Sunday Mail discovers how banks work
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Ever since central banks decided to raise the rate of interest they charge commercial banks to borrow money from them (the bank rate) the financial pages of the papers have provided a continual stream of evidence to expose the Thin Air School of Banking as, well, a load of hot air.
Here’s an example from today’s Times:
“The Financial Conduct Authority, which is the industry regulator, also warned the industry last July that ‘the pace and scale at which firms pass through higher interest rates to savers needs to improve’.
Banks have responded to this pressure by improving their savings rates, while depositors have also become more active in managing their money by moving their cash to accounts that pay better rates of interest.
(….)
These deposit trends, combined with more intense competition in the mortgage market, are putting downward pressure on banks’ margins after a period of rapid expansion.
Lloyds Banking Group said in its first-quarter results last week that its net interest margin, which reflects the difference between what it charges for loans and pays on deposits, fell to 2.95 per cent from 3.22 per cent a year earlier.
Similarly, NatWest’s first-quarter margin slid to 2.05 per cent from 2.25 per cent in the same period in 2023.”Of course banks need deposits — people or institutions lending them money — to function. That’s what they do — borrow money at one rate of interest and lend it at a higher rate. To suggest that banks can, and do, just create out of thin air the money that they lend is just ridiculous.
Here’s a demolition job on the Thin Air School of Banking in the tradition of Edwin Cannan an updated version of which was published in March this year:
https://www.cato.org/sites/cato.org/files/2024-04/working-paper-80-updated-2.pdf
Ok, it is published by the Cato Institute which is a US free-marketeer think tank but then Cannan too was a Classical Liberal economist. And it doesn’t alter the fact that many classical political economists had a better understanding of how banking works than most modern economists.
In any event, all the arguments are there that we have deployed to refute the theory that banks create money out of thin air.
This weekend’s i paper has an article entitled “Banks accused of ‘ripping off’ savers over interest rates”. Amongst those making this accusation is Positive Money:
“Simon Youel, head of policy and advocacy at research and campaign group Positive Money, said: ‘Banks have made record profits from increasing interest rates for borrowers while paying depositors insultingly small rates on their savings.’”
This is true but it is odd coming from an organisation which denies that banks are financial intermediaries borrowing from some at one rate (savers) and lending to others at a higher rates (eg mortgages) and claims that banks can create money out of thin air simply by making a loan.
If this claim was true then banks could make even bigger profits by simply creating the money to loan so avoiding having to attract and pay interest to savers. But the fact that they do need to attract savers shows that the claim is not true.
But then currency cranks are nothing if not illogical.
Boffy’s Blog has an essay – ‘Fictitious capital’. The first three paragraphs of part 4 argue that a bank with just £10,000 can nevertheless lend £100,000 merely by using the paper it owns ( securities, bonds etc. ) as collateral against which it can borrow from a central bank and then lend these borrowings to it’s own customers.
It’s not the ‘out of thin air’ argument, but is it sound?“It’s not the ‘out of thin air’ argument, but is it sound”
I think that’s a sound description. Banks don’t only borrow from the central bank but from other banks too.
It would be a mistake to say that a bank would have to receive 1000 in deposits to make 1000 in loans, they can borrow too.
Or am I wrong?
Found the passage you are referring to:
“If the bank has found from experience that it only ever needs to retain 10% of deposits as cash to meet the needs of its customers, then it can loan the remaining 90%. So, here, if the bank starts out by loaning £10,000 to B, who uses it to buy a lathe, this loan appears as £10,000 of bank capital, against which the bank can then make additional loans. So, on this basis, it may make a further loan of £9,000, to C, which then also appears as additional bank capital. The bank can then make an additional loan of £8,100 to D, which then appears as additional bank capital making possible a loan to E and so on. Instead, of just issuing a loan of £10,000, this initial bank capital of £10,000 enables the bank to issue loans of up to £100,000, and each of these appear on its books as capital, whilst in fact this £100,000 is only fictitious capital, it is only able to earn interest to the extent that the money loaned out is used to buy productive-capital, and thereby generate surplus value.”
https://boffyblog.blogspot.com/2014/12/fictitious-capital-part-4.html?m=1
The first sentence is correct but what follows is not. If a bank lends a capitalist £10,000 to buy a lathe, when the capitalist actually buys the lathe then the bank has to transfer £10,000 to the bank of the person who sold it. The money has then gone. The asset represented by the IOU from the borrower has been liquidated and cannot be used to make another loan of £10,000 (In fact, the initial loan could only have been £9,000 but we can let that pass.)
