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Your 5s — In a fractional reserve system 100 on the asset side supports 100++ carried on the liability side. In the other there would be 100 assets supporting just 100 liabilities…I think ? Not sure how the accounting sorts that out.
Are you saying it all zeroes out at the end? That’s how I am reading your statement.
When you make the transaction (a loan) it has a credit/debit with it. Same with your deposit. The balance sheet does not capture those transactions.
It is only a point in time where we add up all the assets and liabilities of a company and see what it is worth.
In a fractional reserve system a bank could have $300k in loan promises (assets) supported by $100k in liabilities (deposits) with $200k in owners equity (issued stock) ?? Of course there is no room for mistakes (ie non performing loans) on that balance sheet.
In a non fractional reserve system you could only have $100k in loan promises (asset) to match the deposits (liability) of $100k ! Your $200k in owner’s equity (stock) would have to be held in cash (asset) to balance/even it out/zero it out. ? That would be alot of money sitting around to protect yourself from mistakes (non performing loans) !!
Your example 1 is for a fractional reserve bank with ZERO reserves. A fractional reserve bank MUST keep a percentage of depositors deposits in the form of very liquid stuff. Generally cash and in account at the central bank.
You example with zero reserves
Loan book 300k
Owners’ Equity 200k
Depositors’ accounts 100k
Normally the shareholders equity will be wiped out first, so the 200k is a buffer against loans going bad. That is their risk.
An example of a bank with a full loan book and 10% required reserves would look like.
Reserves/cash 10kLoan book 290kLiabilitiesOwners’ Equity 200kDepositors’ accounts 100k
Note that this is FULLY loaned out to the maximum. The bank cannot lend out anything else unless it finds an external source of funding.
Your example 2 is NOT a full reserve example. You cannot have any loans against depositors’ cash, the cash always has to be instantly accessible to the depositors. It would be kept in cash and at the central bank.
Surplus reserves 100k
Loan book 100k
Shareholders equity 200k
Depositors accounts 100k
Both sides add up to 300k
The funding for the loan book has come from the shareholders’ equity and not the depositors.
But can we move on from fractional reserve banking. It is NOT the system we have.
I watched the film “The Road”, and thought, I hope that’s not “The Road” to recovery~?
I’m a bit lost at this time~!
We have corrupt Banks fixing to make gains (and to save institutions)
We have corrupt money laundering banks involved in drugs and horrorwe have corrupt miss-selling We have corrupt Elite tax avoidance.we have corrupt yet to be released~! what does our government talk about~?http://www.telegraph.co.uk/news/politics/9423805/David-Gauke-calls-it-morally-wrong-but-even-the-Prime-Minister-admits-to-paying-in-cash.html
Great theory proposed by Kalecki. It would imply that we need lower taxes and/or lower interest rates to get the economy going. Since both of these items are essentially corporate expenses the next best way is to simply lower wages !!!!
So as usual we find the big government spenders being republicans and not democrates. I think the republicans have this secret binder in the back room for their republican President which tells them that balancing the budget is unnnecessary and you can talk that talk but go ahead and spend, spend since we are the reserve currency of the world and no one except us really understand that we can get away with it.
As far your fives are concerned, I think it shows that if it still mystifies you as it does me to some extent, then is it any wonder really how they come up the numbers they do and get away with it?
Your 5s thing
Are you asking what would happen if you ran a Full Reserve Banking system using “fresh Air Money”
Full Reserve Banking
Fractional Reserve Banking
Thanks, but they don’t help.
I really mean thanks~!
I will give it one last go.
If this doesn’t work, I will have to admit, I don’t understand the question.
Ah no, we are not on the same page.
This is tricky. I have to be understanding your page, or you mine ….. swapping between the two is a waste of time.
It is best not to think of things as cash money, as it leads to this sort of problem. We are accounting, so cheques are much better.
In the second case the newly borrowed 5 is spent …… and the shop/bank it is spent into, demands the transfer of funds for it. Here the central bank writes down the reserves of our model bank.
okay I will have another bash
I have called the reserves “working reserves”
As the loan is repaid, the asset is written down ….. so that, when the loan is repaid in full, the asset value is zero.
The loan agreements asset value is zero (loan is paid off)
but the working reserves have received +5 from the loan being paid off. surely?
