Cooking the Books: Swizz Banking?

Swiss banking reformers have obtained the 100,000 signatures needed to initiate a referendum to restrict bank lending or, as they put it, to stop banks benefiting from being able to create electronic money out of nothing.

Explaining the apparent logic behind the proposal in the Financial Times (5/6 December), Martin Sandhu wrote:

‘The bank decides whether it wants to make you a loan. If it does, then it simply adds the loan to its balance sheet as an asset and increases the balance in your deposit account by the same amount (that’s a liability for them). Voilà; new electronic money has been created.’

This is indeed what happens from an accounting point of view. Double-entry book-keeping requires every new asset or liability to be balanced by a corresponding liability or asset. In this case, in making the loan, the bank acquires a liability. This has to be balanced, in the accounts, by a corresponding asset, recorded as an IOU from the borrower. That a new asset has been created out of nothing is only an illusion arising from an accounting convention.

Outside the accounts department all that has happened is that the bank has committed itself to making a loan to a customer. It ought to be obvious that, to be able to meet the obligation (liability) to pay this, the bank will have to be able to fund it, but currency cranks (and, surprisingly, some financial journalists) overlook this and believe that banks really can ‘simply’ create out of thin air what they lend. Sandhu even used the word ‘scam’.

This is not to say that loans have to be funded entirely from what people have deposited with the bank (a view sometimes attributed to critics of the thin air school of banking) since other sources of funding are available, from the money market (i.e. other financial institutions) or the central bank, some of which can even be done after a loan has been made.

The Swiss banking reformers subscribe to the mistaken, monetarist view that an over-expansion of bank lending causes (rather than merely reflects) booms and busts and they want to control and restrict it to try to prevent this. It won’t work but that’s the theory.

The proposal is that banks should not be able to re-lend money deposited in current accounts. When it receives such a deposit the bank will be required to re-deposit it with the state’s central bank in return for what Sandhu calls ‘State e-money’. All banks would be able to do with this is transfer it between current accounts.

This would certainly restrict bank lending but it wouldn’t (and is not intended to) stop it altogether. As the Swiss banking reformers explain (, after the enactment of their reform:

 ‘The banks can only work with money they have from savers, other banks or (if necessary) funds the central bank has lent them, or else money that they own themselves.’

But this is already, now, the case! Money deposited in a current account is just as much a loan to the bank as is money deposited in a savings account. Banks can, and do, re-lend most of it too, except that, unlike with a savings account, it keeps all the interest.

But if money re-lent from a current account is money created from thin air, why is money re-lent from a savings account not? Don’t ask us. Ask the currency cranks.

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