Basics of Bank­ing: Loans Cre­ate a Lot More Than Deposits

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There’s an excel­lent post by John Car­ney, CNBC’s Senior Edi­tor, on the mechan­ics of lend­ing, deposit cre­ation, and how these inter­act with reg­u­la­tory and cap­i­tal require­ments. Highly rec­om­mended:

I’ll have a crack at mod­el­ing this in Min­sky shortly; I have already done a sim­i­lar model to illus­trate why reserves lag deposits in almost all coun­tries, so it shouldn’t be too dif­fi­cult to knock this illus­tra­tion up in it.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • TruthIs­ThereIs­NoTruth

    The link in that arti­cle is also inter­est­ing

    Does it sound famil­iar?

  • koonyeow

    Title: Off-topic (Or Another Nail in The Cof­fin of Neo-clas­si­cal Eco­nom­ics)–13-lavender.pdf

    Take a look at chart 6.

    Ques­tion: How could real house prices be ris­ing when ratio of hous­ing stock to pop­u­la­tion is also ris­ing?

    Answer: Neo-clas­si­cal eco­nom­ics is obsessed with (non-empir­i­cal) supply/demand equi­lib­rium and it ignores banks and debt.

  • Lyon­wiss

    As I have been say­ing here for a long time, econ­o­mists are talk­ing non­sense when they say com­mer­cial banks “cre­ate money out of thin air”. Loans are not money. Even loans can­not be cre­ated “out of thin air” by banks as there are reserve and other con­straints. I won­der how many econ­o­mists (apart from Steve) will bother with the real-world described by John Car­ney.

    Only cen­tral banks have the power to cre­ate some­thing called cur­rency “out of thin air”. But the more they abuse this power the less their cur­rency is like money, which must have the prop­erty of “store of value”, hold­ing its pur­chas­ing power. I sus­pect we will learn what money really is in the not too dis­tant future.

  • MLC


    Am I miss­ing some­thing, or does the bank’s reserve require­ment decrease, as Mr. Parker spends the money in his deposit? I can­not see that the arti­cle com­mented on this.

  • koonyeow


    The arti­cle did com­ment on that, as below

    Now here’s what hap­pens when Mr. Parker writes a check on his account to pay for a new win­dow for his shop (it was bro­ken by some­one who wanted to stim­u­late the local econ­omy, of course.) Scratch Bank will need to trans­fer $90 dol­lars to the win­dow maker’s bank through the pay­ment sys­tem of the Fed­eral Reserve. Scratch Bank, how­ever, doesn’t have any­thing like $90. All it has is $9 dol­lars in bor­rowed reserves plus $10 in retained earn­ings.

    The bank can’t use those $10 in retained earn­ings, how­ever, because it needs them to meet its cap­i­tal require­ment. Even though the with­drawal of the $90 from the bank account extin­guishes the need for a reserve require­ment against the deposit, the loan still remains out­stand­ing. Which, in turn, means the cap­i­tal require­ment remains in place.’

  • LCTesla

    Great find!

    I imme­di­ately started fol­low­ing Car­ney on twit­ter after I read that post.

  • koonyeow

    Title: Off-topic Reloaded (Or Why I Became A Skirt-chaser)

    Because I sim­ply love intel­li­gent ladies who know how to grill men who pre­tend to be intel­li­gent.

  • John Car­ney

    Thanks Steve. Look­ing for­ward to look­ing at your fol­low up!

  • LCTesla

    Steve, thought you might find this inter­est­ing; a prin­ci­ple very sim­i­lar to the great mod­er­a­tion -> finan­cial crash sequence hypoth­e­sized to be at work in cli­mate change dynam­ics:–8976-92eadfc4092e

    Para­phrasal from a blog I found this at:
    “I stum­bled across this really inter­est­ing cli­mate paper when look­ing for some­thing else. Essen­tially it argues that when the cli­mate goes through a major non-lin­ear flip into a dif­fer­ent state, that is pre­ceded by a period in which the nor­mal fluc­tu­a­tions in cli­mate get less pro­nounced To give a loose idea for non-tech­ni­cal folks, it’s as though, as the sys­tem is being squeezed towards the nar­row bot­tle­neck between the old state and the new state, it has less scope to rat­tle around. They show this hap­pen­ing to greater or lesser degrees for eight past cli­mate tip­ping points of very dif­fer­ent char­ac­ter.”

  • Thank you John! It will be after a cou­ple of posts deliv­er­ing on my promise to show that Krug­man doesn’t under­stand IS-LM.

  • Intrigu­ing. My basic Min­sky model fol­lows what is known as the inverse tan­gent route to chaos; this implies that a cli­mate change may do the same–though at much higher dimen­sion­al­ity.

