[Conversation starter] Where do banks get the money they lend to people in the private sector?

[Econ4Every1]

Then what good are reserves?

Reserves are simply settlement funds.

The Fed can manipulate the supply of money in the broader economy just by manipulating a relatively small amount of reserves via monetary policy.

The Fed can increase or decrease the level of reserves which in turn affects the cost of lending. The Fed can also manipulate the reserve requirement itself.

The much longer answer is:

All central banks provide or oversee the interbank payments system in their country, which is the system that transfers deposit liabilities from one bank to another when customers write checks or use their ATM cards.

We all use double-entry bookkeeping, so the method for clearing payments between banks is essentially the same in all modern economies.

If there are two banks in a system, each of which cashes checks from the other, then each transaction creates an obligation by one bank to pay the other. If we were very inefficient, we could send a courier from one bank to the other every time a check was deposited, to return the check to the bank on which it was drawn, and to return with a sack of cash in the amount of the check.

If we're thinking a little more efficiently, we can agree to send one courier at the end of each day, with all the checks accepted that day, and we can total up the checks deposited by each bank on the accounts of the other, then compare the totals. We will subtract the smaller amount of checks from the larger, and whichever bank had cashed the smaller amount of checks would owe one "net" amount of money to the other bank. That “deficit” bank can send a courier with a small sack of cash to settle the net amount - even though we may have cashed millions of dollars' worth of each other's checks that day, the net amount owed by the deficit bank to the “surplus” bank might be very, very small.

Now if we're being even MORE efficient, we can agree that each of us would open a checking account at the other's bank - so one bank opens a checking account in the other, and vice versa - rather than having to send our courier with the sack with the net amount of cash every day, we just have the deficit bank create a deposit for the net in the account of the surplus bank. At the end of the next day, if yesterday’s deficit bank is now the surplus bank, it can just reduce the “funds” the other bank has “on deposit” with it. If that bank’s surplus is greater than the balance in the deficit bank’s account, the new deficit bank can simply create a balance in the surplus bank’s account to make things add up.

Notice that each of these banks now has funds “on deposit” with the other bank, but neither bank has actually made a deposit in the other bank. The deficit bank simply creates a deposit “out of thin air!” for the surplus bank as a method to keep score between them.

We are now using these two checking accounts to settle our affairs every day, so no money is actually changing hands between us at all unless one of us becomes so severely deficit to the other that we agree we probably ought to settle the net in cash. But in the main, neither of us ever expects to withdraw those settlement funds so that we can lend them to anyone, or to do anything else with them. They are simply there as a scorekeeping mechanism so that we can process each others' payments. That’s pretty efficient.

Of course, there are always more than two banks, so all banks have to do this with all other banks if they are going to all be able to accept each others’ checks. We could do this - have every bank create an account with every other bank for the purposes of settlement. That's certainly better than having bicycle couriers transferring sacks of checks and sacks of cash every day, but we can still see more obvious efficiencies to be had.

What if we created a banker's bank, and ALL of us opened an account with that bank? Then, rather than each bank having to have an account with every other bank in order to settle payments, it would only need ONE account, with the "central" bank.

Well, this is great! Now what we do is hire a bookkeeper (call him a clearinghouse), and we report every day to him with the number of checks we have received in deposit from accounts drawn on other banks.

We don't even care WHICH banks those checks are drawn on. As long as every bank honestly reports the total value of all checks it has cashed (which they have an incentive to do - they wouldn't under-report, because they would short themselves, and they wouldn't over-report, because they have to provide the cancelled checks as evidence), then all we have to do is report ONE net number for all our checking transactions. We can tell the clearinghouse how many checks we accepted from all other banks today, and we can tell them how many of our canceled checks we received from all other banks, and - voila! We know instantly what we owe to "all other banks" or what "all other banks" owe to us. It’s just one net number, and it’s a lot smaller than the number of transactions we processed throughout the day.

