Talk:Fractional-reserve banking

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[edit] Restructure Proposed

This article has many problems including:

  1. Structure is not logical
  2. Poor quality
  3. Too many examples
  4. Lack of NPOV -- it is basically a rant against FRB
  5. Too many other topics are included, such as convertibility, financial ratios and government regulation of banking and history of banking
  6. It is too long.

I propose to restructure the article as follows:

  1. Start with a clear definition and description of FRB, without including pros and cons, and stating its alternative would be full reserve banking.
  2. Give an example of FRB in the context of a bank balance sheet and a maturity analysis of assets and liabilities.
  3. Clarification of possible confusion between reserve ratio and other liquidity ratios, and capital ratio.
  4. Brief discussion of liquidity management under FRB.
  5. FRB in the context of both central banking and commercial banking
  6. FRB and the money stock/money multiplier
  7. Regulation of FRB (i.e. required reserve ratios) under regulations intended to control the stock of money.
  8. Criticisms of FRB and responses to them.
  9. See also, links etc. as now

This structure enables NPOV to be maintained, and pushes the controversy to the later part of the article. Remember the purpose of the article is to explain the term rather than to engage in the controversy. 122.57.90.63 (talk) 19:26, 16 December 2007 (UTC)

I would agree. I also note that the tables appear to be original research, and the one that gives the bank's asset/liability table is wrong (as far as I know). There appears to be significant confusion about the fact that there are different types of reserves (like loan reserves), that may be in either assets or liabilities or contra-accounts. If one looks at a bank's accounting statements, the reserves are not a liability, but an asset - they are a requirement to keep a certain amount of assets in liquid form (often with deposits with the central bank). So the progression works like this (for a bank that has no equity where required deposit reserves are 10%):
Step 1: Bank has zero assets, zero liabilities.
Step 2: Customer deposits $1000 cash. Bank has assets of $1000 cash, liabilities of $1000 customer deposit.
Step 2a (notional step): Bank creates "reserve" of $100 (perhaps by placing a deposit with central bank). Assets of cash $900, liquid cash reserves of $100; liabilities are $1000 deposit from customer.
Step 3: Bank loans $900 to customer B. Bank has assets of $900 due from customer, $100 liquid cash reserve, liabilities: $1000 customer deposit.
If one looks at a bank's actual balance sheet (depending on jurisdiction), the "reserve" may be shown as e.g. mandatory cash balance with central bank or something similar (it may not be shown at all); but it is not a liability. An example can be seen here on page 255, this is Economics: Principles, Problems, and Policies By Campbell R. McConnell, Stanley L. Brue. It is clearly shown that the reserves are shown as an asset, not a liability. (Note in this example, the "total reserves" is shown, not the minimum reserves; a bank's financial reports may or may split these out.--Gregalton (talk) 20:58, 16 December 2007 (UTC)
To put forward a reliable source, see [1] - Economics: Principles and Policy, By William J. Baumol, Alan S. Blinder. Impeccable sources without the rhetoric. This would be a good starting point.--Gregalton (talk) 21:09, 16 December 2007 (UTC)

Greg, Yes, the term reserves can be used for capital reserves (e.g. when the bank revalues the land under its branches upward), for loan loss provisions, for employee entitlement provisions and probably more. Reserves in banking, for the purposes of this dicusssion, really means legal tender reserves, i.e. assets that can directly discharge the bank's liabilities, without needing to be sold or redeemed. Fractional reserve banking means, at least to some extent, the bank is relying on its ability to sell or redeem assets that it can't directly pay out to discharge its liabilities, so for this discussion we need to be strict about the term. Liquid assets are really secondary reserves that anti-FRB people won't admit as reserves.

I have bought in data from a particular bank, ANZ National as an illustration, to avoid claims of original research. Is this the right thing to do?

