of the principal.

https://www.lendingclub.com/public/rates-and-fees.action

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#17

Post by jackgavigan »

downandout wrote: post #11
jackgavigan wrote: post #8

Earlier quoted context omitted.

If the bank's reserve requirement is 10%, wouldn't it only be able to lend out $90 of the $100 it had taken in deposits?

Kind of, sort of, but not really. The $90 that was lent, at some point, winds up back in a bank, where that loan is now a new deposit. Then 90% of the $90 can once again be lent out. Now that original $100 deposit = $171 in loans. And on it goes, until that $100 deposit is roughly $1000 floating around in the economy. This is called the "money multiplier". Here's a chart that shows the expansion potential of money at…

And can't the person who borrowed $100 using a p2p loans marketplace also loan it out again?

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#18

Post by arjunnarayan »

jackgavigan wrote: post #17
downandout wrote: post #11

Earlier quoted context omitted.

Kind of, sort of, but not really. The $90 that was lent, at some point, winds up back in a bank, where that loan is now a new deposit. Then 90% of the $90 can once again be lent out. Now that original $100 deposit = $171 in loans. And on it goes, until that $100 deposit is roughly $1000 floating around in the economy. This is called the "money multiplier". Here's a chart that shows the expansion potential of money at…

And can't the person who borrowed $100 using a p2p loans marketplace also loan it out again?

You are correct, and downandout is wrong. The same fixed point calculation that he/she makes with fractional reserve banking is true of the p2p loans marketplace as well. Your original calculation (reserve requirement of 10% -> $100 of deposits becomes $90 of loans) is correct.

Edit: Downandout isn't wrong, it's the GP userbmf that is, since he/she said that market lenders aren't banks and "cannot use fractional reserve banking", which is a ill-defined statement. I erroneously assumed that the two users were the same. My apologies.

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#19

Post by downandout »

arjunnarayan wrote: post #18
jackgavigan wrote: post #17

Earlier quoted context omitted.

And can't the person who borrowed $100 using a p2p loans marketplace also loan it out again?

You are correct, and downandout is wrong. The same fixed point calculation that he/she makes with fractional reserve banking is true of the p2p loans marketplace as well. Your original calculation (reserve requirement of 10% -> $100 of deposits becomes $90 of loans) is correct. Edit: Downandout isn't wrong, it's the GP userbmf that is, since he/she said that market lenders aren't banks and "cannot use fractional rese…

> downandout is wrong.

Did I say that it didn't apply to p2p loans? It, of course, applies to any money that can be a new deposit. And how exactly am I wrong? The concept of the money multiplier is pretty well documented. There's even a chart that I linked to.

Re: How a Trillion-Dollar Market Remains Hidden in Plain Sight

#20

Post by arjunnarayan »

radmuzom wrote: post #10
jackgavigan wrote: post #8

Earlier quoted context omitted.

If the bank's reserve requirement is 10%, wouldn't it only be able to lend out $90 of the $100 it had taken in deposits?

Yes. But typically banks can leverage - for example, the bank which employs me typically lends out around $125-$135 for every $100 dollars in deposits. I guess the OP was trying to explain the money multiplier but got the example wrong. (Money multiplier is the inverse of the reserve requirement)

No. Deposits are what are used to "lever" up in the first place. If a bank lends out $125 for every $100 that it gets in deposits, where is the other $25 coming from? The answer is that it comes from equity.

Banks have two sets of inputs:

(1) Equity (i.e. the owners of the bank put up capital. This is great because it requires them to have 'skin in the game')

(2) Incoming debt (i.e. depositors give them money.).

They have two outputs:

(3) Outgoing debt (i.e. the loans the bank makes out to people, in the form of mortgages, small business loans, lines of credit, etc.)

(4) Reserves (money they have to keep on hand)

Notice that as an accounting identity, we must have that (1) + (2) = (3) + (4).

Leverage limits essentially limit the ratio (2):(1). For example, a leverage limit of 9:1 means that a bank lends out $100 has to source at least $10 of that from equity, and at most $90 of that from incoming debt.

Fractional reserve limits essentially limit the ratio (3):(4). As "user downandout shows in a sister thread to this one, this can be used to determine a "multiplier" for the economy as a whole, since for a nonzero limit, there is a closed form fixed point solution maximum multiplier ratio in the economy as a whole. (Although in practice the "true" multiplier can be lower since people might stuff their mattresses with money, or have lots of loose change lying around, etc.).

Note that the fractional reserve limits are something that is enforced on banks by the government to limit the multiplier. This restriction doesn't exist on P2P lenders (as of yet), and so if any thing, it means that P2P lenders are even freer to do bad things (such as have no reserves on hand at all).

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