Once the clearinghouse has a tally of every bank's net, it simply hands the list to the central bank, which begins the merry work of either reducing or increasing the settlement fund account balance of every bank in the system by the amount reported by the clearinghouse. The central bank doesn’t care who owes what to whom. All they care about is the net amount. They aren’t “transferring” a balance from bank “A” to bank “B”, they’re just going down the clearinghouse list and creating one transaction for each bank. Every surplus bank is going to receive settlement funds (or *ahem* “reserves”), and every deficit bank is going to lose them. No money is getting transferred. The central bank is simply creating or reducing deposit balances by following the list the clearinghouse provides – one lump sum addition or subtraction to each bank’s balance. The net result is exactly the same as if every bank had sent a courier with cash every time another bank accepted the deposit of one of their checks. It’s just a LOT more efficient.

There's no reason for any bank, under normal clearing, to exchange anything like cash. Now we can see that what we have done is set up a completely different system of money which has very little to do with the bank deposits of all of those bank customers. Settlement funds aren’t being used to protect depositors, or to pay them, or to make loans. We are only keeping score of the net effect of all transactions between banks. What we're really doing here is creating a sort of "mirror" at the central bank of what's going on at our actual banks. It's essentially a complete, duplicate model of our banking system - like one of those WWII strategy boards, where admirals smoking cigars have lackeys push wooden ship models around a plexiglass sea to keep track of the action in the real theater.

Our system of settlements is the plexiglass sea, and reserves are the wooden ships we push around to keep track of which banks are on the attack, and which are hunkering down for a long night of defense.

This is what reserves are. You can't put wooden ship models into battle, nor can banks lend reserves. They exist to aid in score keeping so that we can create and reduce scores as needed to keep track of what's going on without actually having to send couriers to every bank with sacks of checks and cash.

 

[ImJustABill]

Yes. We're not talking about the aggregate.

That's exactly what I was talking about. Reserves don't leave the banking system except as cash. I said several times that reserves are simply transferred between banks.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

 

[Toddsterpatriot]

Then what good are reserves?

Reserves are simply settlement funds.

The Fed can manipulate the supply of money in the broader economy just by manipulating a relatively small amount of reserves via monetary policy.

The Fed can increase or decrease the level of reserves which in turn affects the cost of lending. The Fed can also manipulate the reserve requirement itself.

The much longer answer is:

All central banks provide or oversee the interbank payments system in their country, which is the system that transfers deposit liabilities from one bank to another when customers write checks or use their ATM cards.

We all use double-entry bookkeeping, so the method for clearing payments between banks is essentially the same in all modern economies.

If there are two banks in a system, each of which cashes checks from the other, then each transaction creates an obligation by one bank to pay the other. If we were very inefficient, we could send a courier from one bank to the other every time a check was deposited, to return the check to the bank on which it was drawn, and to return with a sack of cash in the amount of the check.

If we're thinking a little more efficiently, we can agree to send one courier at the end of each day, with all the checks accepted that day, and we can total up the checks deposited by each bank on the accounts of the other, then compare the totals. We will subtract the smaller amount of checks from the larger, and whichever bank had cashed the smaller amount of checks would owe one "net" amount of money to the other bank. That “deficit” bank can send a courier with a small sack of cash to settle the net amount - even though we may have cashed millions of dollars' worth of each other's checks that day, the net amount owed by the deficit bank to the “surplus” bank might be very, very small.

Now if we're being even MORE efficient, we can agree that each of us would open a checking account at the other's bank - so one bank opens a checking account in the other, and vice versa - rather than having to send our courier with the sack with the net amount of cash every day, we just have the deficit bank create a deposit for the net in the account of the surplus bank. At the end of the next day, if yesterday’s deficit bank is now the surplus bank, it can just reduce the “funds” the other bank has “on deposit” with it. If that bank’s surplus is greater than the balance in the deficit bank’s account, the new deficit bank can simply create a balance in the surplus bank’s account to make things add up.

Notice that each of these banks now has funds “on deposit” with the other bank, but neither bank has actually made a deposit in the other bank. The deficit bank simply creates a deposit “out of thin air!” for the surplus bank as a method to keep score between them.

We are now using these two checking accounts to settle our affairs every day, so no money is actually changing hands between us at all unless one of us becomes so severely deficit to the other that we agree we probably ought to settle the net in cash. But in the main, neither of us ever expects to withdraw those settlement funds so that we can lend them to anyone, or to do anything else with them. They are simply there as a scorekeeping mechanism so that we can process each others' payments. That’s pretty efficient.

