[HN Gopher] A simple explanation of how money moves around the b... ___________________________________________________________________ A simple explanation of how money moves around the banking system (2013) Author : ali92hm Score : 100 points Date : 2022-04-23 19:11 UTC (1 days ago) (HTM) web link (gendal.me) (TXT) w3m dump (gendal.me) | _n_b_ wrote: | If this genre appeals to you, the Bits About Money newsletter | (https://bam.kalzumeus.com/archive/) has a lot more content along | these general "how finance really works" themes. The article | about mortgages, in particular, is great. | irq-1 wrote: | FYI Bits About Money is by HN user | https://news.ycombinator.com/user?id=patio11 | dang wrote: | Related: | | _A simple explanation of how money moves around the banking | system (2013)_ - https://news.ycombinator.com/item?id=9351277 - | April 2015 (17 comments) | marcodiego wrote: | The simplest explanation: - You invest in the | bank - The bank loans your money to someone else at high | interest rate - The bank gets paid, keeps most of the | profit and uses a small part of it for your investment. | neilwilson wrote: | Why post something that was explained as incorrect by the Bank | of England in 2014?[0] | | Where did you pick this misconception up from? | | [0]: | https://www.bankofengland.co.uk/-/media/boe/files/quarterly-... | User23 wrote: | Simple, but completely wrong. The bank never loans your money. | When it wants to originate a loan it creates new deposits from | nothing. | cryptica wrote: | Correspondent banking just seems messed up at the incentive | layer... Seems like there is an incentive for banks to just | credit free money into each other's accounts... Surely they | can create lots of smaller (low profile) banks with accounts | all over the place then use this mechanism to print free | money for themselves to expand the money supply ad-infinitum. | The attack surface is massive. With the same money being | loaned and re-loaned across thousands of different banks, how | could anyone possibly detect fraudulent currency creation | (and distinguish it from genuine deposits)? It just takes one | bank to act unethically in a chain of several thousands in | order to subvert the entire system. | | Even without unethical behavior, it seems like a small chance | of human error, when applied across thousands of banks, would | cause accidental printed money to leak into the system. For | example, there have been many news reports of banks | accidentally crediting people with 100x the money which they | were supposed to receive; what about all the times when such | error occurred but was not detected and did not make the | news? That money still found its way into the economy and | still contributed to inflation. | | The problem can be simply summarized as too many single | points of failure. | slv77 wrote: | A homeowner can take $100,000 from a home equity line of | credit and drop it into his savings account and create | $100,000 in new dollars with a button click. The bank | didn't need to "get" deposits to make this happen as the | deposits are created when the homeowner took out the loan. | The new dollars and the liability are just entries in the | banks balance book but the dollars can be spent like any | other dollar at that point. | | If the next day the homeowner moved all the money back and | paid off the equity the dollars are destroyed. This is how | a bank works. | | The size of a banks balance sheet and the number of dollars | it can create is constrained by the amount of shareholder | equity (by regulation). Regulators typically require a 10 | to 1 ratio of loans to capital which has potential for | fraud. | | Just imagine if you had 10 banks levered 10 to 1 and you | took all the deposits and put them on black at the local | casino. Half of your bets would yield a 10x return on | capital and the others you'd lose all your capital (and all | your depositors money) but on average you'd make 5x. | | Because of the risk banks are highly regulated and | regulators require that named individuals that can be held | personally and criminally liable for fraud and auditors who | also can be held personally and criminally liable as well. | NovemberWhiskey wrote: | That is not how fractional reserve banking works, people - | or, to me at least, it gives a wrong impression. | | Say we are in a fractional reserve banking system, where the | required reserve is 10%. | | I deposit $1M at the bank. My bank can now lend $900K to you. | You can now deposit $900K back at your bank. Your bank can | now lend $810K to someone else, and so on and so on. | | The geometric sum of this is "1/reserve_ratio"; so if there's | a 10% reserve ratio, then the initial $1M deposit can lead to | $10M of loans outstanding. No single bank is loaning out more | than is being deposited with it. | mgraczyk wrote: | This used to be true, but hasn't mattered for a long time. | The reserve requirement is zero for most (all?) US banks. | | https://www.federalreserve.gov/monetarypolicy/reservereq.ht | m | tibanne wrote: | Strange that private companies are allowed to create | money from nothing don't you think? | mgraczyk wrote: | It's strange if you have a particular conception of | money. If you think of money as a social technology used | to improve aggregate well being, then it's just a | property that empirically makes sense. Private banking, | with effective regulation, has proven to be a fairly | effective way to stabilize the business cycle and unblock | growth | cryptica wrote: | Sure, it helps to improve the aggregate well being of | those who participate in the fake economy at the expense | of those who participate in the real economy... Great for | crooks! | JumpCrisscross wrote: | > _it helps to improve the aggregate well being of those | who participate in the fake economy at the expense of | those