Sunday Mail discovers how banks work
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Also if Banks can create money at the stroke of a key board, why do they charge interest at all. If they could create money, they could create a £1,000 then offer a loan of £1,000 to a lender who was only required the lender to repay £500, which would mean the lender got a total £500 (very nice little earner), the bank would make an initial £500 profit and end up with an eventual £1,000?
All created from nowhere, what’s not to like?
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Peoples who own the title deed of a real estate property do not know that within 30 or 40 yers they would be paying about 20 or more times the amount of the principal that they borrowed . Why banks have to wait so long in order to make all that money ? They can create all that money by the stroke of a pen or a keyboard and continue lending money in other areas of the capitalist economy The 2008 was not a financial crisis, it was a crisis of over production and many homes and building were over produced. Marx theory of crisis is still valid
Banks that loan out more than what they have available to loan out are in danger of succumbing to a bank run – when depositors, fearful that the bank may not have the funds to cover or return their deposits, get into a panic and try to withdraw their money which then brings about the very crisis they feared. Bank runs have occurred throughout the financial history of capitalism. A recent and prominent example is the Silicon Valley Bank in 2023, the third-largest bank failure in US history which resulted from a $42 billion bank run.
—————————————————————————————————————————————The Silicon Valley Bank case is well explained in this short article:
The capitalists and the capitalist state will give many explanations, but they will never show the weakness of their own economic system, they will never say that this a very unstable economic system.
SVB was taken over by the FDIC and then another bank partially purchased the bank because they did not have enough reserve to buy all the assets and liabilities and the FDIC kept the other portion of the failed bank . The first Citizen bank did not create money from the thin air
Thanks for the responses folks
Im glad to see that ALB is now agreeing with me about the labour theory of value. As all money, whether cash coin or electronic, is token money however we think it is created, whether by government or banks, it has no intrinsic value therefore the argument that money created by banks that is presented by SPGB is clearly invalid. Glad we have that settled as I think this is an important point. That all money is token money today has significant implications for analysing how the money system works.
I think ALB argues that government create money not banks but this is not correct. The Bank of England only creates the notes/coins and the central bank reserves which accounts for about 20% of the money in the UK. Governments only create money by purchasing bonds that are issued by banks and financial institutions. This is also used to add money into the central bank reserves which acts as a back up to allow commercial banks to issue more loans. The reserves however are only used for inter-bank settlements and enable banks to create more loans by acting as a back up for those increased settlements.. All these transaction are electronic money though so again it is a creation of new money whether by banks or government; the bonds issued act as IOUs
The covering of outgoing loans issued by banks are covered by borrowing money from banks, money markets as discussed but these are all new entries on the bank balance sheets and they exist alongside loans the banks issue. They are separate entities. They do not means that banks do not create money when they make loans.
Young Master Sweet is correct in his assessment that token money is backed up by the force of the state and is correct in recognising that banks are limited in their transactions by the need to ensure that loans are capable of being settled appropriately by the borrower and by the need to make profits but also by government rules for the administration of banks and the financial sector. As Robbo203 says these rules also exist to prevent bank runs and also ensure the viability of the financial system; something essential to keep production and the economy as a whole running.
So banks have to aim at behaving legally and in accordance with financial rules just like businesses and directors have rules about their performance and my argument is that banks creating loans is within those rules. Citizen of the World and Bijou Drains fail to recognise that these rules exist and makes some ridiculous assertions that my idea is that banks can loan out or make money willy-nilly including to themselves and that governments can do the same as ways to prevent them going bankrupt etc. Perhaps reading what i have actually said in my book and in the discussions properly might be of help.
Young Master Sweet is correct in his assessment that token money is backed up by the force of the state and is correct in recognising that banks are limited in their transactions by the need to ensure that loans are capable of being settled appropriately by the borrower and by the need to make profits but also by government rules for the administration of banks and the financial sector. As Robbo203 says these rules also exist to prevent bank runs and also ensure the viability of the financial system; something essential to keep production and the economy as a whole running.