The steps you propose to illustrate are good, except you can't dispense with equity capital, it is an essential ingredient in getting people to hold the bank's liabilities. Really a model bank illustration should include equity capital, demand deposits/notes, term deposits, loans and advances, marketable securities, and cash reserves. 122.57.90.63 (talk) 09:20, 17 December 2007 (UTC)

Actually, I didn't really like leaving out equity either, the existing table didn't have it either. The article should, as you say, be much more specific what type of reserves and what they consist of - certainly not liabilities. I also think the article could use some more language on minimum reserves vs "preferred" reserves, that is, the reserves the bank chooses to keep (which also depends on definition).--Gregalton (talk) 11:03, 17 December 2007 (UTC)
In your example, shouldn't you include central bank balances in the reserve ratio?--Gregalton (talk) 11:06, 17 December 2007 (UTC)

Greg, If a customer walks into a bank branch and demands repayment, the customer has a right to insist on legal tender, and the bank can't directly use its balances with the central bank to pay the customer (they aren't legal tender), instead the bank has to redeem its balance with the central bank in legal tender which can then be paid to the customer. Really the only difference between balances held with a central bank and balances held with a commercial bank is that the former may be safer. 122.57.90.63 (talk) 21:11, 17 December 2007 (UTC)

Of course - but in some countries / banking systems, "reserves" in the sense they are used in this article are required deposits with the CB. They are part of the tool used to adjust monetary transmission (as well as protect depositors). In fact, required reserves may be subject to restricted usage (i.e. not available under normal circumstances for banks to meet day-to-day cash requirements). Of course, part of the assumption behind this is that the bank can quickly - if not immediately - convert CB deposits into cash, and hence count as "cash reserves."
In essence, this is dependent in part on local regs. My (very weak) understanding is that deposits with FRB count as reserves.--Gregalton (talk) 22:43, 17 December 2007 (UTC)

Greg,

I think this article is supposed to be pan-jurisdictional and relate to the principle of the thing first, and the variants under regulatory law later.

I've checked out another bank's financial statements, Westpac New Zealand Limited has a less complex balance sheet and it only lists $102m in 'cash and balances with central banks' without breaking it up between the two, and it has a maturity analysis that lists 'on call' separately from 'less than one month'. Interestingly this gives a reserve ratio of just 0.78%, basically the same as the legal tender cash reserve ratio of ANZ National Bank Limited. Perhaps we should put both the balance sheet and the maturity analysis there as the example. David.hillary (talk) 23:20, 17 December 2007 (UTC)

I agree - in fact my comments about the proposed restructuring is that it seems to focus predominantly on FRB approach. For another one, the financial statements for Russia's Vneshtorgbank are available here. The relevant quote that relates is in the notes, "Mandatory cash balances with the CBR and other Central banks are carried at amortized cost and represent non-interest bearing mandatory reserve deposits, which are not available to finance the Group’s day-to-day operations and hence are not considered as part of cash and cash equivalents for the purposes of the consolidated statement cash flows." This is the Russian Central Bank's approach to deposit reserves (there are entirely separate requirements for liquid assets available, etc).--Gregalton (talk) 00:14, 18 December 2007 (UTC)

[edit] Lets keep the table and graph that explains the essence of the fractional reserve system

Since this article is about fractional reserve banking, and the purpose of wikipedia is for people to have the ability to understand things, I think it's necessary to explain what essentially fractional reserve banking is in the simplest way possible. The table that displays the fractional reserve lending system at work does just that. There are a lot of people trying to explain in many words how fractional reserve lending works and this graph does it all for them. There's no need to have long discussions about how much can be lent out. Just look at the table.

Also, the intro to this article is horrible. I have no idea what it's saying. Since wikipedia is supposed to be for people all over the world of different age groups and from different educational backgrounds, I think this article should be designed to be as easy to comprehend as possible. I don't think the intro needs to get too technical or complicated. Just say what fractional reserve banking is: when a bank lends out most of the deposits and increases the money supply without physically creating new money. The table then displays how this works. Not much more is needed in this article after that other than the purpose of this system and the arguments supportive of it and arguments against it.

