Re: Non-Banks versus Banks

From: William F Hummel (wfhummel_at_comcast.net)
Date: 07/18/04 

Date: Sun, 18 Jul 2004 04:48:35 GMT

On Sat, 17 Jul 2004 18:57:49 -0700, The Trucker wrote:

>William F Hummel wrote:
>
>> On Fri, 16 Jul 2004 18:45:37 -0700, The Trucker wrote:
>>
>>>OK. Fine. The point remains: You have said that the assets of the
>>>bank determine the amount of loans it can create.
>>
>> Not true. I never said a bank's assets are what determine the amount
>> of loans it can create. It is a bank's capital that determines the
>> amount of assets it can create through lending. You are apparently
>> confusing a bank's assets with its capital.
>
>Alrighty then! Tell us the difference between the banks assets and
>the bank's capital. I really want to see what a banker means when
>he says _capital_.
>
If you don't understand the difference then I've been wasting my time
with detailed explanations. Go learn something about accounting.

>> OK, let's assume the bank has $10B in demand deposits and $1B in
>> reserves which just meets the 10% reserve ratio requirement. Then the
>> bank receives a deposit of $1B which increases its reserves to $2B.
>> If the bank then issues a loan of $10B, the bank must assume it will
>> be spent. The borrower is not going to leave that $10B on deposit.
>> So he writes checks totaling $10B. How is the bank going to cover
>> those checks with only $2B in reserves?
>>
>> Obviously it cannot issue $10B against a new deposit of $1B, unless it
>> is prepared to borrow $9B before the borrower has spent the money.
>
>Not so!!! According to the rules the bank can create as many new
>loans as it's "capital" and its reserves will allow. The whole
>idea behind fractional reserve banking is that not all the people
>will come at the same time for the money that is "in this bank".
>And while this/these borrowers (the one(s) that is/are the recipient
>of the loan(s)) will be writing checks against these loans and the
>money will be ending up in other banks, there is a reciprocal
>flow of funds from loans being created in other banks and checks
>written against those loans that will be transferring money into
>THIS bank. And each check that will move money from one bank to
>another will also be moving reserves from one bank to another.

OK, I'll try once more. There is an important difference between (1)
deposits created by a loan issued by the bank, and (2) deposits held
for checking activity by its depositors.

(1) Deposits held in checking accounts normally remain fairly stable
in total, so the bank can cover transient losses in reserves due to
checking activity on such deposits with reserves only a small
fraction of the total deposits.

(2) Deposits created by loans are hot money that the borrowers expect
to spend in short order -- nearly all of it. No bank would issue a
$10B loan backed by only $1B in reserves. However If it were only a
$10M loan, a large enough bank might be able to cover that by dipping
into its existing reserves until it could borrow the balance.

The loan itself creates an aggregate shortage of reserves in the
banking system. The notion that checking activity in the banking
system will generate new reserves in time for the bank to cover the
$10B in outgoing checks is patently absurd.

