[HN Gopher] A simple explanation of how money moves around the b...
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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!
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