Here is the table again. Could someone please explain why this shouldn't be in this article?:

Table 1: $1,000 of actual money loaned out 10 times with a 20 percent reserve rate
Individual Bank amount deposited at bank amount loaned out amount left in bank (reserves)
A $1,000.00 $800.00 $200.00
B $800.00 $640.00 $160.00
C $640.00 $512.00 $128.00
D $512.00 $409.60 $102.40
E $409.60 $327.68 $81.92
F $327.68 $262.14 $65.54
G $262.14 $209.72 $52.43
H $209.72 $167.77 $41.94
I $167.77 $134.22 $33.55
J $134.22 $107.37 $26.84
K $107.37
total reserves:
$892.63
total deposits: total amount loaned out: total reserves + last amount deposited
$4,570.50 $3,570.50 $1,000.00

I think this simple table explains things more than sufficiently. Who does or does not like this table? Please state your reasons. Analoguni (talk) 19:32, 19 December 2007 (UTC)


The problem is that the table above and the one in the current article, do not correctly reflect how the banking system works. In particular, the table claims that loans are made from reserves, which is not correct. Bank loans are not made from reserves. From: "Modern Money Mechanics, by the Federal Reserve Bank of Chicago":

Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.

It also neglects the fact that new money is created when loans are made. Loans are in fact just bookkeeping entries, where the maximum amount is determined by the amount of excess reserves that are available. Here's a revision of the table that tells the story more accurately:

Table 1: $1,000 of actual money loaned out 10 times with a 20 percent reserve rate
Individual Bank amount deposited at bank required reserves excess reserves new loan
A $1,000.00 $200.00 $800.00 $800.00
B $800.00 $160.00 $640.00 $640.00
C $640.00 $128.00 $512.00 $512.00
D $512.00 $102.40 $409.60 $409.60
E $409.60 $81.92 $327.68 $327.68
F $327.68 $65.54 $262.14 $262.14
G $262.14 $52.43 $209.72 $209.72
H $209.72 $41.94 $167.77 $167.77
I $167.77 $33.55 $134.22 $134.22
J $134.22 $26.84 $107.37 $107.37
K $107.37
total required reserves:
$892.63
total deposits: total reserves + last amount deposited total amount loaned out:
$4,570.50 $1,000.00 $3,570.50

As the number of banks and loans increases, the total required reserves approaches the amount of the initial deposit and the total amount loaned plus the initial reserve approaches 1 divided by the reserve requirement times the amount of the initial deposit (1*1000/0.2 = 5000x in this case).

I suggest the table above be included in the article instead of the current one. --AceNZ (talk) 10:20, 6 May 2008 (UTC)


Sorry I find this table and the explanation of FRB as 'lending out deposits' as confusing and unhelpful. What happens to the money lent by the bank in a sense isn't what FRB is about: it is about the money the bank doesn't lend out but hold in reserve, hence the term FRACTIONAL RESERVE BANKING. Since deposits are the bank's liabilities, to talk about lending deposits I think is very confusing.

I think we should start with the individual bank, and then move to the system as a whole, and then introduce the controversy converning the stock of money and price of money as close to the end of the article as possible. For this reason I have restructured and edited the article to start with an example of the balance sheet of the fractional reserve bank, showing that the bank's stock of legal tender reserves are a small fraction of its demand liabilities, which is the essence of fractional reserve banking. David.hillary (talk) 04:59, 20 December 2007 (UTC)

I disagree strongly with David's comments. I find the table and the associated explanation clear, factual and worth re-inserting. I find David's comments unconvincing. The diagram associated with the table was also very useful. Frankly I don't know why so many edits have occurred on this page over the last couple of weeks. There was a very clear version of frb only a few weeks ago and it seems to have been wiped. Also the Libertarian stuff has basically been wiped. A lot of "wiping" seems to be going on here with very little explanation. I, for one, don't like it.--Karmaisking (talk) 15:42, 25 December 2007 (UTC)