Of course, there are always more than two banks, so all banks have to do this with all other banks if they are going to all be able to accept each others’ checks. We could do this - have every bank create an account with every other bank for the purposes of settlement. That's certainly better than having bicycle couriers transferring sacks of checks and sacks of cash every day, but we can still see more obvious efficiencies to be had.

What if we created a banker's bank, and ALL of us opened an account with that bank? Then, rather than each bank having to have an account with every other bank in order to settle payments, it would only need ONE account, with the "central" bank.

Well, this is great! Now what we do is hire a bookkeeper (call him a clearinghouse), and we report every day to him with the number of checks we have received in deposit from accounts drawn on other banks.

We don't even care WHICH banks those checks are drawn on. As long as every bank honestly reports the total value of all checks it has cashed (which they have an incentive to do - they wouldn't under-report, because they would short themselves, and they wouldn't over-report, because they have to provide the cancelled checks as evidence), then all we have to do is report ONE net number for all our checking transactions. We can tell the clearinghouse how many checks we accepted from all other banks today, and we can tell them how many of our canceled checks we received from all other banks, and - voila! We know instantly what we owe to "all other banks" or what "all other banks" owe to us. It’s just one net number, and it’s a lot smaller than the number of transactions we processed throughout the day.

Once the clearinghouse has a tally of every bank's net, it simply hands the list to the central bank, which begins the merry work of either reducing or increasing the settlement fund account balance of every bank in the system by the amount reported by the clearinghouse. The central bank doesn’t care who owes what to whom. All they care about is the net amount. They aren’t “transferring” a balance from bank “A” to bank “B”, they’re just going down the clearinghouse list and creating one transaction for each bank. Every surplus bank is going to receive settlement funds (or *ahem* “reserves”), and every deficit bank is going to lose them. No money is getting transferred. The central bank is simply creating or reducing deposit balances by following the list the clearinghouse provides – one lump sum addition or subtraction to each bank’s balance. The net result is exactly the same as if every bank had sent a courier with cash every time another bank accepted the deposit of one of their checks. It’s just a LOT more efficient.

There's no reason for any bank, under normal clearing, to exchange anything like cash. Now we can see that what we have done is set up a completely different system of money which has very little to do with the bank deposits of all of those bank customers. Settlement funds aren’t being used to protect depositors, or to pay them, or to make loans. We are only keeping score of the net effect of all transactions between banks. What we're really doing here is creating a sort of "mirror" at the central bank of what's going on at our actual banks. It's essentially a complete, duplicate model of our banking system - like one of those WWII strategy boards, where admirals smoking cigars have lackeys push wooden ship models around a plexiglass sea to keep track of the action in the real theater.

Our system of settlements is the plexiglass sea, and reserves are the wooden ships we push around to keep track of which banks are on the attack, and which are hunkering down for a long night of defense.

This is what reserves are. You can't put wooden ship models into battle, nor can banks lend reserves. They exist to aid in score keeping so that we can create and reduce scores as needed to keep track of what's going on without actually having to send couriers to every bank with sacks of checks and cash.

Reserves are simply settlement funds.

Great, so simply lend me my $200,000 with no deposits or reserves already.

nor can banks lend reserves.

They can't lend without them.

 

[Toddsterpatriot]

Yes. We're not talking about the aggregate.

That's exactly what I was talking about. Reserves don't leave the banking system except as cash. I said several times that reserves are simply transferred between banks.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

So you agree, in both cases my loan reduced (used) the reserves of my lender.
Tell me again that they didn't lend me reserves. LOL!
And that those reserves weren't from a customer deposit. LOL!!!

 

[Econ4Every1]

Great, so simply lend me my $200,000 with no deposits or reserves already.

I realize that was TLDR...but if you had read it, you realize that settlement funds (what reserves really are) make banking more efficient.

They can't lend without them.

If we wanted to go back to the system that existed prior to the creation of the Federal Reserve we could. But why would anyone want to do that?

However, today, you are correct, the Fed (not the market) sets a requirement for reserves so that it can carry out monetary policy, but that doesn't mean that banks lend reserves.