  • Lyon­wiss

    @M Feb­ru­ary 28, 2013 at 9:22 pm

    The bank­ing sys­tem relies on the fact that when Mr Parker spends his money, his deposit goes to the deposit of some­one else in another bank. The bank which has lost Mr Parker’s deposit usu­ally gains some­one else’s deposit from another (dif­fer­ent) bank. The total deposit of the bank­ing sys­tem remains about the same and any sys­tem imbal­ance is man­aged by the cen­tral bank in the unse­cured overnight lend­ing mar­ket in which banks with excess reserves lend to banks with defi­cient reserves.

    A bank run is when a par­tic­u­lar bank’s depos­i­tors with­draw their cash, en masse, and put it “under the pil­low” and not lend to another bank as at-call deposits. A bank run proves that bank deposits are not money. In this case, the whole bank­ing sys­tem will be net short of reserves, a sit­u­a­tion to be dealt with by the cen­tral bank as the lender of last resort.

  • Farnorth5

    RE : The John Car­ney post :

    What a wel­come sur­prise to see in print the actual method used by
    all major banks to cre­ate arti­fi­cial debt money , based on the dou­ble entry book­keep­ing sys­tem in use around the world this past 600 plus years. This is usu­ally kept as a “Pub­lic Secret”. (The Cen­tral Banks use the same sys­tem)

    To think that all a bank has to do to make arti­fi­cial debt money is to cre­ate
    an Accounts Receiv­able dou­ble entry.( Debit Accounts Receiv­able /Credit
    Check­ing Account ‚say $20,000 for a stu­dent loan)

    There you have it ($20,000 arti­fi­cial debt money cre­ated out of thin air)

    Not actu­ally ‚but $20,000 cre­ated by a sim­ple Accounts Receiv­able entry.

    Now if every­one under­stood the real sig­nif­i­cance of this entry, as 97% of the worlds exist­ing money sup­ply is cre­ated by it, it would bring into sharp focus what role debt man­age­ment really is all about in rela­tion to the bal­loon­ing of cer­tain asset prices such as Stocks/Bonds/Residential Real Estate etc. and why the huge Inter­na­tion Finance prob­lems exist.

    The day to day legal manip­u­la­tion by the Cen­tral Banks and Major Fed­eral Banks is enor­mous. The ques­tion is always the same.

    Is it for the ben­e­fit of the pub­lic at large or for the ben­e­fit of the Major Banks/Other finan­cial insti­tu­tions ???

    At the end of the day we all have to accept it is a con­tin­u­ously manip­u­lated finan­cial sys­tem and always chang­ing ‚never in equal­ib­rium.

    God did not make this sys­tem .Man did .
    The sys­tem is always “Fixable“from a tech­ni­cal point of view. 

    The cur­rent Intel­lec­tual arro­gance and stu­pid­ity really knows no bounds ‚when you see the “Spin” in use by both Polit­i­cans and so called “Knowl­edge Work­ers” in the field of Bank Finance/Debt Man­age­ment.

  • Steve Hum­mel

    Money being basi­cally accoun­tancy has been a Social Credit ten­ant since 1919.
    Under­stand­ing this is also essen­tial to see­ing com­pre­hend­ing the inher­ent sys­temic scarcity of indi­vid­ual pur­chas­ing power in com­par­i­son to prices. As for whose ben­e­fit the sys­tem cur­rently is designed to be in, it’s obvi­ously the cur­rent large eco­nomic, finan­cial and polit­i­cal enti­ties. We could change this by wak­ing up to the fol­low­ing:

    Banks are nearly unable to lend in an envi­ron­ment that does not have an accu­mu­la­tion of tech­ni­cal advance­ment and a strong mid­dle class with suf­fi­cient demand. This cul­tural his­tory of pro­duc­tive poten­tial is hence utterly impor­tant to them. Yet, who is the actual heir to our his­tory of tech­ni­cal inno­va­tion? It should take about a sec­ond to rec­og­nize that progress is a com­mu­nal asset, an asset of almost ines­timable value and that the finan­cial sys­tem (the Banks) have usurped this asset for their ben­e­fit only. It also needs to be under­stood that this accu­mu­lat­ing asset is actu­ally the most dom­i­nant fac­tor in pro­duc­tion, oth­er­wise the New Pony Express would be able to com­pete with Fed­eral Express and USPS in mail deliv­ery. Being a fac­tor, in fact the dom­i­nant fac­tor in pro­duc­tion such asset could and should be mon­e­tized and dis­trib­uted directly to all cit­i­zens (or per­haps all those 18 years and older) on a per­ma­nent and peri­odic basis, say monthly. This would replace the neces­sity to bor­row and hence require much less ulti­mate money cre­ation by the FED/Government/Private Banks. It would also enable us to elim­i­nate then redun­dant unemployment/welfare and even even­tu­ally social secu­rity taxes. It would also cre­ate and main­tain an incred­i­bly robust mid­dle class with the per­ma­nent demand that tech­no­log­i­cally advanced economies are hav­ing trou­ble pro­vid­ing. Finally, uti­liz­ing a widely used mech­a­nism already preva­lent in com­merce, a dis­count at retail sale, and which would be fully com­pen­sated back to par­tic­i­pat­ing mer­chants, would elim­i­nate any infla­tion for the con­sumer. We need such new think­ing in eco­nom­ics.