No …….. ? ………. I don’t think so. 5 is deducted from the customer’s account (bank liability) and a corresponding 5 is taken down on the asset side. All evens.
I’ll think more on it. but again, the problems occur when you think of cash not just `accounting numbers`.
Yes, I am starting to see some extra on the asset side.
Loan man pays in 5 cash = standard 5/5.
Says to bank, use that 5 to strike my loan = 5 (loan doc)/5(Loan man credit) both struck off ….. leaving the cash on the asset side.
I am seeing it, but am imagining that it is a mistake somehow~!?
correcting the diagram, I was getting all confused myself.
But I think we have got there in the end.
Nope. I have just been through it all with Linda and it is all `as you were`.
No extras left over at all.
on the off chance that last part of the diagram is confusing. I have changed it.
No extras left over at all ??
All gone. Here I should quote that someone who said if all loans were paid off, we would have no money at all.
I think I am (almost) happy with all that.
Am I happy with full reserve banking.
Yes, I think there is a place for it. Not sure if I would put all my savings in one though.
With a full reserve system you would NOT get any interest, as the bank would NOT be allowed to lend out your deposit.
You would suffer from
I like that too.
I find it also helpful to bring in “Bank 2,” which Mystic also brought into his illustration during the 2nd “scratch” video, ;-), albeit only verbally.
For that allows us to get a rudimentary sense of what happens in the *aggregate* during “the life cycle” of a loan, which is very important to Keen’s model.
For example, when we bring in the fuller illustration that goes through the whole cycle of the loan, including the time when the money is deposited into Bank 2 (because the bicycle seller has deposited the funds the debtor gave him for a bike), we can see the following statement from Keen as occuring within our illustration:
“The flow of loans by the private banking sector to the non-bank public is modeled as a transfer of the banking sector’s assets from reserves to loans, matched by the private non-bank sector depositing the flow in its deposit accounts. The two operations cancel each other out on the aggregate private banking sector reserve account, but increase the loan assets of the banking sector and the deposit liabilities at the same time.” — Steve Keen
As Keen states would be the case…
We can see, through our illustration, that the initial draw down of reserves in Bank 1 is cancelled out by the rise in reserves in Bank 2, once the bicycle seller has made his deposit.
This is why Keen so often says that in bank lending there is very little impact on reserves, most especially if physical cash is not withdrawn, and the flow of money occurs through checks or direct electronic transfers, which leaves the flow of reserves *almost* exclusively to inter-bank transfers.
It’s not that reserves aren’t an integral part of lending in Keen’s model.
He concedes that they are indeed needed for every loan, and that reserves do move from deposit account to deposit account. It’s just that, in aggregate, they remain virtually unchanged (sometimes paper cash, withdrawn from reserves as part of a loan, does not end up in another bank, but that applies to only a tiny portion of reserves used in lending).
As Keen also states would be the case…
During this interim time in the ”life of the loan,” we can also see, through our illustration, that although the change in reserves has been cancelled out once the flow from the loan has been deposited into Bank 2, there has been an aggregate *increase* in the banking sector’s assets and liabilities:
Due to the loan, once the deposit has been made by the bicycle seller in Bank 2, and before the debtor has repaid the loan, there is an overall total of $10 in assets/liabilities.
This is quite different than would be the case if there had been no loan in our illustration, and the original customer in Bank 1 (who had put $5 into Bank 1 in order to have a deposit account) had made a withdrawal from Bank 1 and had used that money to pay the bicycle seller, who would have then put that money into Bank 2…
In that case, in the aggregate, there would be $5 total in both assets/liabilities ($5 less than would be the case with the loan added to our illustration).
Of course, that increase is only temporary, lasting until the loan is repaid.
I think we have some sort of a foundation.
Well done us~!!
Yeah, I’m truly proud of these last few collaborative days. I feel like I’ve been doing some real school work, ;-).
And it’s especially helpful to me now because I can feel much more confident about what Keen is bringing to the table.
I feel like I really can follow what he’s sharing about his work (at least the portion we’ve been working on here). And I feel confident now that he’s correct. I can “see” now how it works (at least on a very basic level); I can follow it as it plays out, and just as he says it would.
I’m now heading up top here to write a little about the statement that goes something like, “All money is debt.”
View this as two completely and unrelated transactions.