who participate in the real economy_ | | This is financial Luddism. Just because something is | unfamiliar doesn't mean it's bad. | | Private money creation is necessary for a growing, | dynamic economic condition. (The problem is simpler in a | static or simply cyclic economy.) Growth is heterogenous. | To preserve price and bank stability, you want money | created where it's needed and not in excess where it's | not. In times past, this was largely geographic: banks in | the West created money faster than banks in the agrarian | South. Today, the divisions are more complex: a bank | serving tech companies probably creates more deposits | than one serving aging manufacturers. | | Centralising this function in a state apparatus has been | proposed. But the central bank would have to run and then | implement an economic model. Decide where and for whom to | create money. This is central planning. It has a poor | track record. (This is also the argument against bank | concentration [1].) | | [1] https://fred.stlouisfed.org/series/DDOI01USA156NWDB | cryptica wrote: | The way the banking system works now, it mostly creates | money where it's not needed. That's why there is such | high inequality which keeps growing. New capital is just | deployed to chase old capital. It creates anti- | competitive moats which prevent money from going where | it's really needed and where it could be used most | efficiently. It makes bureaucracy viable and economic | efficiency non-viable. | | The vast majority of people who benefit from bank loans | are not value creators, they are rent-seekers. Value | creation necessarily requires taking calculated risks and | banks these days aren't willing to take any risk.... They | need full collateral. It's all about existing collateral. | In the short term, the safest investment you can make is | to build a moat around your existing investment... But if | everyone in the economy is busy building moats (because | that's the only activity which is sufficiency safe for | banks to fund), there will be nobody remaining to do | useful stuff which moves the economy forward. | slv77 wrote: | This is less of a problem with the way that the monetary | system operates and more about policy choices made by | central banks and politicians after the 2008 financial | crisis. | | Debt is a promise to return something if value tomorrow | for something of value today. Too many promises have been | made than will ever be able to be repaid and promises are | going to be broken. | | Regulators and politicians have three choices on how to | deal with broken promises. The first is through | bankruptcy courts where a judge allocates losses | according to the law. The second is through taxes where | politicians take money from one group to honor promises | made to another. The third is to drive inflation and | break promises by returning dollars that have less value | then promised. | | This choice that central banks made was the latter by | trying to drive up inflation. The side effect of the | policy choice however it has tended to favor speculators | and the well connected versus other policy paths. | | I'm not entirely sure those other paths would have been | _better_. Broken promises tend to be what drives | revolutions and the best path is to not make promises | that you can't keep. | howeyc wrote: | That's how it has been for a while, as the bank of | England paper explains. | | The key is that the bank is "on the hook" for being able | to get that money back eventually. So they don't just | loan indiscriminately. | hgomersall wrote: | "On the hook" right up until the point they're about to | go bust, then they hand over responsibility to the | government to rescue them from their rampant speculation. | SilasX wrote: | But "eventually" can mean "now, as an easy loan from the | central bank/lender of last resort", which trust the | solvency of the bank's loans. | User23 wrote: | It's the defining characteristic of a banking license. | Like any license it permits activity that would otherwise | be illegal. In this case, creating new dollars. | NovemberWhiskey wrote: | It doesn't matter because no banks have been anywhere | near the reserve requirements that were previously in | effect. The change to the "ample reserves" regime is just | a tacit admission that lending is not functionally | limited by reserve ratios in the U.S. at the moment. | mgraczyk wrote: | Yep that's what I meant by "hasn't mattered for a long | time". | NovemberWhiskey wrote: | I'm sure you know, but (based on discussions that took | place at the time of the announcement back in 2020) I | know a lot of people who leapt directly to the assumption | that the removal of the reserve requirement was so that | banks could "create even more money out of thin air than | they were previously allowed to do". | | I hope you don't mind me clearing that misconception up, | even if it's not for your benefit! | RobertoG wrote: | That's not how it works. | | Banks lend and then try to find reserves, after the fact, | because they have legal requirements. No bank loss a good | lending business because they have not reserves enough. | | When a bank make a loan, there are two possibilities: they | have enough reserves, then they don't need to do anything. | | Or they don't have enough reserves, so they have to borrow | them from other banks or from the central bank. | | If they borrow them from other banks they are creating | demand for reserves in the inter-bank market. That makes | the interest rate go up. | | The central banks don't try to control the quantity of | money, but the interest rate. If there are a lot of demand | for reserves and the Central Bank don't add reserves to the | system the interest rate will go up. So, the Central Bank | add or retire reserves in order to keep the interest rate | in the range they want. | | The