Hey Link
But those “rules” that you refer to work to ensure that banks cannot loan out more than what is deposited with them plus what they can borrow from the money market. This is the point. If they exceed this limit, they run the risk of a bank run, and that is precisely what the regulations are designed to supposedly prevent.
It is not just the creditworthiness of the potential borrower that we are concerned with, but also with the ability of the bank itself to finance a loan without jeopardising its other financial commitments, including its ability to repay other banks from which it had borrowed money
This whole idea of “fractional reserve banking” is based on an optical illusion, as this article makes clear
Bank regulations have been created in order to protect banks against bankruptcy and operational failures. Bank failures is a clear indication that banks or governments can not create money by itself
I have read several books on money, and this small pamphlet sweep the floor with all of them:
1. I think we are agreed, Link, that, if a government issues more of an inconvertible paper currency (one not convertible on demand into a fixed amount of gold) than the economy requires, this will lead to a rise in the general price level. This assumes a value relationship between commodities that is unaltered irrespective of the number of such paper “money tokens” that are issued. (Where there is a paper currency that is convertible into gold, as was generally the position in Marx’s day, the result is a different; it does not lead to a rise in the price level but to gold coins being withdrawn from circulation). In both cases, the validity of the labour theory of value remains. So I don’t see what argument “presented by the SPGB” is invalid.
2. Yes, I am arguing that only the government (but not commercial banks) can issue money-tokens that, if over-issued, have the effect of raising the general price level. If you chose (or it is chosen) to define bank loans as money, then of course — by definition — banks create money. Including bank loans as money is confusing, but it need not necessarily be as long as you don’t confuse such money with state-issued money-tokens. You would need to distinguish between date-issued “central bank money” and “commercial bank money”.
3. Conventional monetary theorists do in fact do this, as for instance the European Central Bank here:
“To understand how money is made, it’s important to distinguish between two types of money.
Central bank money is backed by a public institution, like the ECB. In the euro area, the national central banks can create this kind of money. It is most visible to citizens in the form of banknotes. Another type of central bank money is the deposits that commercial banks have at the central bank – known as central bank reserves. These are created electronically through our open market operations.
Commercial bank money makes up most of the money that people actually use. It is backed and balanced by the assets held by commercial banks. So it is created by banks expanding their balance sheets. For example, if a commercial bank grants you a loan to buy a car, they create money in this way. And when you repay the loan, the money created disappears.”https://www.ecb.europa.eu/ecb-and-you/explainers/tell-me-more/html/what_is_money.en.html
(Note here the statement that bank loans have to “backed and balanced” by the assets they hold.)
4. Your description of how the central bank gets more money into circulation seems basically correct — that it buys bonds off the commercial banks and pays them by adding (by a keyboard stroke) to the banks’ reserves held with it. The banks can then withdraw this and use it to lend more (provided there is a credit-worthy demand for more loans, which is not always the case, eg in a slump).
5. It is by such “open market operations” that extra money-tokens usually get into circulation rather than by the central bank simply allocating extra money to the government or by loaning money to it by creating money to directly buy government bonds (though these have happened). This is where there appears to be a mistake or maybe a misprint in your description when you write that “Governments only create money by purchasing bonds that are issued by banks and financial institutions”. The government central bank could, I suppose, do that, but in fact the bonds that it purchases are not those that banks themselves issue but government bonds that banks have acquired.
By coincidence, just after sending the post above I read this story in the papers:
It’s about the increase in the commercial banks’ reserves with the Bank of England resulting from the government bonds (and some corporate ones) that the Bank bought from them under Quantitative Easing. These reserves were increased by the Bank paying for them by adding to them (from “thin air”, as Tice correctly puts it — but which only a central bank can do, not a commercial bank). However, the banks didn’t put the new money into circulation but kept it there and banked the interest.
In some other countries the central bank doesn’t pay interest on the reserves it requires the commercial banks to deposit with it.