 

[ImJustABill]

That's exactly what I was talking about. Reserves don't leave the banking system except as cash. I said several times that reserves are simply transferred between banks.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

So you agree, in both cases my loan reduced (used) the reserves of my lender.
Tell me again that they didn't lend me reserves. LOL!
And that those reserves weren't from a customer deposit. LOL!!!

That's exactly what I was talking about. Reserves don't leave the banking system except as cash. I said several times that reserves are simply transferred between banks.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

So you agree, in both cases my loan reduced (used) the reserves of my lender.
Tell me again that they didn't lend me reserves. LOL!
And that those reserves weren't from a customer deposit. LOL!!!

You are confusing association and causation.
In your mortgage example, transferring reserves to another bank caused the reserve balance to decrease, not your mortgage.
In your cash example, settling a liability in cash caused the reserve balance to decrease, not your loan.
In the Super Bowl, scoring more points caused the Pats to win, not your lucky hat.

Banks do not lend out reserves. Reserves come from deposits from the Fed to customers, not from customers.

I apologize, but I just can't make this any simpler for you, but here is some additional reading you can do on your own.
https://www.kreditopferhilfe.net/docs/S_and_P__Repeat_After_Me_8_14_13.pdf

 

[ImJustABill]

Great, so simply lend me my $200,000 with no deposits or reserves already.

I realize that was TLDR...but if you had read it, you realize that settlement funds (what reserves really are) make banking more efficient.

They can't lend without them.

If we wanted to go back to the system that existed prior to the creation of the Federal Reserve we could. But why would anyone want to do that?

However, today, you are correct, the Fed (not the market) sets a requirement for reserves so that it can carry out monetary policy, but that doesn't mean that banks lend reserves.

With that said, there are other countries with sovereign currencies and central banks that do not have a reserve ration requirement.

 

[Toddsterpatriot]

Great, so simply lend me my $200,000 with no deposits or reserves already.

I realize that was TLDR...but if you had read it, you realize that settlement funds (what reserves really are) make banking more efficient.

They can't lend without them.

If we wanted to go back to the system that existed prior to the creation of the Federal Reserve we could. But why would anyone want to do that?

However, today, you are correct, the Fed (not the market) sets a requirement for reserves so that it can carry out monetary policy, but that doesn't mean that banks lend reserves.

I asked you back in post #20 to give me a $200,000 mortgage without using customer deposits or reserves.

Have you given up?

 

[Toddsterpatriot]

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

So you agree, in both cases my loan reduced (used) the reserves of my lender.
Tell me again that they didn't lend me reserves. LOL!
And that those reserves weren't from a customer deposit. LOL!!!

That's exactly what I was talking about.

I'm talking about a single bank.
Still working on my $200,000 mortgage with no deposits?
Because, so far, you're failing to deliver.

I said several times that reserves are simply transferred between banks.

You said banks don't make loans from deposits or reserves.
I just showed you two ways you're wrong.

I said that banks create money Ex Nilo and account for those funds on their balance sheets.

And then you ruined it when you said they had to pay it back to thin air.

Banks do not lend out reserves to customers. There is inter-bank lending, but that is a separate topic.
Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability. The liability could be a check or a deposit into another customer's account. If it goes to someone without a account at the same bank, then reserves are transferred to the other bank. In either case, additional deposits funds are created from your loan.

When payments are made from an account at one bank to someone with an account at a different bank, once again reserves are transferred accordingly.

When cash is withdrawn from a bank, that is effectively the same as a transfer of reserves (usually temporary) as cash is basically a portable reserve account.

For paying back the loan:
When you transfer money from your checking account to your loan account, both balances are reduced by the same amount and that credit is extinguished.

Banks do not lend out reserves to customers.

Then what good are reserves?

Banks do transfer reserves as customers move deposits, make payments, or withdraw cash.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Are those reserves still available for my bank to use for their other business?

For your mortgage, a $200k asset was created for the bank along with a matching $200k liability.

Yes.

The liability could be a check or a deposit into another customer's account

Yes.

If it goes to someone without a account at the same bank, then reserves are transferred to the other bank.

Yes.

Then what good are reserves?
Short answer: Non-cash reserves are used to settle payments. For example, your write a check to someone and they deposit to another bank.
Vault cash is kept on hand to meet cash withdrawal demands of customers.