quantity of money is decided by the demand of lending | in the economy. | | The Central Bank can choose to try to control the quantity | of money or the interest rate, but not both. All modern | Central Banks try to control the interest rate. | metadat wrote: | The reality is actually significantly worse than what parent | comment posits. Money gets created out of thin air frequently | in banking, it's quite the scheme / sham. | | Learning more about how the financial system works is usually | upsetting, and in surprising ways. The entire business has a | certain ring and scumbag scent to it. | epistasis wrote: | I don't think that's a fair interpretation of money or of | what banks are doing. | | Imagine that a business has $1M/month of revenue, mostly | through a quote and purchase order system where the terms | are typically net 30. Then imagine they turn to net 60 or | net 15, either increasing or decreasing their cashfrow for | a single month. The terms of the invoicing are debt | creation. And all debt creation is money creation. | | Thinking of money like swapping gold really limits the | reality of how money has always functioned in our society. | Money and debt are social relations, bonds between people, | bonds between individuals and a larger collective. It's a | human creation, that's been created again and again over | time, and the idea of a money-less society is pretty much | impossible to come up with. | | We must think of money not as an external thing, outside of | humanity, but as an essential part of what humans do and | create. | OscarCunningham wrote: | Except that the people who are loaned money withdraw it | pretty quickly, and then the bank does need cash from | deposits (or from inter-bank lending, but the net amount of | that is zero). | JumpCrisscross wrote: | > _or from inter-bank lending, but the net amount of that | is zero_ | | Banks in a crunch don't look for deposits. They approach | the Fed's discount window [1]. | | Capital requirements aim to ensure banks have enough high- | quality collateral to borrow sufficient reserves in most | catastrophes. (When the situation threatens to exceed that | threshold, we call it a systemic event.) | | [1] https://www.federalreserve.gov/regreform/discount- | window.htm | slv77 wrote: | Banks cover their funding needs through the interbank | market that provides the overnight loans required to | balance their books at the end of the day. Banks will | raise deposit rates to attract deposits if they | constantly find that they need to go to the interbank | market to balance their books because it is cheaper. | | The discount window is used when the bank is unable to | access the interbank market which is usually an indicator | the bank is expected to fail. The discount window | provides liquidity for high quality assets at high costs | (which is why it is called the discount window). | | If the bank runs out of high quality assets and can't | raise capital it becomes insolvent (bankrupt) and the | FDIC takes over the bank and winds it down. | JumpCrisscross wrote: | > _will raise deposit rates to attract deposits if they | constantly find that they need to go to the interbank | market to balance their books because it is cheaper_ | | This is true for the largest banks. For many smaller | banks, interbank lending is cheaper than deposits. | Particularly if those deposits must come from new | customers. | | Your model is roughly correct over long, strategic time | periods. But in tactical timeframes, deposits are assumed | fixed or lightly. (In fact, the post-97 role of money | centre banks has been to attract deposits to then lend to | smaller banks.) | slv77 wrote: | Yes, if a small bank is in an geographic area | experiencing high loan demand the interbank market may be | a cheaper source of funds. If the bank also has | inefficient infrastructure to service retail customers | they may find internal deposits more expensive then the | interbank market. | | Regulators however are less than thrilled if these | imbalances persist long term because banks that rely | heavily on hot funds tend to experience runs. | tmnvix wrote: | Edit: Apologies for being slightly off topic here - this was | meant more as a response to a comment elsewhere on money | creation. | | I've been keenly interested in the subject of banks, debt, and | money creation ever since I picked up a book on the subject of | debt around 2006. I really appreciated having a (very faulty but | nonetheless useful) mental model to apply when trying to make | sense of subsequent events. I sometimes like to think that I saw | the GFC coming, but was probably just primed to see how | precarious our debt based financial system had become. | | With my local (NZ) housing market once again appearing to be on | the brink of big changes (many are suggesting a crash), my | interest has been piqued again. Looking about at what is out | there that can help me make sense of what's going on I | rediscovered a nice little interview (from our friends at RT no | doubt) that I'd recommend to anyone trying to create their own | mental model to help them understand the fascinating, | frustrating, and confusing reality of banking. | | https://www.youtube.com/watch?v=EC0G7pY4wRE | | One of the interviewees is Richard Werner - the man who | introduced the concept of quantitative easing during the Japanese | Financial crisis in the 90s. | utunga wrote: | I have no idea who you are but the fact you're interested in | debt and in NZ makes me wonder if you'd be interested in a | project we're working on https://cashless.social | contingencies wrote: | https://en.wikipedia.org/wiki/Debt:_The_First_5000_Years | perhaps? Happy https://en.wikipedia.org/wiki/Anzac_Day ... miss | the biscuits! ___________________________________________________________________ (page generated 2022-04-24 23:00 UTC)