I agree with David's comments and didn't find the table and graph useful - just an opinion. And the "wiping" of libertarian stuff was on this talk page for some time with no argument proposed as to why this page should contain a section devoted to a single political party or movement's viewpoints (why not Communist? Why not every other?) This is an economic/academic topic, and if there is a need for viewpoints, no particular party's approach should receive special attention.--Gregalton (talk) 17:15, 25 December 2007 (UTC)
I have reverted Karma's re-addition of this material while being discussed on talk page. David's comment above is accurate: FRB is about what the bank does NOT lend out, not what it does lend out. In addition, this whole geometric progression thing is a gross oversimplification: a) the reserve is a minimum, not the actual amount; b) leaves out bank equity and capital, which is often more significant than the resrves; c) makes no account for 'friction' in the system (i.e., relative desire of recipients of loan money to keep money in the banking system, or hold reserves at different levels, etc; d) makes no account of other restrictions on lending, such as minimum capital requirements, etc. So it tells you something in theory (maximum amount that could be created) but not much in practice (how much will be created). If others have a strong opinion, please let us know, but at minimum, this type of "illustration" should be further down the article.--Gregalton (talk) 09:45, 26 December 2007 (UTC)
FRB must include its EFFECTS, not just the simplistic anodyne statement that the bank lends more than it has in cash deposits. That's almost deceptively simplistic and doesn't explain the dynamic implications of frb. The table and the easy-to-understand diagram convey accurately the GENERAL effects of frb, which are undeniable and acknowledged by all monetary economists. It should be at the start of the article as it is the "main" economic effect of frb and is the issue of most interest to people ignorant of frb. Can someone else please comment, as Gregalton is strangely insistent that this stuff remain deleted.--Karmaisking (talk) 12:19, 26 December 2007 (UTC)

[edit] here is the source for the table

Here is a good source for the data in the table. It's from the New York regional reserve bank of the US Federal Reserve System: http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html Scroll down to the "Reserve Requirements and Money Creation" section. Here is what it says:

"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity."

I rest my case. By the way, I am the creator of that table. Analoguni (talk) 09:38, 27 December 2007 (UTC)

Great job. You are amazing. That's the best explanation of frb I've EVER seen. If I had a hat, I'd take it off to you :-) --Karmaisking (talk) 12:37, 29 December 2007 (UTC)
Just a quick note - diagrams are even more informative and show the effects of lower reserves. Excellent work. Don't let troll Zenwhat discourage you. He has clearly indicated his obsessive interest in defacing this page - and has even asked Gregalton to help him remove references to the great Ludwig von Mises. Specifically, he has asked Gregalton help him delete references to Mises.org here, stating in unambiguous terms to Gregalton: "Also, in case you're interested, one of the easiest ways to find economics articles that have been vandalized is to do a search for links to Mises.org". References to von Mises amount to VANDALISM??? What a sicko! Both "editors" appear to be interested in defacing articles relating to monetary theory or frb. Sad to say, but given these comments, the only conclusion one can draw. I, for one, am grateful for your persistence in the face of repeated silly attacks by monetary trolls.--Karmaisking (talk) 11:22, 10 January 2008 (UTC)

Be Careful Analoguni!!! - you have to keep reading the Fed article that you are citing. The paragraph after the example states, "In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest ... Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves." This indicates that Fractional Reserve Banking is about RESERVES - and not deposits. - http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html