Does my $200,000 mortgage reduce the reserves of the bank I borrowed from?
Depends. If the corresponding liability stays at the bank, then no. If the payment goes to a different bank, then yes.

If I borrow $200,000 and ask for $20s, does my loan reduce the reserves of the bank I borrowed from?
Yes, vault cash is included in a bank's reserve balance. The corresponding reserves go with the cash until they are redeposited.
The bank is still creating both an asset and liability and then settling that liability with cash the same as another other deposit account.

So you agree, in both cases my loan reduced (used) the reserves of my lender.
Tell me again that they didn't lend me reserves. LOL!
And that those reserves weren't from a customer deposit. LOL!!!

You are confusing association and causation.
In your mortgage example, transferring reserves to another bank caused the reserve balance to decrease, not your mortgage.
In your cash example, settling a liability in cash caused the reserve balance to decrease, not your loan.
In the Super Bowl, scoring more points caused the Pats to win, not your lucky hat.

Banks do not lend out reserves. Reserves come from deposits from the Fed to customers, not from customers.

I apologize, but I just can't make this any simpler for you, but here is some additional reading you can do on your own.
https://www.kreditopferhilfe.net/docs/S_and_P__Repeat_After_Me_8_14_13.pdf

You are confusing association and causation.

No, I'm not.

In your mortgage example, transferring reserves to another bank caused the reserve balance to decrease, not your mortgage.

I took out the mortgage, to pay the seller.
Did my loan cause the reserves of my bank to fall?
If they fell, why would you say they didn't lend me those reserves?
They didn't gift me reserves.
Just as when I deposit money at a bank, their increase in reserves isn't a gift from me.

Deposits add to reserves, loans subtract from reserves. Pretty simple.

Banks do not lend out reserves

I borrowed $10000 in $20 FRNs. My bank had them in reserves, after my loan, they no longer do.

What did they lend me if not reserves?

I apologize, but I just can't make this any simpler for you,

No need. Make it simpler for yourself.

but here is some additional reading you can do on your own.

Thanks. I enjoy that paper.

For an individual bank, the link between reserves and loans is an indirect and largely uncontrollable one. Individual banks can try to "get rid of" their excess reserves by making new loans, and, to the extent that the deposits so created leave their bank and, importantly, do not return as new deposits (the bigger the bank the less likely this condition is to hold), this will work for them

 

[Econ4Every1]

I asked you back in post #20 to give me a $200,000 mortgage without using customer deposits or reserves.

Have you given up?

I did in post #36.

Though in reading your question here, now that I understand what you are objecting to in better context given our conversation....

I said banks don't lend reserves to customers. I never said banks don't use reserves and I never said that reserves are transferred between banks.

 

[Toddsterpatriot]

When a customer deposits money in a bank, that banks reserve level rises.

Yes, deposits add to reserves, loans subtract from reserves.

Absolutely correct, but the reserves are transferred between banks accounts at the Fed. They aren't lent to customers.

Today banks are paid a flat rate in interest for excess reserves.

Banks are paid for reserves, not for excess reserves. Be precise.

The Fed only pays interest on excess reserves (do you dispute this?). The term "excess reserves" gives us some hint as to the fact that they are excess in that they aren't being used as reserves to meet a banks reserve requirement against loans made.

Banks don't earn interest on required reserves, they earn interest on the money they created and lent.

Ok, so let's say a bank has created $100 from thin air and lent it. The bank must maintain a 10% reserve ratio, thus it must have at least $10 on deposit at the Fed.

Where can it get this $10 reserve?

It can attract deposits or borrow it from other banks.

Now let's say the bank makes a $10 loan. Now it has $110 in loans and $10 as a reserve. The bank is $1 short. This it has a deficit of $1 of reserves.

No, its deficit is $1 larger than before. Currently the deficit is $11.

How could it have a deficit of $11 when it already had $10 in reserves and made a new loan of which it had to acquire an additional dollar in reserves?

Sure, that's why banks keep a small amount of "physical stuff" on hand. As I said, in order for a bank to have physical dollars it must acquire them via deposits or it must swap reserves at the Fed.

In order to lend me a $1 FRN, the bank needs deposits? Sounds like your claims are evolving.