1. Debtor pays five money into his account. Bank’s cash reserves go up by five and the debtor’s account shows plus five money.
2. Debtor pays off debt. His account is reduced by five and the debt cancelled. Balance sheet shrinks by five.
Read on Windy … read on~!
I have read on. And I still believe that this is being made complicated by attempting to combine the loan making process with the normal transactional flow of cash through the banking system.
Bloke borrows five money.
Bank adds five to asset side and five to liability side.
Bloke immediately repays money
Bank removes five from asset side and five from liability side.
I suppose you could describe this as
Bank creates loan asset and moves five from reserves to asset.
Bank bungs five money into blokes account.
Bank immediately swipes bloke’s account and leaves the liability to pay him five money.
Bank puts the swiped five money back into the reserves.
Bloke takes five money in cash.
Bank takes five money from vault cash and hands it to bloke.
Bank cancels liability to pay five money to bloke.
Bloke pays five money into his account.
Bank swipes account and puts money into reserves, leaving liability to pay bloke five money.
Bloke instructs bank to pay back debt.
Bank cancels liability to pay bloke five money.
Bank cancels debt.
But I think that is not the way it works.
The bank manager says “yes, OK”.
Here is your debt contract.
‘And “hey presto!” in your deposit account there is the money’.
Although at this point it is merely the liability to pay the customer.
If you take the long winded method, then what happens when there are no reserves left? The system graunches to a halt.
If you take the way I’ve described it, the system continues until the customer tries to withdraw the money and take it to another bank. At this point the originating bank has to find the money, which can come from the money market, or the central bank, or attracting more depositors, or issuing more equity.
”If you take the long winded method, then what happens when there are no reserves left? The system graunches to a halt.”
Why are there going to be no reserves left~?
Long or short descriptions are all good …… as long as the are right~!
No reserves left?
Banks try to keep reserves at the absolute minimum. They want to earn money on them.
Excess reserves earning no interest at the CB would be used to pay off higher interest bearing liabilities or distributed to employees as bonuses or maybe even shareholders. That perversely improves the performance figures.
We have been through this.
The bank manager does not look what reserves they have before giving out a loan. The bank manager has a table of interest rates and he will always give out a loan at that rate as long as he is convinced the customer can stump up the loan plus interest and the bank’s policies allow it.
The immediate funds for the loan are created when the loan is issued. But nobody really mentions that apart from us lot.
There is no involvement in the banks reserves until the loan is used for something via a normal bank/interbank transaction.
So the long winded method describes a possible way of looking at things, but it is erroneous in real life.
Keep it simple.
The issue of the debt is balanced by the creation of the deposit in the customer’s account.
The reserves are used to facilitate normal banking transactions afterwards.
You’re definitely helping me to push further along in my learning about this (when I had thought I had grasped the basics fairly well).
Right now, not having taken many further steps to incorporate what you’ve contributed, I see now that I need to.
I think I’ve found, a little while ago, just the article to help me to better do that. I haven’t read it all the way through yet, and certainly haven’t yet fully absorbed it, but I think it’s going to help me to get a better handle on your contributions to this discussion, windslice.
It’s by Scott Fullwiler, and it comments on the Krugman/Keen debate that went on for a little while between them earlier this year.
It gets into the nitty gritty of what happens in banking operations, along with the business model that commercial banks tend to follow (which highlights your point – the more reserves in the banking system, the less banks earn), and some other key things.
Strange that I couldn’t find it earlier – I was searching pretty diligently over the past few days on that site in order to get a better feel for actual bank operations that occur in association with lending, but I didn’t come across this particular article until now.
But now I’m glad about that because, with the exercises several of us have been working our way through (even if we haven’t been fully on the mark, we’ve definitely been getting closer to the mark – I’m far, far better off today than I was a few days ago with this, before Mystic brought his 5s to the sandbox, which, in turn, spurred me on so well, ;-)), and now, in realizing I’m not yet taking clearly into account some of the key things you’ve been bringing to the table… maybe I’m a little more “primed” for this article now than I would have been when I first started looking for help in this area).
Thanks, windslice (and Mystic, and blackstone, and richardo, and everybody else seeking to “work our way through” bank lending, and to get a better feel for how it actually works).
The reserves are not affected.
The amount of the loan (asset side) is reduced at the same time as the debtor’s account (liability side) is reduced. The balance sheet shrinks by five money.