Example - A brand new bank opens up with no assets/money whatsoever. The day that it opens, it loans Joe Schmo $1,000 by opening him a checking account and putting $1,000 in it (it doesn't actually put real cash in the checking account - it just marks down on its books that Joe has an account with $1,000 in it). At the end of the day, the Bank notes that it has "lent" $1,000 to Joe (still just noting an amount of $1,000 in his checking account), but that it has no actual money in reserve - as nobody has made any deposits with the bank. At this point, if Joe tried to take any money out in cash, the bank would say "Sorry - we ain't got any." So the bank goes to the money market and borrows $100 at the prevailing federal funds rate. Now the bank has $100 from the money market in actual money and puts it in its vault ("in reserve"). Why only $100? Well because it is equal to 10% of what it lent out to Joe. This way they are meeting the statutory regulations imposed on them of having 10% reserves. This way, when Joe tries to take some cash out of the checking account, the bank has some cash to give him. Chances are he won't ask for the whole amount, and that is why the law says that the bank only has to keep 10% on hand.

So, including your chart only confuses what Fractional Reserve Banking is about. It is true that your example shows a way that transaction deposits can be created through Fractional Reserve Lending, but is seperate and distinct from what Fractional Reserve Banking is. —Preceding unsigned comment added by 70.64.6.187 (talk) 06:08, 13 January 2008 (UTC)

So if they lend Joe $1000, where does the money come from? What if Joe wants cash? You're absolutely wrong. They have to get all the money from the fed and pay interest on that money. 167.1.150.121 (talk)
You don't understand what that page is describing. What it means when it mentions the reserves is that in the U.S. system specifically, the government regulates things my influencing the cost of interbank lending of reserves. This is U.S. specific and doesn't apply to fractional reserve banking in general, although there are probably other nations who regulate the banking system in the same specific ways that the U.S. government does through the Federal Reserve system. As far as deciding whether fractional reserve banking is about either deposits, loans, reserves, or the money supply, I would say that it's about all of these, not just one of them. You said:
"This indicates that Fractional Reserve Banking is about RESERVES - and not deposits."
This is incorrect because it is about reserves AND deposits...and loans...and the money supply. For the information about reserve requirements:
"In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest"
What this is referring to is that individual banks will not usually lend out the maximum permitted amount based on the reserve requirements. This happens for a number of reasons. One reason is that the more a bank loans out, the higher the risk is that it could go bankrupt or that there could be a bank run. Remember, a bank is a private business and exists to make a profit and it's not in the private bank's interest to go bankrupt. Also, in the U.S. specific case, government regulations can be used to prevent an individual bank from loaning out money even if it still has more reserves then the legal reserve requirement. If you want to see how this applies in a real world situation, just look at the current housing bubble in the united states. The banks didn't necessarily lend out the maximum amount permitted but they still gave loans to people who didn't have enough income to pay back these loans. The Federal Reserve System has regulators in place that are supposed to be able to stop a bank from giving out loans to people who cannot possibly pay them back. The Federal Reserve regulators failed to properly regulate the subprime loans. This is how the U.S. system is supposed to prevent bad loans from being given out even though the banks have more money available then the reserve requirement. This is U.S. specific and doesn't apply to fractional reserve banking in general. Analoguni (talk) 23:38, 26 January 2008 (UTC)

[edit] A statement from the Federal Reserve on money creation through fractional reserve banking

Fractional reseve banking isn't just about the reserves but it is also about the money supply in a banking system and/or economy. (back in the 1800's, in the free banking era, private banks controlled their own money. This is why I say banking system (free banks) and/or economy (govt regulated banks)). Fractional reserve banking has a direct effect on the money supply and it is not only important, but necessary to include the effects on the money supply in this article.

The table above shows how the money supply is expanded through the fractional reserve lending system and I think it's necessary to include it in this article.

Here is a quote from the U.S. Federal Reserve's official education website (www.federalreserveeducation.org). It is from a document that was created to educate people on how the federal reserve system works. It is titled, "The FED Today". Some text on the cover says, "Histroy, Structure, Monetary Policy, Banking Supervision, Financial Services, and more", and, "Lesson plans and activies for economics, government, and history teachers". The link to it is: http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf

Myth: The Fed is not a good supervisor of banks because it allows banks to keep only a fraction of their deposits on hand.
Fact: The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to “create” money.