See this is where things get really confusing. There is timing involved.

When a bank (a credit worthy and stable bank) makes a loan from thin air to a customer, they do not have to have the necessary reserves on hand to cover their reserve requirement. They can borrow reserves after the fact that night. This is why there is an overnight system for lending of reserves.

As a matter of fact, banks that do less than $15 million in transactions aren't required to keep any reserves at all.

Banks that do between $15-$115 are required to maintain a 3% reserve requirement and those over $115 million have a 10% requirement.

See Fed Regs here

Where did I say a bank doesn't need reserves/ deposits?

Post #4. "So, no, loans do not come from deposits."

At the risk of being condescending as I've been accused, but you realize that what I said and you said aren't the same thing, right?

Loans (more precisely) aren't funded from reserves, but most banks (see above) need to acquire reserves (if they lack adequate reserves) to meet their reserve requirements.

What I said is that banks don't lend customer deposits to other customers.

Show me. Make me the $200,000 mortgage loan I need from your new bank. Don't use deposits!

Sure....A banks loans are ultimately backed by capital, not reserves, but before I continue a little background on "reserves" and "captial" in case we disagree.

The name "reserves" is perhaps a major source of confusion because a reserve is conceived of as some sort of backup plan, something set aside in case of an emergency.

In accounting, a reserve is an acknowledgment of a contingent liability designed to prevent us from being caught short if that liability arises.

Reserve balances "on deposit at the Fed" don't serve any of those functions: none of them.

If your bank fails, its depositors will never see a dime of "reserves". If a bank gets into trouble, it cannot withdraw "reserves" to pay creditors. A bank cannot lend "reserves" to customers, or buy Wall Street assets with them.

What we oddly call reserves (in this context) are what is called, in most countries, "settlement funds".

Ok, so the solvency of a bank is determined by its capital relative to its liabilities, not it's reserves. Loans defaulted on are paid for with the collateral that secured them and if that is insufficient, the banks capital.

Ok, so how do we start a bank without deposits? Simple.

First, depending on the risk profile you wish to make loans you might need between $6-$20 million in capital. 20-25% of which must come from individual investors. The rest can be collected from shareholders of which there should be at least 750 to 1000 or more. This capital is deposited at the Fed. (Find all the rules here).

To sell you a $200,000 mortgage a new bank (with no deposits) could, as I said, create the loan out of thin air and acquire the necessary reserves after the fact via the interbank market (borrowing other banks excess reserves). Substantiating my claim that loans aren't lent from reserves.

So my bank now has a $200k liability and a $200k asset plus interest. That night it goes on the interbank market and borrows the necessary reserves, in this case, $2000. If my bank lends to you at ~4% and acquires the required reserves for 1.12%, then I would make 4% on $200k and pay 1.12% on $2k.

Now here is where savers come in. Let's say the next day someone opens a checking account and deposits $1000. Since I don't pay interest on checking accounts, I now have $1000 in excess reserves (as long as the average daily balance of all my depositors checking accounts is $1000

So I can make loans without deposits, but deposits increase my profits.

Banks use deposits to meet reserve requirements.

Right, deposits add to reserves and nothing subtracts from reserves. LOL!

First, reserves are split into two categories, required and excess.

If a bank has excess (pre-2008) they were earn nothing and would be incentivized to lend them to another bank. Post 2008 banks either keep their excess reserves and get paid 1.25% or they lend the

To sell you a $200,000 mortgage a new bank (with no deposits) could, as I said, create the loan out of thin air and acquire the necessary reserves after the fact via the interbank market (borrowing other banks excess reserves). Substantiating my claim that loans aren't lent from reserves.

So my bank now has a $200k liability and a $200k asset plus interest. That night it goes on the interbank market and borrows the necessary reserves, in this case, $2000.

You think your new bank can give me a $200,000 mortgage with no deposits and no reserves and then simply borrow $2000 in reserves?

(borrowing other banks excess reserves)

Where did this other bank get $2000 in excess reserves?

 

[EdwardBaiamonte]

Banks do not lend out reserves.

if they hold an excess of reserves they can elect to lend out what were once reserves, if reserve requirements change they can elect to lend out what were once reserves.
If they lend out reserves they are no longer reserves so who knows what you mean?

