Banks / Loans / Monetary Theory

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Have read recently that when a bank makes a loan it effectively creates the money. This is news to me and means that there are fundamental things in the economy that i really do not understand as well as i thought i did...!

Some questions
  • As this money is created by the bank, isn't the bank effectively taking no risk in making loans?
  • As the bank receives the call of the loan in repayments, isn't the total of the repayments (principal and interest) effectively profit?
  • How is this managed to ensure that loans are not made in a circular way so that everyone benefits - wasn't there a deal between Barclays and Qatar during the financial crisis where Qatar state purchased a share in Barclays funded by a Barclays loan?

Links to articles discussing the subject.

Given that banks can create money in this way, and governments can create money by 'quantitative easing', why is there such a mantra to ensure we pay for our NHS etc via taxes?
I suppose some may say it will cause inflation, but BoE put in nearly half a trillion (!) into the economy following the crash and we didnt experience any excess inflation.
 
Rapscallion said:
Have read recently that when a bank makes a loan it effectively creates the money. This is news to me and means that there are fundamental things in the economy that i really do not understand as well as i thought i did...!

Some questions
  • As this money is created by the bank, isn't the bank effectively taking no risk in making loans?
  • As the bank receives the call of the loan in repayments, isn't the total of the repayments (principal and interest) effectively profit?
  • How is this managed to ensure that loans are not made in a circular way so that everyone benefits - wasn't there a deal between Barclays and Qatar during the financial crisis where Qatar state purchased a share in Barclays funded by a Barclays loan?

Links to articles discussing the subject.

Given that banks can create money in this way, and governments can create money by 'quantitative easing', why is there such a mantra to ensure we pay for our NHS etc via taxes?
I suppose some may say it will cause inflation, but BoE put in nearly half a trillion (!) into the economy following the crash and we didnt experience any excess inflation.
Click to expand...

Best of luck with your request.

You have hundreds of years of hisrory to get your thinking around ‘what is money’.

It will bring you to ‘The Gold Standard’

https://en.wikipedia.org/wiki/Gold_standard

And the post war monetary policy set out by the Bretton Woods meetings which created the end of the Gold standard

https://en.wikipedia.org/wiki/Bretton_Woods_system

So that is your ‘starter for ten’

It’s an interesting journey snd may open your eyes to what debt actually means and how shaky economies are.

Steve
 
Rapscallion said:
Some questions
  • As this money is created by the bank, isn't the bank effectively taking no risk in making loans?
  • As the bank receives the call of the loan in repayments, isn't the total of the repayments (principal and interest) effectively profit?
  • How is this managed to ensure that loans are not made in a circular way so that everyone benefits - wasn't there a deal between Barclays and Qatar during the financial crisis where Qatar state purchased a share in Barclays funded by a Barclays loan?
Click to expand...
(1) No. Banks are required to balance their books every day. If they lend to you, they have to have assets to cover that (eg other people's money they are holding in current accounts etc) or else they have to borrow it on the overnight markets.
(2) No. See (1).
(3) See (1).
 
the bank of England can make money to lend to lend to other banks at the base interest rate of current .5% so banks get cheap money to sell on at higher rates.
danger is if the bank of England makes to much money in this way it can cause to much cheap money out there and cause inflation as people buy things with all that cheap money.
they have for a fe years been carrying out quantative easing which is exactly that.
I am assuming somewhere down the line there is a mechanism to pull it back in a bit.
 
Your first statement is incorrect, Phil.

Therefore the rets doesn't follow.
 
Rapscallion said:
Have read recently that when a bank makes a loan it effectively creates the money.
Click to expand...
Don't know where you got that from. If it were true, there would have been no sub-prime mortgage scandal and no banking collapse a decade ago.
 
Has anybody read the linked articles?
From the oxford page

A landmark paper[1] released by the Bank of England in March 2014 explains how private banks create the vast majority of money we use when they make loans. When you go into a commercial bank and take out a loan, the money is created out of thin air: ‘Ping!’ Money is created and at the same time, so is debt[2]. 97 per cent is created in this way, the remaining three per cent of the money in circulation is in the form of cash; the coins and notes in your pocket.
Click to expand...
 
StewartR said:
(1) No. Banks are required to balance their books every day. If they lend to you, they have to have assets to cover that (eg other people's money they are holding in current accounts etc) or else they have to borrow it on the overnight markets.
Click to expand...
Incorrect! They have to hold a certain percentage of cash previously known as the reserve asset ratio, now known as the leverage ratio which currently runs at about 5% though in reality it is c 3%
 
Let me quote much more. I have bolded one section: -
If you ask a person in the street ‘how is money created?’ they will probably look at you blankly. A couple might hazard a guess and say the Bank of England.