I just listened again and now understand your real question?
Person makes deposit +5 cash +5 deposit (real)
When the loan gets made +5 promise +5 deposit (not real)
Spend Loan -5 cash – 5 deposit (real)
Left with +5 promise +5 deposit (not real)
Make another loan +5 promise +5 deposit (not real)
Spend loan -5 cash – 5 deposit (real) — bank as no real money to do this !
Get Central Bank
deposit +5 cash + 5 deposit – now bank has enough cash
so loan can be spent
Deposits are real (cash) and not real (credit) !!
Hence we have government depositor insurance for “real” deposits only !
So yes everyone is right because loans get made from deposits. The problem is we need to distinguish between a deposit transaction that is cash (real) and credit (not real)?! Me thinks !
Forget that comment on deposit insurance !! It is probably incorrect. The rest is ok.
The thing is, as Joe would point out, the `real` deposits started their life as `not real` loan spending~!
You are looking for the transaction accounting I thought ? The bank in my example above could have borrowed from another bank, bought out an investment company (to grab the deposits), etc.
Lots of options “other than the central bank” until there are no other options “but the central bank” !!!
It is late for me, don’t make me have to think.
The point is – ALL MONEY STARTED OUT AS `NOT REAL`~!!
Of course it did. … When I say backed by central bank real money….what the hell is that ? It is whatever central bank real money is ~!!
I have no idea what you are on about.
No we don’t.
You have to separate the loan creation.
Assets up by five money
Five money put into debtor’s deposit account.
From the normal transactions that run through the banking system. If you try and mix up the two, you will get into a mess.
The only way I can make sense of the 5′s is to have three sets.
1. for the client
2. for the bank
3. for the central bank.
1. The clients 4×5′s accounts pretty much credits and deposits
At this operational level secured loans provide a asset for the banks account.
2. The banks 4×5′s accounts for its capital and gains from interest margins, bank charges etc.
3. The central banks 4×5′s accounts for bank reserves, loans and interest on the currency. At this level the bank loan is fractionalised.
I cannot make any sense of that whatsoever.
I don’t understand the 5s so I have kept out of it. Strangly, I understand Steves explanation better. Anyhow we poorer Americans just want the rich to pay their fair share. As Buffet has said he pays less tax then his secratary. And that their is a war between his side (rich) and the poor and that his side is winning. As for the pie not growing , cheep oil was enableing employers to employ lots more workers, in my opinion.
I also have/had a problem with this concept.
In a full reserve system the banks cannot lend out against depositors’ accounts. There would always have to be five in a deposit account on the liability side against five in liquid reserves on the asset side. So if the bank wanted to make a loan of five money on the asset side, it would have to find five money on the liability side by borrowing from someone long term with penalties for early withdrawal. Charges would also be made to deposit customers who do not want their money lent out. The current system of simply creating the money would not work. The money would have to be available BEFORE the loan was created.In a zero reserve system the banks could lend all of the depositors’ cash out for a million years. And a depositor would have to wait for the million years to get his money back.I believe we have a no reserve system, but the perception of the deposit customers is that of a full reserve system. Deposit customers always expect to be able to withdraw their cash at any time. So they behave as though it is a full reserve system. Although, indeed, most of them do have an inkling that there is never enough cash in the bank to give all of them their deposits back at the same time.So I think that the distinction is:
A full reserve system must find the money to lend out BEFORE the loan is created, a non reserve system uses the money CREATED by the loan to fund the loan.
I like the last sentence …………. although I think I am going to have to start again with all the accounting.
I could go along with that.
This bit I am not sure of”.I believe we have a no reserve system” but it wouldn’t surprise me.
no savers, no reserves
No, that is not what is meant.
A fractional reserve system means that a certain percentage of depositors’ accounts is kept in very liquid stuff such as cash and central bank deposits. But we DO NOT have a fractional reserve system and it is now getting a bit boring trying to correct all the misconceptions.
If there were no savers then the bank would have to find the funds from other sources, such as the money market or borrowing overnight from the central bank or selling equity to raise the cash.
This leads to the big problem that Northern Rock had, as it relied on the money market and loans from other financial companies to fund its loan book. These funds dried up and left it in the shit.
quick question, no need for a long reply.
Is there a difference between a no reserve system and a zero reserve system ?
