Michael Foster wrote: > Reviving this crusty old thread: > > Stephen A. Lawrence wrote: > >> I have as yet not come across any information indicating that >> commercial banks can lend out more than about 90% of their net >> asset value
Sorry, I should have said their "deposits" here. >> -- reserve requirements currently being around 10% -- >> and you are claiming they can actually lend out about 900% of their >> net asset value. > > You have to be very careful in using the term "asset" when it comes > to banks. When they say assets, they mean the total of their > outstanding loans, not the deposits in them. Not exactly. A loan owned by a bank -- or any other institution -- *is* an asset (it returns interest income, and eventually will return the principal). So outstanding loans are necessarily included as assets on the balance sheet, along with all other assets such as cash, fixed physical plant, securities other than loans, and whatnot. A deposit, on the other hand, represents both an asset (cash) and a liability (the amount "owed" to the depositor). If you borrow $100 from me, and give me an IOU, I have lost a cash asset (the $100) but I've gained a paper asset (the IOU). This is exactly what a bank does when they record a loan on their books as an "asset". This is not deceptive, even if it is confusing; it's merely *accurate*. > A good way to determine > what a bank has lent out relative to the deposits in it is to look at > its annual report. Total assets/total capital = that banks > multiplier. Depends on how they define "capital". I have not found bank annual reports to be masterpieces of clarity in the past -- in fact I'd go so far as to say the ones I've read appeared to be intentionally opaque. (But that observation doesn't bear on the question of how the reserve system is supposed to work.) The NAV of a new (or insolvent) bank could, hypothetically, be zero, while it might still have substantial deposits. Its outstanding loans could be equal to its deposits (but no larger). In that case, the total of its outstanding loans would be (at most) one times its deposits, but would be infinity times its NAV, since NAV=0 in that case. Of course, current banking rules may not allow a bank to operate in that state (for very long). My objection was -- and is -- to your claim earlier in this thread (which I have quoted later in this note) that banks could lend out more than the total of their *deposits* and make up the difference by borrowing from the Fed. > >> I will continue looking around but it would save time if you could >> provide a link to the relevant information. Next step will be dig >> my old macro book out of the basement and see what they say about >> the detailed operation of the discount window, which is what this >> is all about, of course. > > > Here, right from Jed's favorite source of information, Wikipedia: > > "Reserve requirements affect the potential of the banking system to > create transaction deposits. If the reserve requirement is 10%, for > example, a bank that receives a $100 deposit may lend out $90 of that > deposit. If the borrower then writes a check to someone who deposits > the $90, the bank receiving that deposit can lend out $81. As the > process continues, .... Yes, of course, I've already pointed that out, a number of times, in earlier posts, in which I've included at various times an analytic formula for it, and a short parable illustrating it. It's occasionally called the multiplier effect and it has *NOTHING* to do with the Federal Reserve system. Your claim, which I've quoted a bit later in this note, was something stronger: you claimed an individual bank could lend out *more* than that bank's total deposits. I was looking for information to back that claim up, not information on the fractional reserve system. > > So there you have it. By this mechanism, banks lend out ten times as > much money as is deposited in them. $100 is magically transformed > into $1000. Nice business, eh? You misrepresent the article in your summary. If you go back and add up all the deposits in the Wiki article you'll find they total more than all the loans. The multiplier, as I've already pointed out (repeatedly), is a result of the fact that banks lend out their deposits. The banks are allowed to lend out up to 90% of their deposits (or 100% of their deposits in certain cases). Period. *Not* ten times their deposits. Your earlier claim, quoted below, was that an individual bank could lend out 10 times the amount of that bank's total deposits. The above quote from Wiki does not support that claim. In fact they cannot lend out any money which they don't have. This is an extremely important point, and cannot be overemphasized: There is *no* "magic" associated with banks. They accept deposits in order to gain access to funds, and, in order to make a profit, they lend out those funds (and charge interest on the loans), and that was just as true 150 years ago as it is today. Michael Foster stated, earlier in this thread: --------------------------------------------- > Sorry Stephen, I left something out, which makes the thing rather > confusing. The multiplier, that is the amount of money commercial > banks can lend out versus the deposits in them is in fact 10 just > now. It varies. However, that doesn't mean that they create the > money out of thin air. They borrow the money from the Federal Reserve > at the discount rate... You said two things in this quote: You said they can lend out 10 times their *deposits*, which is false, and that they *borrow from the fed* to make up the difference, which is also false. In other words, you said 90% of the money lent out is borrowed directly from the Fed. This is *FALSE*. They do *NOT* borrow the money which they lend out from the Fed; they receive it from their depositors. They can *NOT* lend out ten times their deposits; in fact they can lend out only money which is deposited in them. However, the fact that they lend out their deposits results inevitably in a "multiplier effect", because it results in multiple people "owning" the money at the same time. Current rules (which may or may not be effective) restrict what banks can do, in an effort to rein in money supply growth and reduce the likelihood of bank runs. As such, the rules are *restrictions* on banks, not special powers granted to banks. But, again, the existence of the Fed and "paper money" doesn't bear directly on the multiplier effect, which existed just as surely when the country was on the gold standard.