 

[EdwardBaiamonte]

. Reserves come from deposits from the Fed to customers, not from customers.

reserves don't come from customers? If a bank takes in $100 from a customer that would in effect create a $10 reserve. If bank takes in deposits from Fed that in effect creates a higher reserve requirement for bank. If bank takes in deposit from Fed for simultaneous lending then you might say, owing the fungibility of money , reserves come Fed deposits to customers.

 

[Econ4Every1]

You think your new bank can give me a $200,000 mortgage with no deposits and no reserves and then simply borrow $2000 in reserves?

Apologies, it would have to borrow 10%, thus $20k, not $2k (typo).

In theory yes, in practice, banks are like any other entity that wants to make money. Banks will assess the risk of the bank in question and make the decision to lend and decide the rate accordingly.

Of course, the lending bank knows where it stands with other banks before it makes a loan.

Where did this other bank get $2000 in excess reserves?

Historically the US wasn't created as a fiat economy. I know I don't have to explain the gold seizure of 1933 or the transfer of $600 million dollars in gold to the Treasury in 1934 or the fact that a small portion of that was held by the Fed. Later the US disconnected from backing currency from gold altogether, thus there was already money in the system.

From that point, domestic deficit spending (dollars that ended up being saved in the US Federal reserve system) done by the government ends up in the banking system as savings/ reserves. Given the fungible nature of money, I can't tell you, exactly where the justification for the creation of the dollar in your pocket came from any more than I can tell you exactly where the reserves the Fed holds cam from.

As I said in post #36, hypothetically if a government were to start off as fiat, it could declare it's dollars as valuable and spend them into the economy. The act of spending would create savings (through the purchase of productivity) and savings would create the reserves that banks need to issue loans.

 

[Econ4Every1]

reserves don't come from customers? If a bank takes in $100 from a customer that would in effect create a $10 reserve. If bank takes in deposits from Fed that in effect creates a higher reserve requirement for bank. If bank takes in deposit from Fed for simultaneous lending then you might say, owing the fungibility of money , reserves come Fed deposits to customers.

When a customer deposits $100, that creates $100 in reserves because banks don't lend reserves to customers. Any reserves a bank holds are either required, in that the bank has made loans of some amount against which it must keep 10% reserves on deposit at the Fed, or excess reserves in that excess reserves aren't required to keep them on hand. Banks can lend excess reserves to other banks in the federal reserve system that find themselves at a deficit of reserves.

Since loans create deposits, the act of lending creates reserves.

 

[Toddsterpatriot]

You think your new bank can give me a $200,000 mortgage with no deposits and no reserves and then simply borrow $2000 in reserves?

Apologies, it would have to borrow 10%, thus $20k, not $2k (typo).

In theory yes, in practice, banks are like any other entity that wants to make money. Banks will assess the risk of the bank in question and make the decision to lend and decide the rate accordingly.

Of course, the lending bank knows where it stands with other banks before it makes a loan.

Where did this other bank get $2000 in excess reserves?

Historically the US wasn't created as a fiat economy. I know I don't have to explain the gold seizure of 1933 or the transfer of $600 million dollars in gold to the Treasury in 1934 or the fact that a small portion of that was held by the Fed. Later the US disconnected from backing currency from gold altogether, thus there was already money in the system.

From that point, domestic deficit spending (dollars that ended up being saved in the US Federal reserve system) done by the government ends up in the banking system as savings/ reserves. Given the fungible nature of money, I can't tell you, exactly where the justification for the creation of the dollar in your pocket came from any more than I can tell you exactly where the reserves the Fed holds cam from.

As I said in post #36, hypothetically if a government were to start off as fiat, it could declare it's dollars as valuable and spend them into the economy. The act of spending would create savings (through the purchase of productivity) and savings would create the reserves that banks need to issue loans.

Apologies, it would have to borrow 10%, thus $20k, not $2k (typo).

Thanks.

Where did this other bank get $20000 in excess reserves?

Historically the US wasn't created as a fiat economy.

I don't care, I just want to know where this other bank got the excess reserves that your new bank is borrowing.
Not the serial number of the FRNs, the source of the excess reserves.