This is on page 57 of the document. Analoguni (talk) 07:51, 27 December 2007 (UTC)

Now let's contrast the statement from the federal reserve with the statements by users above:

"Sorry I find this table and the explanation of FRB as 'lending out deposits' as confusing and unhelpful. What happens to the money lent by the bank in a sense isn't what FRB is about: it is about the money the bank doesn't lend out but hold in reserve, hence the term FRACTIONAL RESERVE BANKING. Since deposits are the bank's liabilities, to talk about lending deposits I think is very confusing." David.hillary (talk) 04:59, 20 December 2007 (UTC)
"David's comment above is accurate: FRB is about what the bank does NOT lend out, not what it does lend out." Gregalton (talk) 09:45, 26 December 2007 (UTC)

Clearly, the loans and resulting deposits are important because new money is created this way. The money supply is expanded through this system. Analoguni (talk) 08:21, 27 December 2007 (UTC)

[edit] Need more information for the two types of money

There are several characteristics of fractional reserve banking that aren't included in the article. For example, commercial bank bank money gets its value from the fact that it can be exchanged at a bank for central bank money. It only exists "on paper" in the form of checks or electronic transfers. Also, some more info on how deflation occurs as debts are paid back can be helpful. The addition of new money has a multiplying affect since it can be used to create more commercial bank money. There is much more commercial bank money in existence then there is central bank money. Official money supply statistics show how much more commercial bank money exists then central bank money. I put in a list with these things but it was changed and some information was removed without at least putting in citation tags. I think all of these things describe fractional reserve banking and help to give an understanding of how it all works.

An analysis of how much money is needed to pay back the loans is probably necessary too, since it would show if and how new money would be needed within a system in order to be able to pay back a loan plus interest. The banks make their profits from taking money out of the system, but it also might be important to point out that the banks spend the money they make so it could still be within the system. An analysis of this could be useful. Analoguni (talk) 04:03, 7 February 2008 (UTC)

[edit] keep it simple so ordinary people can understand what fractional reserve banking is

There's too much complicated stuff in this article. I think it would be best to have sufficient information so that someone who doesn't know what fractional reserve banking is will know what it is after reading this article. Analoguni (talk) 20:05, 19 December 2007 (UTC)


I think everyone agrees with this, the debate is on what we can lose and how to structure and word the article so it is clear and unbiased. David.hillary (talk) 04:59, 20 December 2007 (UTC)



this article is just wrong. cash reserves deposited at a central bank allow banks to MULTIPLY their money by the reserve requirement. 1 dollar may be turned into 9 with a 1:9 ratio.

if the chequebook money created by the bank is deposited at another bank they are now required to keep a portion of it as a reserve. see

http://uk.youtube.com/watch?v=hfXavRTM4Fg&feature=related

why can't i edit the article to make it accurate? —Preceding unsigned comment added by 91.110.50.216 (talk) 06:39, 31 December 2007 (UTC)

[edit] Okay, just... stop it

Banks are required to keep 10% of deposits "On reserve" in case of a run. They are allowed to lend out ten times this 10%, or 100%. This is not 1,000%, and it never was.

See: http://www.fdic.gov/regulations/index.html Sim 05:51, 1 February 2007 (UTC)

The can loan out 1000% of their reserve, which is 100% of their deposits. The 1000% number is correct, it just needs to be clear what number they are referring to. Paladinwannabe2 14:29, 26 June 2007 (UTC)


"If a bank has $100 in reserves, with a 10% reserve ratio, it can lend out $90. That $90 is then paid into another bank, which can similarly lend out 10% ($81) on that $90 deposit. That $81 dollars also winds up in a bank, and the bank can then lend out 90% of that, and so on. The banks are lending based on money that has itself already been lent, many times over, in a series of decreasing amounts, until the amount becomes to small to practically lend. By that time, a total of $900 has been lent in total. Including the original deposit, $1000 now exists where there was once just $100.