China has a cash reserve of more than 3.75 trillions dollars and a gold reserve of 263 billions dollars
Chase Bank has more than 3.05 billions dollars in cash reserve for bad debts or uncolective loans, and he is one of the biggest real estate lender
They have taken over the liquid assets and deposits of several banks that were failing
PS: During the 1937-1948 the Cuban and Dominican pesos ( Pesos Oro ) were in parity with the US dollars and both countries did not have a large reserve in gold, in certain occasions the “Pesos Oro ” was higher than the dollars and peoples did not want dollars, the price of one egg was one cent and the price of a lb of rice of was 10 cents, it shows the inflation is monetary devaluation. Ironically a dictator was doing much better than Donald Trump and Joe Biden
This has been an interesting discussion as to how banks work that has pushed me to finding out more about bank systems, trouble is that the various websites are not necessarily clear nor do they say the same thing and i do not think that some of the SPGB contributors here have not bothered to investigate the details and do little more than make up their own assertions about how accounting works. So I remain unconvinced by the intermediary theory.
No currencies in the world are exchangeable for gold. There is no real money in the economy any more. All money is either electronic money or well as notes and coins and they are all simply tokens of exchange with no real value.
Most currencies use just fiat money but there is an increasing creation of cryptocurrencies or Central Bank Digital Currencies.
What is absolutely clear is that all electronic money is created on computers, there is no other way possible – the issue here is more about who creates this money, banks or governments.
To be honest I can find not clear history of money that identifies the proportion of whether governments or banks created it. Of existing money in the UK, 3% is cash, 20% is electronic central bank reserves (both created by the government) and the rest is electronic money. It may well be that over time the Bank of England has destroyed the previous cash and replaced it by electronic money but the economy has more than tripled in size since the 1960s when cash still dominated so new electronic money has clearly had to be created.
It is clear that commercial banks do create electronic money when they make loans and this fact is irrespective of how much cover you believe is held against such loans. These loans and hence the money involved are deleted when the loans are repaid. So this means that at any given time, there is a quantity of loans and hence of electronic money circulating in the economy in a cycle of creation and deletion.
I accept that loans made by banks need to be limited in some way, but i can find no ‘rules’ that loans have to be the same or less than deposits and loans from other banks. In fact the evidence I have found is that the proportions do vary but this is overseen by banks to ensure banks do not lend out too much – but this is related to whether they have sufficient capital holding rather than deposits to justify the level of loans.
Bank deposits cannot be used to pay out loans, if there is a rule, then this is an accounting rule that banks must abide by. Bank deposits are IOUs and can only paid out to the depositors themselves. Loans made and deposits received are separate records that are kept permanently separated in the banks’ Balance Sheet. Runs happen when trust in the banks falls and the banks do not have enough cash to repay depositors.
Also bank losses similarly are not paid out of deposits but out of its capital holdings. A bank will go bankrupt when the capacity of its capital to cover losses is insufficient this may be too much risk taking or failure to make a profit. If a bank goes bankrupt, it still owes the depositors the value of their accounts even if it cannot pay them
Banks can go bankrupt for a range of reasons eg due to market changes, investments failings, loans not repaid, risk taking and not just because they have made too many loans as some are have implied. A bank will go bankrupt when the capacity of its capital holdings is insufficient to cover losses.
As Raya Dunayeskaya wrote on one of her books: There is not enough gold or silver in the whole world to cover all the money that is circulating over the earth, they can dig all mines of the world, and it will not be enough,
When paper money was backed up by gold ( and reduced to a tiny piece to cover the paper money ) there was not sufficient precious metal to cover the dollar and other currencies,
Some small countries had sufficient gold in their reserves to cover their currencies and their currencies was in parity with the dollars until the IMF came in to impose their rules on others countries
When gold was eliminated as the backup for currencies, industrial productions, prestige and machines gun, gunboat diplomacy became the backup, but money is not issue by banks, it is issued by governments before and after the emerge of computers and digital money transfer.