There’s a Chinese proverb that says: ‘The fish is the last to know water.’ Money is all around us, playing a role in almost everything we do, yet it can be difficult to understand. We are swimming in a society that depends on money—that’s become obsessed with money—but few of us know where it comes from or how it actually works.

A landmark paper[1] released by the Bank of England in March 2014 explains how private banks create the vast majority of money we use when they make loans. When you go into a commercial bank and take out a loan, the money is created out of thin air: ‘Ping!’ Money is created and at the same time, so is debt[2]. 97 per cent is created in this way, the remaining three per cent of the money in circulation is in the form of cash; the coins and notes in your pocket.

The paper goes onto show how money exists in the form of accounting entries in a computer system—a kind of electronic money that’s created when banks make loans, and destroyed when those loans are repaid. So most of the money we use is a kind of temporary money—bank IOUs that are being continuously created and destroyed.

The significance of this paper from the Bank of England shouldn’t be underestimated. It dismisses the money creation theory taught in almost all economics courses (the so-called money multiplier model). The fact that this Bank of England paper was newsworthy[3] shows that the topic is subject to such widespread ignorance. Positive Money polled MPs on their understanding of money creation, and only 1 in 10 were able to correctly identify that money is created when banks make loans, and that when loans are repaid, the money disappears. Even some economists have fallen victim to this confusion, Nobel Laureates Joseph Stiglitz and Paul Krugman have both made comments suggesting they don’t understand that banks create money when they make loans[4][5]. With such a widespread misunderstanding about a fundamental tenet of economics—how money is created—it’s not surprising that economists failed to see the economic crisis coming, and that politicians are failing to build a sustainable recovery.

Over the last 40 years, banks—which are profit seeking corporations—have had the freedom to make as many loans as they want and lend based on their own profits and confidence. Banks therefore tend to allocate money to property and financial markets, skewing economies towards housing bubbles and the financial sector. As a result, people and households all end up under mountains of debt.

Since the 2008 financial crash, the biggest crash in living history, banks haven’t been creating as much money[6], so central banks have had to step in. Central banks have been undertaking a programme, known as unconventional monetary policy, called quantitative easing (QE). QE is when central banks create new money and use it to buy mostly government bonds from financial institutions including pension funds, insurance companies, and banks[7]. Essentially, new money is used to flood the financial markets, inflating share and bond prices. The transmission mechanisms through which QE work are weak and uncertain[8],[9]. But a major outcome of QE is that it makes the rich richer and does little to help ordinary people and businesses. In fact a study from the Bank of England showed that QE in the UK has actually increased inequality[10].

SNIP
.
.
Click to expand...

I have to say that i am struggling to get my head round this as it is different to what i perceived the reality to be. But it certainly seems from that and other articles that the money is created by the bank does it not?
 
StewartR said:
(1) No. Banks are required to balance their books every day. If they lend to you, they have to have assets to cover that (eg other people's money they are holding in current accounts etc) or else they have to borrow it on the overnight markets.
(2) No. See (1).
(3) See (1).
Click to expand...

The Back of England article seems to suggest this isn't the way it works

  • Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
Click to expand...

There is also this video linked form the BoE article, relevant comments around the 1 minute mark -

 
Banks can and do lend money that they haven't actually got, it's been like this for hundreds of years, ever since someone realised that there would never be a situation where all customers who had deposited money with the bank demanded it back at the same time - except of course that this can very occasionally happen, i.e. when customers lose confidence in the bank and there is then a run on the bank, which is unable to meet its debts. But even when this happens, they get rescued by another bank or by the state. What has changed over the years is the ratio of loans to actual assets.

So yes, banks lend money that they don't have so, for them, they money isn't real. For the borrower of course it is real, and the interest that the borrower pays and the lender receives is real too, and is a primary cause of inflation.
Rapscallion said:
Given that banks can create money in this way, and governments can create money by 'quantitative easing', why is there such a mantra to ensure we pay for our NHS etc via taxes?
I suppose some may say it will cause inflation, but BoE put in nearly half a trillion (!) into the economy following the crash and we didnt experience any excess inflation.
Click to expand...
Well, this is a good question.
There is a world of difference between household finance, where people who get themselves into debt take a real risk of causing themselves massive financial problems, business finance (micro economics) where debt is usually a positive thing, needed and which helps the Company to grow and national finance (Macro economics) where, arguably, debt isn't a problem at all because it is almost impossible for a country to go bust (after all, Zimbabwe seems to have been trying to go bust for years but is still there :) )

Margaret Thatcher said, many years ago, that the government needed to balance its books in the same way that households need to balance their books, this of course is total nonsense and this country, which is one of the richest in the world, can easily afford both the NHS and other necessary forms of social care - it's about politics, not money.
 
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