It may be that this process happens within just one bank (because they cannot recognise the money as originating with them), or it may happen within many. The system continues to operate on a large scale as long as money continues to flow in and out of banks."

Can I please suggest using the above example of the way money is created through FRB to be put at the beginning of the article? It is simple and gives the layman a solid background. As it stands, this article is very difficult to penetrate and appears to contradict itself.

202.130.159.184 10:14, 21 September 2007 (UTC)


it is a reserve RATIO not percentage. i believe it is 1:9 in the us currently.

thus you deposit ten dollars, they may use this as a reserve and lend 90.

10:90

reserve:check book money —Preceding unsigned comment added by 91.110.58.90 (talk) 16:17, 15 December 2007 (UTC)

The bank does not lend from its reserves; it lends from its deposits (or other sources). The reserves are a fraction of the bank's deposits that it is required to keep as a risk management policy. Thus, it is wrong to suggest that "If a bank has $100 in reserves, with a 10% reserve ratio, it can lend out $90". It would rather be "if a bank has 100$ in deposits, with a 10% reserve ratio, it can lend out 90$". Then what happens to this 90$ really depends on what the borrower does with it. If he deposits it (makes little sense because he loses on the interest margin), then yes, the next bank must keep 10% reserve (9$) and can lend the other 90% (81$), a process that "created" virtual money (171$ lent out of a 100$ initial deposit). But if he, for instance, invests it or lends it, the forthcoming events are quite different. --Childhood's End (talk) 16:11, 21 January 2008 (UTC)
If banks needed deposits to make loans it would be like full-reserve banking. Deposits are not a loan to the bank and are not required for lending. Why doesn't the Federal Reserve Act mention that a bank needs to use deposits to make loans? Orangedolphin (talk) 20:34, 15 March 2008 (UTC)
What happens with the money that has been invested or lend? Does it not go into a bank again?--Rougieux (talk) 17:52, 14 February 2008 (UTC)
It might if it's invested in bank shares, but that would not be a deposit and would instead add to the bank's capital. If it's invested in another company's shares, it will add to this company's capital. If it's lent to entity X, then who knows what entity X will do with it, and so forth. --Childhood's End (talk) 19:36, 14 February 2008 (UTC)
I think the answer is that the money will be either placed in a bank account or spent. It may be spent on a house, a car, groceries, shares, foreign currency, gold, a work of art... or anything, including any investment. (There is no reason to distinguish between investing and spending: investing is simply buying something you expect to increase in value.) The seller will then either bank the money or spend it in turn. Unless a seller keeps the money in banknotes under the bed, it will eventually return to a bank, and if the payment was not in cash it will never leave the banking system. So, if we consider the entire banking system to be one big bank, the scenario where the borrower redeposits the money in the same account is an accurate, if simplified, model of the bigger picture.
In the example of bank shares, the money would only be added to the bank's capital if the shares were bought directly from the bank at their first issue. Most cases would be a simple purchase from a seller and would not affect the bank's capital in any way.89.243.99.97 (talk) 14:34, 28 March 2008 (UTC)

[edit] added some criticism from the Federal Reserve page

Hi,

Just wanted to say that I added a bit of criticism from the Federal Reserve page that had been written about fractional-reserve banking in general and didn't really belong there. I didn't want to delete it altogether, though, so added it here (in condensed form). I also thought the intro paragraphs were very long, so put the discussion of risk into a separate section.

Afelton 03:19, August 2, 2005 (UTC)

[edit] Videos-Documentries

I came across these two videos tonight. Very detailed history of the US Federal Reserve up to its current monetary system. (my own opinion: Slightly conspiracist. States in plain terms the threat of the potentially nefarious power to print money in private hands; private bodies other than the citizenry. However, very informative.)