Cryptocurrency has been created for money laundering and for money transfer to drugs dealers money and to eliminate central banks but it does not have any real value
Link, you say “I remain unconvinced by the intermediary theory”. But in fact you implicitly accept it, that is if you agree that
“Banks receive interest payments on their assets, such as loans, but they also generally have to pay interest on their liabilities, such as savings accounts. A bank’s business model relies on receiving a higher interest rate on the loans (or other assets) than the rate it pays out on its deposits (or other liabilities). (…) The commercial bank uses the difference, or spread, between the expected return on their assets and liabilities to cover its operating costs and to make profits.”
(https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy).Marx had noted this 150 years ago (it wasn’t a great discovery but simply described a generally accepted fact):
“A bank represents a centralisation of money-capital, of the lenders, on the one hand, and on the other a centralisation of the borrowers. Its profit is generally made by borrowing at a lower rate of interest than it receives in loaning.”
(https://www.marxists.org/archive/marx/works/1894-c3/ch25.htm)This is not incompatible with calling bank loans “bank money” (if you want and the Bank of England does) as long as you don’t think that this is new money. That’s just a question of definition.
On the alternative view — that banks are “new money creators” — a bank’s business model would be that a bank creates the money it lends and uses the interest to cover its operating costs and to make profits. But this is neither credible nor in accordance with the facts.
Why don’t you take the next step and come out and explicitly reject that view.
ALB, I really do not understand what you are saying in 258804. It makes no sense.
Firstly i do not accept the banks as intermediaries theory but your quote from the bank of England i do accept and think everybody does. Of course banks earn money from charging more for loans they make than they are charge on loans they receive. This is obvious and nothing to do wtih the idea that banks loan out deposits they received which is what i thought the intermediary theory is.Then. you say that “… a bank’s business model would be that a bank creates the money it lends and uses the interest to cover its operating costs and to make profits” is incorrect because this is banks being new money creators.
I think you have got confused somewhere and if something was written incorrectly please do change it.
Lastly let me quote from the same Bank of England link you used but which i do agree with:
“This article explains how the majority of money in the modern economy is created by commercial banks making loans. 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 deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.”
Link, you say “I remain unconvinced by the intermediary theory”. But in fact you implicitly accept it, that is if you agree that
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That is what banks are, nothing else, intermediary institutions, Money is issued by governments and the over issuance of money produce inflation, banks can not produce money by the stroke of a keyboard, if they can do that, they will never fail, they will cover their own defaults
Everybody certainly does not accept the Bank of England’s (accurate) description of a bank’s business model. Some of those you quoted in your book don’t. Aaron Sahr, for instance, who you summarise as saying
“money is quite simply a product of using a keyboard as the banks create money by making and recording loans on their computer”.
and
“The whole financial system is based on creating money out of thin air. The whole financial industry really is just based on creating electronic assets (ie, virtual money) that are loans on which interest can be charged”.
He, for one, thinks (if you have summarises him correctly) that a bank’s business model is not to make money by borrowing at one rate of interest and lending at a higher one. He thinks that a bank doesn’t need to borrow money at all but can simply create it by a keyboard stroke and then lend it at interest. There is no “spread” between the two rates of interest; to calculate its income, the interest from lending does not have to be reduced by what the bank pays as interest to those it borrows from. Its income is the whole of the interest from lending.
The difference between the two models is that, in the one case, a bank’s income is its interest from lending net of the interest it pays; in the other case, it’s the whole interest from lending.
The question people who argue like him should ask themselves is: why does a bank borrow any money? Why does it seek deposits or loans from other financial institutions? That would seem to be pointless even counter-productive as the interest it has to pay reduces its income.
I think that the Bank of England’s point is that a bank is not a simple intermediary as, today, the commercial banks are part of a banking system centred on the central bank. They are arguing that it is the banking system as a whole, not single banks on their own, that create money. That may be true but it doesn’t mean that a single bank is not an intermediary between lenders and borrowers.
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