Correct me if I am wrong- but I don’t believe it works this way. The bank can only lend a ( less than 100%) amount relative to its deposits. It can lend out a multiple of its reserves if those reserves are re-deposited in that particular bank. So €100 reserve,lend €90, deposit €90 (reserves and deposits now=190) lend €81(lending =171) etc.
That’s exactly it.
I often wonder what percentage of the public understand how it works ?
Sorry. A reserve is the portion of the deposit that the bank must hold onto. It is free to lend out the remaining. My statement that a bank can lend out a multiple of its deposits is still correct in terms of people go into banks, deposit money, and banks can lend out a multiple of that. A multiple does not have to be greater than 1.0. Most people at this stage DO know how the reserve system works with all the chain emails and internet forum bombing I would say. It’s not alien to me, but I did not need to go into it to make the simple statement that basically there is a relationship between deposits and lending that might well be called a multiplier?! That deposits are significant to how much can be lent out?!
10 % reserve required.
So the bank lends out €90.
This also becomes a deposit.
€90 lent out.
10% reserve required.
So they now need to hold €19.
They can now lend out a total of (€190 - €19) €171.
They have already lent out €90, so they can lend out an additional €81.
Is this right or wrong ?
Well if you redefine the word to mean whatever you want it to mean - then yes you are correct.
If you actually accept the existing meaning - then no.
EDIT: excluding negative integers of course…
To be absolutely precise, it is not actually a simple multiplier relationship (which could indeed be less than 1.0). I was approximating for brevity. But as might have been read from the context, the point was to say is that yes, there exists a functional relationship between levels of deposits and amount that can be lent out.
@mranderson, yes that is correct.
Edit: Sorry, yes I see a ‘multiple’ has to be an integer. I had in mind a multiplier relationship.
a number that may be divided by another a certain number of times without a remainder.
i.e. X/Y = Z where Z is an integer. (i.e. greater than 1).
My issue is that whether by accident or intention you stated that a bank can lend more than money than it has in deposits. This is precisely one of the wrong and widely held opinions that should be tackled. (I had a recent conversation with a Greek guy who was trying to argue the money Greece borrowed was “fake” (and implying therefore that it should not be paid back), that the bankers were responsible and that Angela Merkel “had blood on her hands” (implying that Germany should give more of its “fake” money to Greece - though of course it should not be paid back. There was no acceptance of responsibility on the part of the Greeks themselves of course).
Sorry I was lax on the integer part of ‘multiple’. Thanks for pointing it out.
Your point is very close to my own. I’m somewhat confused though as to whether you are actually correct.
For example, this is taken from Anglo’s balance sheets. Here loans ARE more than deposits, even before the cataclysm:
Is it not true that whether the approximate multiplier goes above 1.0 is dependent on the reserve requirement? I have not really thought this right through yet. But I had a broad intuition and sense that there was a relationship roughly as per the above graph.
I believe the discrepancy is that they become reliant on borrowing money on the money markets - and that money backs their loans.
We are moving past my level of knowledge in the area now though…
Deposits and reserves are getting confused here, but that’s understandable because that’s how things have traditionally been described.
There are two constraints on a bank’s ability to lend:
(i) its capital ratio – i.e. the ratio of loss-absorbing capital to the total balance sheet
(ii) liquidity requirements – cash on demand
While most businesses are looked at in terms of profit and loss, it’s often more revealing to look at banks in terms of balance sheets. Assets = Liabilities + Equity
Loans are assets
Deposits and other borrowings are liabilities
Shares and in some instances more exotic instruments are equity
Note that deposits are NOT reserves, they are always liabilities
So what does a bank do day-to-day? They lend money. They can grow their balance sheet up to a certain multiple of their equity (this gets complicated but traditionally they need to maintain 8% equity ratios, so the balance sheet can grow to 12.5 times the stock value).
However every loan must be funded. They can be funded through deposits or, if the bank doesn’t have sufficient deposits, through bond issuance or the money markets (both of which are typically referred to as “the wholesale markets”). Deposits don’t directly limit the bank’s lending ability, they just affect the cost. Many banks lend more than their deposit holdings, and there are many institutions with deposits greater than their lending (e.g. post office banks). But the loan-to-deposit ratio is often a keenly watched number for regulators because deposits are considered a less “flighty” source of funding than the wholesale markets during stressed times.
The Northern Rock blowup was a great example of a bank which lent far beyond its deposit base, became dependent on wholesale funding, and then suffered liquidity issues (which then led to a bank run amongst depositors). Most of the Irish banks suffered similar.
Until the crisis, banks weren’t overly worried about liquidity because it was always possible for them to meet short term cash demands – the main value add of banking after all is the transformation of demand deposits into long term loans. Nowadays the regulators are much more explicit about the need to maintain a liquidity buffer. However that doesn’t change the key dynamic: once banks are sufficiently capitalised and liquid, they can lend. The mix of deposits vs other sources changes the economics but isn’t a limiting factor.
Gold Daily and Silver Weekly Charts - Sleepwalking To a Wipeout -> jessescrossroadscafe.blogspot.co … ts_18.html
Thanks Rawkspider, and to clarify further, a banks loans are the banks assets/reserves.
Daniel, you just explained the first event in regards the process of money creation & the process of the balance sheets - but to clarify what you just said- the “deposit” in one mans bank account will earn the bank say 8% interest, as it’s a loan, however he has it sitting in the banks current account, which earns him shitty 1% interest.
So this creation you speak of - in once sense is an asset to the bank earning 8%, at the same time, it’s also a liability, where they are paying 1%. But overall they are earning 7% in the difference. From a reserves point of view the commercial banks balance sheet is is unchanged from a capital perspective, but the % interest earned has increased. It’s reserves are earning a greater interest.
Now, lets move to the next step DP.
This 50k that is now sitting on deposit in one mans bank account will be spent on a brand new car.
This 50k is now a liability to the receiving bank of this deposit. This bank will then issue a loan of 50k to get a higher % interest.
So in simple terms - the more deposits, the more a bank will want to lend.
When you grasp this concept and realise % interest earned is based on risk - you will realise why banks will rather leave money in a central bank earning little to nothing than issue a loan that is likely to be defaulted on. Or, rather not lend to someone for a 50k car loan.
Refer to BoE doc for more information, and confirmation that QE is inflationary;
bankofengland.co.uk/publicat … eation.pdf
Central banks have bought governments time, and yet we see Ireland already mouthing of about the possibility of giving the PUS a pay rise.
PM’s have the potential to weather the coming storm quite well.
Whats a “PM”
Precious metals. On Mervyn Kings note, I think alot of the geopolitical risks are being driven by the debt issues. I think the US will try to become more forceful with Russia and try drag Europe into the conflict.
I think the Germans are sitting on the fence.
Russia overtakes China to become world’s No. 6 in gold reserves -> rbth.com/business/2014/08/20/rus … 39147.html
China allows three more banks including StanChart to import gold : sources -> reuters.com/article/2014/08/ … 6920140819
India prepares for shining return of gold demand -> ft.com/intl/cms/s/0/f2e2f570 … abdc0.html
Gold Slips Again On Strong Dollar, Touching June Lows - -> blogs.barrons.com/focusonfunds/2 … june-lows/
Ah, you see, Peak Gold has caused the global recession and now everyone is too impoverished to buy gold…
Nearly time to buy some bullion
Actually scrap that, I’m going to add some gold miners into my retirement portfolio, cheap and hated.