>
>It is best to look at the entire banking system as one great big
>bank. So long as the money does not leave "the system" it does
>not matter whether the money even "exists" or not.
>
>>>
>>>So below you must be talking about a different subject, i.e. a
>>>deposit of $1B created by a loan as opposed to the deposit
>>>of $1B in train riding money (real money). You seem to be saying
>>>that a loan adds to reserves at this bank but that these "reserves"
>>>are then whisked away as the depositor spends the dough and the
>>>accounting moves to other banks.
>>
>> Once again, banks cannot create reserves. However a new deposit at
>> the bank from whatever source will increase its reserves by the amount
>> of the deposit.
>
>Yep! If I write a check to Joe for $100 and he puts it in his
>checking account at his bank then that moves $100 worth of "reserves"
>from my bank to Joe's bank. Of course Joe will be writing checks to
>Pete and Pete will write checks to Sally and at the end of the day
>the reserves and the money have moved all around in the system.
>The bankers go have a beer and decide who needs to borrow from
>who so as to meet "reserve requirements" at the individual banks.
>
>> A loan issued by the bank increases its assets and
>> liabilities equally, with no change in reserves or capital. When the
>> loan is spent, assuming the proceeds end up in other banks, the bank
>> loses reserves equal to the amount spent.
>
>But this bank will also be receiving "proceeds" from other banks.
>
>>>
>>>> Before the new deposit of $1 billion, if it just met the reserve ratio
>>>> requirement, it could lend the entire $1 billion. After the loan is
>>>> cashed, the bank will lose the new reserves and the demand deposit
>>>> created by the loan, leaving it as before just meeting the reserve
>>>> ratio requirement.
>>>
>>>I think what is being said here is that the bank can create a new
>>>loan and sell that loan to a bank that has the reserves to back the
>>>loan. But I don't really know.
>>
>> It's very simple. If a bank receives a new deposit of $X, it can
>> issue a loan of $X without violating the reserve ratio requirement,
>> assuming it was in compliance before the loan was issued. When the
>> loan is spent, the bank loses the deposit liability of $X and the
>> reserves of $X that it acquired from the new deposit. That leaves its
>> reserve ratio as it was before it received the new deposit.
>
>NOOOOOOOOOOOOOOOOOOO!!!!!!!!!!!!!
>
>If a bank receives a deposit of $X it can issue loans in the amount of
>10$X (as based solely on reserve requirements). This here friggin
>bank has increased *ITS* reserves by $X. That is the difference between
>a deposit created by a loan and a deposit created by money coming
>from an outside source (outside source in this case being any other
>bank or the fed or the Martians or anything else). The loan created
>deposit does not increase this bank's reserves but, instead, puts
>a drain/strain/claim on this bank's reserves. Speaking again now of
>a deposit NOT CREATED BY A LOAN, the interbank swapping of checks
>and deposits does not increase total reserves. The banks as a group
>still have the same amount of reserves when all the money swappin is
>done. Some banks will have more and some will have less but
>the aggregate will be the same. So long as a bank receives as many
>bucks in deposits during this day as the bucks that left the bank
>in this day then the reserve position of the bank will be the same.
>The banks create new money when they create/make a loan. Bigger
>banks make bigger loans and these bigger banks also attract more
>deposits. Smaller banks attract smaller deposits and make smaller
>loans.
>
>>>
>>>> However the bank could lend more than $1 billion
>>>> if it makes up for the reserve deficiency created when the loan is
>>>> cashed.
>>>
>>>A bank can loan more then it has reserves for because it has 14 days
>>>or so to acquire the needed reserves.
>>
>> Correct.
>>>
>>>> It can acquire the needed reserves by borrowing in the money
>>>> market. For example, it could lend $2 billion today and follow up by
>>>> borrowing $1 billion to cover the withdrawal of the entire loan.
>>>
>>>But these numbers then make no sense: If the reserve requirement
>>>for a loan of $2B is $2M (10%) then why would the bank need to
>>>borrow any more than $2 million???
>>
>> You didn't read carefully. I said if the bank were to lend $2B, it
>> would need to borrow $1B to go along with the $1B it received from the
>> earlier deposit. It would then have sufficient reserves to cover the
>> checks written against the $2B loan.
>
>We seem to have a real problem here. Fractional reserve banking is
>exactly what it says: The bank need only have a _fraction_ of the
>money in reserve because all the depositors will not be coming all
>at the same time. The Fed says that the bank need only have 10%
>of the money IN RESERVE. The Fed knows that the money will be
>moving INTO the bank as well as LEAVING the bank as all the players
>in the system write checks on all the banks in the system and thus
>transfer money within the system.
>
>>>We also see that money in the
>>>money market is counted as reserves (base money).
>>
>> When a bank borrows in the money market, it receives new reserves
>> equal to the loan while the bank on which the loan was drawn loses
>> those reserves. Base money on deposit at the Fed equal to the amount
>> of loan is transferred.
>
>That's what I said.... All the money in the money market is reserves
>and at the end of each day the boys have a beer and decide who owes who.
>
>>>
>>>> The
>>>> 14-day averaging period in reserve account provides flexibility as to
>>>> when it must acquire the borrow the funds.
>>>
>>>>>As new loans are created this bank must send additional funds
>>>>>to the Fed but the bank will keep most of its dough in bonds or
>>>>>T-Bills or something (reasonably liquid).
>>>>
>>>> Banks hold T-bills as secondary reserves, but no more than needed to
>>>> provide flexibility. T-bill do not count as official reserves, and
>>>> they return far less than a bank earns through lending. They can sell
>>>> T-bills as a way to support additional lending.
>>>
>>>This thing about T-bills is extremely important. It is important
>>>because we want new money to be created without it having to be base
>>>money (or do we?). Let's review the process:
>>>
>>>1. Government buys a bunch of tanks and a couple of aircraft carriers
>>>and refuses to tax the people that benefit from the purchases (i.e.
>>>the people that own everything).
>>>
>>>2. The Fed/Treasury sells T-Bills and we will assume it is the banks
>>>that are buying the T-bills since that is where all the currently
>>>existing money must be. We also assume that this is M3 type money.
>>>
>>>(a word of explanation here: People do not buy T-bills with their
>>>grocery money. They buy T-Bills with money that would have otherwise
>>>been "saved" (retirement withholding stuffed in 401Ks and such) or they
>>>buy T-Bills with money they had in a passbook account or something
>>>like that. Banks buy T-Bills if the economy is in the ditch and
>>>nobody wants to borrow any dough)
>>>
>>>3. The money then comes into the economy as M1 as the people that
>>>supplied the tanks get this money and put in the bank as checkable
>>>deposits. We now have no more money in the system than before but
>>>we have more M1, less M3, and these here T-bills.
>>>
>>>So what happens to reserves here???? It seems to me that reserves
>>>have been increased by whatever amount the government spent but that
>>>is not the case because the T-bills are not counted as "reserves"
>>>or as base money. The excess spending is soaked up by the
>>>T-Bills.
>>
>> On balance, what the Treasury spends is matched by its receipts from
>> taxes and the sale of Treasury securities, meaning its outflows are
>> equal to its inflows, on average. Therefore Treasury spending does
>> not affect aggregate banking system reserves except for short term
>> transients. There is no secular component.
>>>>>
>>>>>This bank can also lend the excess reserves it has captured to other
>>>>>banks in a straight up fashion that does not create any new money.
>>>>>e.g. if this bank is undercapitalized and has excess reserves it will
>>>>>lend the reserves to a bigger bank. So no matter where the $1B gets
>>>>>deposited it will add to reserves.
>>>>
>>>> A new deposit adds to aggregate banking system reserves only if the
>>>> funds come from outside the private banking system. Examples: net
>>>> cash deposits by the public
>>>
>>>But net cash withdrawals will subtract (i.e. if everyone decides
>>>they want to bury a box of money in the back yard then the Fed will
>>>need to start buying more bonds).
>>
>> Correct. The Y2K episode was a major case of cash hoarding. The Fed
>> had to buy securities to replenish banking system reserves lost to
>> cash withdrawals in late 1999. Most of that cash was returned to bank
>> deposits in early 2000. The Fed then had to sell securities to soak
>> up the excess reserves in the banking system.
>>>
>>>; spending in USD by foreign central banks
>>>
>>>I'd like to see an example of this.
>>>
>> Foreign central banks hold accounts in USD at the Fed. Those deposits
>> are not reserves of the banking system. If a foreign central bank
>> spends USD, the funds will end up in the banking system and increase
>> banking system reserves.
>>>;
>>>and spending by the Fed to purchase securities. Spending by the
>>>> Treasury does not on average add to aggregate banking system reserves
>>>> because that spending is simply a part of the reciprocal flow of funds
>>>> with the private sector due to taxes and bond sales.

