Cooking the Books: Banking Demystified Again

I was going to suggest too that Adrian look at that thread to see the evidence that banks can only make loans out of funds they already have, funds that come not just from deposits but also from what they borrow wholesale from the money market.Just to correct two factual errors.1.

This is not true. The total value of UK economy, ie all wealth in the UK, in 2010 was £7.3 trillion (£7,300,000,000,000). A measure of “total loans outstanding” can be M4 (which is actually larger than bank loans). In 2010 this was only £1564 billion (£1,564,000,000,000).2.

The “liquidity ratio” and the “reserve asset ratio” are two different things (and neither determine how much banks can “increase their loans as a multiple of their deposits” since banks can’t lend more than they already have).The Liquidity Ratio is the proportion of a bank’s deposits and its own borrowing that it needs to keep in a form that can be quickly converted into cash to meet any demands on it, eg withdrawals. Mostly, it is money lent for short periods, even overnight, on the money market. At one time (until 1971) there was a formal requirement to keep it at 30%. Now it is left to the discretion of those running a bank to decide what level is safe. A 30% liquidity ratio didn’t mean that banks could increase their lending three times more than their deposits (and borrowings) but only that it could lend out only 70% of these as longer term loans.The Reserve Asset Ratio is the ratio of a bank’s own capital (not at all the same thing as its deposits) to its loans. It places a limit on the maximum amount a bank can lend (provided, that is, it has the funds to lend) and is intended to ensure that a bank can absorb from its capital any losses should thse occur (banks normally make a profit). If a bank increases its capital this does not mean that it can lend more. It may be able to, but only if at the same time its deposits and/or its own borrowings (the source of what it lends) also increase.

Comment received from a reader

Dear Comrade,

I have just been reading my first ever copy of your monthly magazine for May 2012
and came across the above column. I was so horrified at the lack of accuracy that the
article contained, that I feel compelled to rectify the numerous errors of factual
analysis!!!! To be frank, the author cannot have any real understanding of the basic
principles of banking!!! And as a professional accountant who has worked in finance
for many years, the errors cannot go unchallenged!

The author states that Banks ‘CANNOT CREATE CREDIT FROM NOTHING’. What utter
nonsense!!  We would be unable to operate a capitalist system at all were that the
case!!! In the days before the ECB and various so-called technical adjustments, banks
issued credit/loans using a regulatory tool called the Liquidity ratio (now more
strictly defined and called the Reserve Asset Ratio and part of the so-called Basel
Accords of recent years). This ratio determines by how much the banks are allowed
safely to increase their Loans as a multiple of their bank deposits, and there are
several measures of this which used to go under the names M1, M2, M3, M4 as measures of
the money-supply by the regulators. It currently stands as broadly 8.5% throughout
the banking system. This is the method by which banks issue Credit out of nothing
and it is what they do day in day out, in theory managing the risk of  over-lending
in this way!!! I fear the author is getting very muddled as to what constitutes money!!!!
Notes and coins are today completely insignificant as they are a miniscule %.

Were the banks unable to issues credit vastly in excess of bank deposits, the
capitalist system could not function due to the time it takes to administer all the
rules etc and the fact that the demand for credit vastly exceeds what is genuinely
required for the real productive economy, owing to the vast speculative activities
in currencies, property,commodities, oil etc etc that creates market distortions but
which no govt. seems willing to regulate!! Hence the credit crunch!!! In order to
keep the gravy train rolling and not to breach the basic liquidity ratio rules,
banks started to fund their lending to the non-productive economy by taking on
short-term debt from various sources, and lending it longer-term to their pals in
the City Hedge Funds, currency gamblers, all sorts of dodgy finance, and shifting
it off-Balance Sheet, but the minute that it all went pear-shape, they were left
totally exposed to short-term liabilities that were not covered by any liquid assets!
And they had to run to the Govt to bail them out of the mess they had created.

This, of course, is the exact opposite of what the theory of free-market capitalism
says should happen!!! It says that if a business fails, it goes bust!!! But that
apparently now only applies to the workers!!! If we lose our jobs and run out of
money, we go bust!!! They dont!

There is a very simple way of seeing that credit is almost entirely created out of
nothing – if you add up the banks’ balance sheets Total loans outstanding at any
time, you will see that it is many times the value of the entire UK economy!!!! Were
loans only created out of ‘Real’ assets, then this could not happen!!!I fear your
colleague needs to study finance rather than economics!!!  Economics as presently
taught is 99% bullshit. Not since the end of the Gold Standard has credit been
remotely tied to what a bank holds as deposits. This is why some monetarist purists
are now calling for a new Gold Standard so that all money has to have an equivalance
to the value of the gold in existence- pure fiction of course!!!Since the USA hold
90% of the banking gold reserves, WW3 would be just round the corner!!!! Just
imagine if the USA had control of the entire world money system!!! They would have us
all bowing and scraping to their demands!!! The mind boggles to be frank! Not for nothing
did the Yanks accumulate most of the gold reserves! Its the only thing that prevents
USA from being declared insolvent by the IMF!!! But it wont be long coming. They have lost sight of the most basic laws of economics!

Incidentally, the collapse of the banking system in 2008 was due solely to the
massive explosion of the use of Derivatives by the financial gamblers in the City,
Wall St etc, who saw a way of inventing profit purely by creating artificial
contracts by the sale of so-called CDOs, MBS’s etc, with an ‘implicit’ rate of
interest, but all it was  is book-keeping entries in a bank ledger, thus creating
fictitious profits, a process of gigantic speculation that could not be sustained
once the underlying assets (housing) began to lose value due to inflated property
markets running out of steam!!! In fact the real productive economy was not at risk
until the casino collapsed around it. But to his shame, Gordon Brown knew nothing,
saw nothing and DID nothing to stop it!!! A more hubristic case of vainglorious
lunacy driven by arrogance, we are I trust unlikely to see again for a long time (???).

I am seriously thinking of joining the SPGB, given that capitalism is going to
collapse fairly soon and we shall need to prepare for its replacement. When is the
next meeting at Clapham?? I’d like to come along.

Regards, Adrian.