There is, however, one circumstance under which theoretically it could — if the seller of the lathe happened to bank with it. There would then be a fresh deposit of £10,000 and the bank could lend 90% of this, ie £9,000. If the seller again happened to bank with it then it would have a new deposit of £9000, of which it could lend out 90%, or £81,000. This process could continue (assuming the sellers always banked with it) until total loans of £90,000 had been made. But this would have been balanced by total deposits of £100,000.
Of course this is a quite unlikely, not to say impossibke, scenario for a single bank but, applied to the banking system (all banks) it is the theory of fractional reserve banking which used to be taught in university economic courses. It is not incorrect but doesn’t mean what it is sometimes interpreted as meaning that (with a cash ratio of 10%) a single bank could lend 9 times an initial deposit.
Michael Roberts in that blog from 2014 does indeed seem to be putting forward a thin air theory of banking even if he doesn’t call it that — as the “bank capital” he bases it on does disappear as soon as the borrower spends the loan and the bank has to transfer money to the seller.
This is explained in chapter 5 of our pamphlet The Magic Money Myth:
I don’t know if he still adheres the view he expressed in 2014 but in a later blog he explicitly repudiates the thin air theory of banking embraced by David Graeber:
The £100,000 they borrow from the Central Bank needs to be repaid, they have gained an asset of £100,000 but they also have a liability of £100,000. They have created nothing out of thin air. If they could create money from thin air they wouldn’t need to borrow from the Central Bank!
Interesting interview though the guy being interviewed, a professor Werner, seems to subscribe to the mystical theory of banking as mentioned elsewhere on this thread ….
I wouldn’t say Werner’s views were “interesting”. They are just bog standard currency crankism by someone who has someone managed to get the title “Professor” to go with his name which gives them a credibility they don’t deserve.
His views are dealt with in chapter 4 of our pamphlet The Magic Money Myth entitled “The Pure ‘Thin Air’ Theory of Banking’.
Is Musk going to start up a bank (and possibly add even more to $314 billion fortune)? Will the banksters have even more of a field day when Trump ascends the throne?
Some groups of the Latin American capitalist class created their own bank known as the Bank of the South ( Banco del Sur ) with large deposits in order to confront the influence of the USA banks and the International Monetary Fund
https://en.wikipedia.org/wiki/Bank_of_the_South
It looks like that king is going to be controlled by several powerful members of the capitalist class, and some peoples ironically are calling him Vice President Trump
As Adam Buick wrote: Gates Vs Musk and I think that Bezos must be included
As Adam Buick wrote: Gates Vs Musk and I think that Bezos must be included
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Yes, its interesting you should mention Gates and Musk. As members of the parasite class they still nevertheless seem to have different agendas. For instance, Gates wants to reduce population numbers while Musk is obsessed with wanting to raise the birth rate. Why the difference? Also, Trump himself is opposed to electric vehicles, climate change and so on whereas Musk as CEO of Tesla takes a quite opposite view. Yet despite that, he is now a central player in team Trump.
It’s gonna be interesting to see how this all plays out when Trump gets in
Let’s see how long this honeymoon is going to last. Joe Biden has already imposed tariff or import taxation in many Chinese and Mexican commodities including electrical cars and metals, therefore, Trump is not the only one, Biden has done like Obama who continued George Bush, and Biden has continued some trump policies
Tesla electrical car are also produced in China, and the Chinese electrical cars are much better and cheaper than Tesla, Chinese and Brazilian electric cars are being sold in Latin America, they have a big chunk of the market, and Russian gasoline cars are going to be exported to Latin America
Donald Trump was a democrat and he became a Republican, nobody knows if the situation might force probably Ellon Musk to become a democrat, capitalists oscillate from one side to another.
There is a lawsuit to sell Google and it might benefit Bill Gates and he gave and his wife made large contributions to the Democratic Party and Bezos has also invested in both political parties.
The biggest representatives of the US oligarchy have invested in this election
https://www.automotivelogistics.media/russian-carmakers-to-export-vehicles-to-latin-america/19640.article
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