 

[Toddsterpatriot]

reserves don't come from customers? If a bank takes in $100 from a customer that would in effect create a $10 reserve. If bank takes in deposits from Fed that in effect creates a higher reserve requirement for bank. If bank takes in deposit from Fed for simultaneous lending then you might say, owing the fungibility of money , reserves come Fed deposits to customers.

When a customer deposits $100, that creates $100 in reserves because banks don't lend reserves to customers. Any reserves a bank holds are either required, in that the bank has made loans of some amount against which it must keep 10% reserves on deposit at the Fed, or excess reserves in that excess reserves aren't required to keep them on hand. Banks can lend excess reserves to other banks in the federal reserve system that find themselves at a deficit of reserves.

Since loans create deposits, the act of lending creates reserves.

When a customer deposits $100, that creates $100 in reserves

If a customer deposits $20,000 does that create $20,000 in reserves?

 

[Darkwind]

I'm not going to sugar coat things for you, but I assure you in advance that my tone towards you is not meant to be aggressive or disrespectful. One of the limitations of this form of communication. looking forward to good conversations on the topic of economics.

Cheers

E4E1

I know everyone isn't from the US, but this conversation is largely pointed at those in the US, though much of what I say will, to some degree apply in nations like Canada, Japan, UK and Australia.

So does anyone know where banks get the money they lend to people? I'm fascinated how few people, including people that work at banks, actually know the answer to this question.

Let's have a little "fun" and see how many people enjoy a good conversation out the economy.

-Cheers

So does anyone know where banks get the money they lend to people?

Deposits.

This is the response I get from most people. This is what happens when the economy changes but school and college curriculums aren't updated.

So, no, loans do not come from deposits. This is why I was trying to get you to answer the savings question in the other thread (which you responded to me with a Misis article).

Fact, banks don't lend deposits to customers.

Evidence:

Standard and Poors Cheif global economist

Here's a paper from the Bank of England

Fractional Reserve Banking, at least how most Austrians understand it, ended in 1934 when convertibility to gold ended. The fact that most Austrians stubbornly refuse to acknowledge this is amazing and completely undermines the Austrian theory of economics.

Todd, everything you think you know about the economy is rooted in this idea and it's an idea that completely vanished in 1974 when the fiat standard was adopted.

You believe that saving supports lending and investment.

This is wrong. Savings does not support investment, investment supports savings.

Example. I bought my house. It is an investment, but no one's savings made it (see linked articles for evidence and understanding) possible . However, when I borrowed the money from a bank (that created the money it lent me out of thin air) and paid it to the previous owner, the seller took what was left after they paid off the house and deposited it as savings. See how that works? My investment supported their savings.

Think about it. How many people make large investments with cash? Some but most investments made via borrowing and that investment creates savings.

So what happens to the money you deposit at a bank?

Simple, 100% of it becomes bank reserves. Not 10%, not 3%, 100%.

Where does a bank get money to lend to customers?

Banks create it out of thin air. Simple keystrokes on a keyboard.

How does this happen?

Because the bank takes your approved loan and deposits it as an asset. An asset worth the value of the loan plus interest, minus the money created and lent. The bank profits from the interest and when you repay your loan, the bank uses that to zero out the cash it created.

So if you take a loan for $1, the bank deposits your loan (the note) as an asset for $1 and then creates and gives you $1. The bank expects you to return with it's dollar plus some interest which it keeps.

Don't forget the creation of currency through credit cards!

 

[Darkwind]

 

[ImJustABill]

. Reserves come from deposits from the Fed to customers, not from customers.

reserves don't come from customers? If a bank takes in $100 from a customer that would in effect create a $10 reserve. If bank takes in deposits from Fed that in effect creates a higher reserve requirement for bank. If bank takes in deposit from Fed for simultaneous lending then you might say, owing the fungibility of money , reserves come Fed deposits to customers.

Hi Edward. Ultimately all reserves originate from federal spending.
Example: You (or someone you know) gets a social security check. When that check is deposited, the Federal Reserve adds those dollars to the bank's reserve account and the bank adds them to your account. If the check is for $100, your balance and the reserve balance both increase by $100. This adds $100 each to the liability (your deposit account) and asset (bank's reserve account) side of the banks balance sheet.