  • Steve Hum­mel

    The citizen’s div­i­dend answers all of the ques­tions posed by Dirk Beze­mer here, includ­ing how to shrink the Banks, debt of all kinds, but pri­mar­ily indi­vid­ual, and per­haps most impor­tant the ques­tion of what is and should be the PURPOSE AND INTENTION of a healthy and humane finan­cial and eco­nomic sys­tem.

  • alain­ton

    I admire for­mer bankers like Mark Car­ney and Fran­cis Cop­pola who get stuck in to the endoge­nous approach to money and in my books what they write on bank­ing the­ory is bet­ter than 99% of econ­o­mists. There are big bear traps here as use of terms such as ‘reserves’ by bankers and spe­cial­ist accoun­tants are very dif­fer­ent to those used in eco­nom­ics text­books and is a big bar­rier to under­stand­ing.

    What Car­ney is focussing on here is the role of equity, As you know steve I have argued that this is a gap in your dou­ble entry model of endoge­nous money cre­ation as your sim­ple model breaches the fun­da­men­tal equa­tion of account­ing. There is no equity to enable the money to be cre­ated. Money sadly can­not be cre­ated from thin air. Mod­el­ling equity and how the credit accel­er­a­tor is related to vari­a­tions in equity val­ues I think is the log­i­cal next step in your mod­els, and I hope holds the key to a replace­ment for IS-LM. Scott Full­wilers use of the Dupont equa­tion to under­stand the role of bank cap­i­tal is a another log­i­cal thing to model in Min­sky at the same time.

    There is an inter­est­ing rela­tion­ship here to Keynes con­cept of a ‘revolv­ing fund of finance’ and the ‘Opti­cal illu­sion’ that sav­ings pro­ceeds invest­ment. I dis­cuss this in some depth here

    Heres an extract

    Let us look at the steady state posi­tion of a bank that lends from its ini­tial equity – that credit is cre­ated, the loans are paid back, the lend­ing power is restored and new loans are made.

    We know from the detailed dou­ble entry mod­el­ling from pre­vi­ous arti­cles that the ini­tial lend­ing power of the bank is equal to its equity, but that ini­tial cap­i­tal turns over, turns a profit, is accu­mu­lated and can be lend again. Indeed we dis­cov­ered that if the banker’s sur­plus is not issued as div­i­dends the lend­ing power can expand, and even if issued as div­i­dends it becomes excess reserves to other banks expand­ing their lend­ing power.

    In dis­tri­b­u­tional terms then the ‘base’ lend­ing power of banks depends on the fac­tor returns of hold­ers of money. It is related to prior ‘sav­ings’ but it is not a one to one iden­tity, as it also depends on the turnover of cap­i­tal and the ‘depre­ci­a­tion’ of money (infla­tion). If in one year the rate of inter­est is equal to the rate of infla­tion and the loan turns over once then strictly savings=investment. How­ever if the loan is prof­itable and inter­est rates are used to expand lend­ing power and those inter­est pay­ments in turn are recy­cled to expand lever­age then there is no one to one iden­tity, the amount of ‘finance’ as a flow will be greater than the ini­tial sav­ings.

    Imag­ine though that the bank turns its sur­plus over to its investors but per­ceives of prof­itable lend­ing oppor­tu­ni­ties. It needs to expand its lend­ing power. It can only do so through attract­ing addi­tional ‘sav­ings’ as we have seen, but once lent this again turns over and becomes part of the revolv­ing fund of finance.

    Put for­mally

    ?Invest­ment (stock)= ?Sav­ings (stock)
    ?Lend­ing (flow)= ?Invested Sav­ings (flow) X turnover
    So if a finan­cial insti­tu­tion between times T0 and T1 needs to attract ?Invested Sav­ings (assum­ing no change in turnover) then from (1) and that ?Savings=?Income-?Consumption it must attract fund­ing from either idle bal­ances or con­sump­tion.

  • Clint Ballinger

    I think MCT approaches are what is miss­ing from MMT, but the inte­gra­tion of the two still needs a lot of work. I am work­ing towards that here Towards a Pure State The­ory of Money

  • Agreed Clint. That’s one of the issues that Min­sky is intended to help clar­ify.