In the context of reserves being held against depositors’ accounts in a fractional reserve banking system.
Banks still must have reserves, for example capital reserves held against the loan book. And money held in the central bank is also part of the bank’s reserves. But the amount is not determined by the depositors’ accounts.
I googled zero reserve banking system.
I liked this cynical interpretation
Not sure if cocoa is good for you. Way too much sugar !! Go back to tea…you will sleep better !
You could do some research ….. and find out if cocoa is good for me~!?
Oh, my goodness. I had been busy all day in another sand pile, and I had no idea of all the play (especially with those 5s) that had been going on in this sand pile over here, ;-).
Carry on, ;-).
Are you receiving E-mails now for replies to comments~?
No. I followed your suggestion (that you wrote within another thread a few days ago), and that did indeed give me notifications – but for everything, ;-). That, I didn’t want, and so I went back in and unchecked some things, but left the one at the bottom for “Over the Peak,” and for replies to my comments. But that leaves me with no notifications – not sure of the problem. So I’ve just accepted that I’ll simply need to check in fairly often and see, ;-).
I want to write a little about the statement that goes something like, “All money is debt.”
Yes, technically, that’s true. For example, there’s the case of U.S. Dollars:
Yes, U.S. dollars, from the very first dollar issued until the present, and for as long as the U.S. continues to issue USDs, have all been issued as U.S. debt.
To be clear, it’s not that all of the USDs ever issued are still in existence and constitute the present national debt (from the beginning, some have been destroyed/debited out of existence over time - part of the ongoing ebb and flow of national spending and taxation, for example – or simply damaged to the point of not being usable or lost).
But that’s not what we’re talking about when we talk about bank loans made to the non-govt., non-banking sector.
There are binding “promises to repay” made when the Central Bank provides loans to commercial banks.
But there is also, of course, a great deal of spending by the U.S. federal govt. that is not associated with a “promise to repay.”
Quite to the contrary, with each and every bank loan made to the private sector, there is associated with it a binding legal contract, a legal “promise to pay” (and whatever further terms are a part of any particular bank loan agreement).
So I think, for the most part, it is unhelpful to lump those two categories of “debt” together, as if bank debt and national govt. debt are the same thing.
I do, however, think that there are some exceptions. For example, there are discussions I can appreciate that bring up national debt in the context of alternative national monetary systems in which a nation’s money doesn’t have to be constituted as debt at all, and how that plays out through a nation’s whole monetary system.
Okay, ”that’s all I have to say about that…” ;-).
To revisit the mysterious extra five.
I am not sure if this has been discussed to completion.
Ignore the loan creation of a bank.
When a customer deposits five money cash in his account, this is reflected in an increase of five money in the cash reserves.
If a customer takes five money in cash from his account and stuffs it in his pocket, the cash reserves of the bank are depleted by five.
The “mysterious extra five” comes simply from the cash reserves or, in the case of a transfer, the reserve account, from another bank. It merely shows the balancing of the reserves around the banks in the banking system.
Now here is a much harder issue to think about.
Is it possible for a bank to make a commercial loan from its reserves?
Let’s take this to the extreme.
A bank has the following balance sheet.
Yep, the bank has not loaned out a single money of the cash it has. 500 money all lying around earning nothing.
Can it now lend out a one hundred money loan from its reserves?
And for the life of me I cannot see how this is possible.
Think about it and tell me if it is possible.
This takes us right back to the start again.
The answer is still, no~!
Or, the better answer – When it can make a fountain-pen loan ….. why would you want to~!?
That was quick!
So the next question is, how on earth should QE “stimulate the economy” by exchanging reserves invested in government bonds for cash?
I cannot see a mechanism.
Except that it has reduced interest rates to zilch. Which, IMO, only increases the thrift of the peeps.
QE ….. again, right from the get-go, the MMT crowd pointed out that it cannot have any `physical` effect.
just been looking at that
note the initial QE money gets destroyed eventually
The only reason I would take a loan from the bank is to make a profit for myself through a business.
Other people might want the ‘pleasure’ of driving a new BMW from the showroom floor or are convinced that the bricks and tiles surrounding them is a great investment.
I look upon house ownership as a coffin.
Family income has increased? Does that figure women coming into the workforce? Would make sense that family income doubles, if both parents are now working, to buy the same house, food and car.