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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18 Responses to Basics of Banking: Loans Create a Lot More Than Deposits

  1. TruthIsThereIsNoTruth says:

    The link in that article is also interesting

    Does it sound familiar?

  2. koonyeow says:

    Title: Off-topic (Or Another Nail in The Coffin of Neo-classical Economics)

    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.

  3. Lyonwiss says:

    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.

  4. MLC says:


    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.

  5. koonyeow says:


    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.’

  6. LCTesla says:

    Great find!

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

  7. koonyeow says:

    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.

  8. John Carney says:

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

  9. LCTesla says:

    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:

    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.”

  10. Steve Keen says:

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

  11. Steve Keen says:

    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.

  12. Lyonwiss says:

    @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.

  13. Farnorth5 says:

    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.

  14. Steve Hummel says:

    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.

  15. Steve Hummel says:

    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.

  16. alainton says:

    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.

  17. Clint Ballinger says:

    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

  18. Steve Keen says:

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

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