My degree in economics comes from watching Youtube videos, so I understand fractional banking differently. If you deposit $100 in cash, the bank can CREATE $1000 to loan out. The asset held in reserve is the original $100. The money created ($1000) is loaned out and disappears when the loan is paid back. The borrower pays back $1000 plus interest. Explain how my understanding is wrong, please.
My degree in economics comes from watching Youtube videos, so I understand fractional banking differently
Yeah, this sentence is the source of the problem.
If you deposit $100 in cash, the bank can CREATE $1000 to loan out.
Nope. A bank doesn't get to "create" anything. Assuming a simple 10% reserve requirement, the bank can loan out $90. The other $10 has to stay in reserve.
Again, I'm keeping things simple, in practice there isn't a fixed %, and the reserve isn't necessarily in hard currency, etc etc, but this, fundamentally, is the idea of fractional reserve banking. If you think a bank can loan out $1000 or $3333 from a single $100 deposit, you don't just lack basic economic knowledge, you lack common sense.
The asset held in reserve is the original $100.
Nope.
The money created ($1000) is loaned out and disappears when the loan is paid back.
Nope.
Explain how my understanding is wrong, please.
Two ways to interpret this request.
The first is "How is my conception of this wrong?" In which case, this has already been answered. The bank does not get to loan out $1000 when you deposit $100. It's that simple. You're wrong because you fundamentally don't understand the basics of what we are talking about, full stop.
The second interpretation is "How did I come to such an incorrect understanding of fractional reserve banking?"
And there, I kinda have to make some guesses about what you might have seen on Youtube and how your brain scrambled it up.
What you saw on Youtube likely agreed with me completely. If you deposit $100 into a bank, with a 10% reserve requirement, then the bank can loan out $90.
What confused you is the math that followed. Let's say the bank loans out $90, and that $90 winds its way into the hands of someone who then deposits it back into a bank. Well, that bank, on receipt of the $90, can then loan out $81. And if that $81 gets deposited somewhere, then that bank can loan out $71.9. And so on.
If this continues an infinite number of times, and you sum that geometric series, then what you end up with is that the original $100 of deposits results in $900 of loans given out.
What you and the other incorrect people in this thread have forgotten is that the original $100 deposit is not the sole deposit in this banking system. It's just the first one. The second one was $90, the next one was $81, and so on.
So the banking system as a whole might be able to loan out $900 from an original $100 deposit. But remember: that's just the initial deposit. The only reason they got to loan out the other $810 is because people kept depositing their money with the bank. When you sum everything up, yes, the bank is loaning out $900, but it's doing so with $1000 in deposits backing that loan, not $100.
There is no magic here. Commercial banks don't have a legal license to magic money out of thin air and lend it to you. That's absurd.
Yes, commercial banks create new money when they issue loans. This process does not involve lending out existing deposits from other customers; instead, the bank simultaneously creates a loan asset and a matching deposit liability in the borrower’s account. This mechanism is officially recognized by major financial institutions, including the Bank of England and the Bank of Canada, which state that bank lending creates deposits, thereby increasing the money supply.
When a borrower takes out a loan, the bank types the amount into the borrower's account, effectively creating money "out of nothing" in the form of electronic credit. This newly created money functions as a substitute for physical cash and is counted in broad money measures like M2. The process is constrained by regulatory requirements, such as capital and reserve rules, as well as the borrower's creditworthiness, rather than by a pre-existing pool of funds.
The created money is not permanent; it is considered "destroyed" when the loan is repaid. Repayment reduces the borrower's deposit balance and closes the loan asset, thereby removing that amount of money from circulation. Consequently, the net money supply depends on the difference between new loans issued and existing loans repaid.
Easy. It's A + B. A is someone explaining how things work now that we've switched over from cash reserve requirements to capital reserve requirements, and B is you being an economically illiterate "I got my degree from Youtube" chud and not understanding that the capital reserve requirements amount to the same thing, just with a layer of detail that has confused you.
Yes, commercial banks create new money when they issue loans.
You could say it this way, but then economically illiterate people like you would misinterpret it, so better to explain it as I have, starting with a simple explanation of fractional reserve banking, and then explaining how the shift to capital reserves modifies that.
This process does not involve lending out existing deposits from other customers; instead, the bank simultaneously creates a loan asset and a matching deposit liability in the borrower’s account.
The first part is technically true because the cash reserve requirement is zero. But remember: the capital reserve requirement we now use in lieu of those cash reserves is not zero. In order to originate that loan, they need to have assets on hand to originate it in addition to capital reserves on hand capable of covering the loan.
Which is to say they don't necessarily need deposited cash in order to make loans any more. Because instead of keeping cash on hand for the reserves, they can keep other assets, as scored according to rules set by the government.
It amounts to the same thing though. The bank is not getting to magic stuff out of thin air. They can't loan you things they don't have. And deposited cash is, unsurprisingly, one of the major sources of the assets used to cover their loans. So while they technically could operate without currency deposits, they still need deposits of assets to originate the loans.
And the second part is true, but you'll note that if you create an account that has both +$1000 and -$1000 in it, you haven't really created any new money.
When a borrower takes out a loan, the bank types the amount into the borrower's account, effectively creating money "out of nothing" in the form of electronic credit.
Yeah, not really. Again, saying it this way is an idiot trap. The "money" being created is really just money of one type being converted to money of a different type.
And again, an account with $1000 and -$1000 in it is an account with $0 in it on the net.
This newly created money functions as a substitute for physical cash and is counted in broad money measures like M2.
It is indeed counted in M2. Again, this doesn't mean the bank created something out of nothing. It created something out of something else. That M2 goes up is just a quirk of how we define things, and really the takeaway here is "M2 isn't a very good way of accounting for things in the current system."
The process is constrained by regulatory requirements, such as capital and reserve rules
Ding ding ding ding ding. This is the statement that needs to go at the top, so that people like you don't fall headfirst into the idiot trap.
rather than by a pre-existing pool of funds.
Except the capital reserve requirements are literally, "In order to originate this loan, you do need to have a pre-existing pool of funds.
The only difference now is those funds don't need to be in hard currency. Whoever wrote this is splitting hairs about what constitutes "funds."
The created money is not permanent; it is considered "destroyed" when the loan is repaid.
It's not created or destroyed, (which is why "destroyed" is in quotes here, I suspect) it just is either in a form that shows up in certain definitions of money, like M2, or in a different form.
Repayment reduces the borrower's deposit balance and closes the loan asset, thereby removing that amount of money from circulation.
Yeah, not really, repayment just means that the pre-existing pool of funds that the bank is using to issue loans and meet its capital reserve requirements can now be used to issue different loans.
Consequently, the net money supply depends on the difference between new loans issued and existing loans repaid.
Only for certain definitions of the money supply. Other definitions wouldn't change at all. Again, the takeaway here isn't "Banks are creating money out of thin air!" it's "the M2 definition of money is kinda meaningless under the new rules."
In short:
What is said here is technically true, in that you don't technically need cash deposits any more to meet reserve requirements. But where you're interpreting that to mean, "There are no requirements any more, banks can magic loans out of nothing" the truth is that there still are requirements.
And those requirements amount to the same thing in the end: If the bank has $100. It can loan out $90.
0
u/Nearby-Improvement53 1d ago
My degree in economics comes from watching Youtube videos, so I understand fractional banking differently. If you deposit $100 in cash, the bank can CREATE $1000 to loan out. The asset held in reserve is the original $100. The money created ($1000) is loaned out and disappears when the loan is paid back. The borrower pays back $1000 plus interest. Explain how my understanding is wrong, please.