Relevant Pages

  • Re: Non-Banks versus Banks
    ... >> simply equal to the amount of that deposit. ... >additional reserves. ... >bank determine the amount of loans it can create. ... If the bank then issues a loan of $10B, the bank must assume it will ...
    (sci.econ)
  • Re: Non-Banks versus Banks
    ... After the loan is ... However the bank could lend more than $1 billion ... It can acquire the needed reserves by borrowing in the money ... There are N banks in the banking system. ...
    (sci.econ)
  • Re: Non-Banks versus Banks
    ... Due to the ability of the bank to ... >> borrow whatever it might need at a discount, ... >> it has sufficient reserves to cover the loan BEFORE it issues the loan ... >> demand deposits to reserves. ...
    (sci.econ)
  • Re: Non-Banks versus Banks
    ... >>So in the 10 seconds before the loan is granted the bank borrows ... I have said only that EVEN IF THE BANK ACTUALLY HAD ... >>borrow so as to cover the loan. ... > demand deposits to reserves. ...
    (sci.econ)
  • Re: Non-Banks versus Banks
    ... the limit on what one particular bank can create ... >is imposed as 10 times that bank's assets. ... >(or on deposit at the Fed). ... When a bank receives a new deposit, the increase in its reserves is ...
    (sci.econ)