Links not working... http://video.google.com/videoplay?docid=-2665915773877500927 http://video.google.com/videoplay?docid=-8753934454816686947

[edit] Latest revision made things worse

The revisions made in February took what had been a reasonably good explanation of fractional reserves and made a mess of it--for example: a T-account with 3 columns instead of the usual two, and a long string of transactions trying to show what had been adequately expressed with just two transactions. —Preceding unsigned comment added by 67.49.42.239 (talk • contribs) on 10 February 2007.

[edit] U.S. centric

Hi, I tried to remove some of the more confusing references to the Fed in the opening example, as if this is meant to introduce the situation by example it really doesn't work at the moment (being both Americo-centric in stand point and confusing by adding all the Fed information). Any chance of moving the Fed stuff out of the opening example?

[edit] Should Reserve requirement merge into this article?

Sorry if I am entering really late, but the two articles deserve separate spaces, beacause:

  1. One is a system with a structure and the other is a property. Treatment has to be different and it'll be hard to frame an article to accomodate both (I believe the above topics spring from this difficulty).
  2. Both have their own history and complexities.
  3. Both are different at different places (in the world).

One again, sorry if I am entering this discussion too late, and what I mentioned has already been gone over. Nshuks7 (talk) 19:33, 26 January 2008 (UTC)

Two articles sounds like a good idea to me. What do others think? Orangedolphin (talk) 00:56, 27 January 2008 (UTC)
what 2 articles are you referring to? What is the system with structure and what is the property? Analoguni (talk) 03:30, 27 January 2008 (UTC)
I love riddles! Okay, one is a "system" and the other is a "property", and both are treated differently. Both have separate histories. Both are different in different areas of the world. I want to say fractional reserve banking and money supply, but both of those already have articles. What are the two articles? --EGeek (talk) 05:35, 27 January 2008 (UTC)
Proposal for merger of Fractional-reserve banking and Reserve requirement redirects here, to this talk page. In that context. Nshuks7 (talk) 06:34, 27 January 2008 (UTC)
Okay, I fixed the discuss link so that it redirects to this section. I also agree on two separate articles. --EGeek (talk) 07:36, 27 January 2008 (UTC)

I actually thought you meant we should have two articles for the alternative views on FRB. One could be the "mainstream" view and the other could be the Libertarian/Rothbard interpretation. Anybody think this is a good idea? Orangedolphin (talk) 11:19, 27 January 2008 (UTC)

I would support - this would allow us to have one core article, and then another that split off all the different interpretations, that was clearly identified as non-mainstream. There have been too many POV forks under quasi-respectable names (more editors on Monetary policy of the USA would be helpful, for example).--Gregalton (talk) 14:09, 27 January 2008 (UTC)
I think that this article can be maintained as a single article with both views being covered. It simply needs a big cleanup (especially sections 3 to 8 imo) and some more info/clarifications on the core rather than on the "examples". --Childhood's End (talk) 14:49, 31 January 2008 (UTC)
Is there a template for articles of this category? We should stick to a template. If there is no template, different sections for definitions, machinations, explanations, examples and critical views should suffice to give structure to this otherwise chaotic article. Nshuks7 (talk) 11:47, 7 February 2008 (UTC)

[edit] Lead definition

I agree that the deposits in a bank do not belong to that bank. I also understand that banks can use these deposits for more than "financing borrows"; however, the phrase "to their own ends" is too vague to explain this function. The original source cited states, "to finance profitable but illiquid investments", so I will use that instead. --EGeek (talk) 20:04, 21 February 2008 (UTC)

I really disagree. The bank can use the money to whatever ends it wishes and is not restrained to finance investments. And it can use it to non-profitable projects if it wants; another problem with the sentence you propose. The bank can also invest it internally in its information systems, buy back shares, and who knows what else. "To their own ends" may be vague but is the only acceptable description, unless you can suggest something else that I cannot think of. --Childhood's End (talk) 21:55, 21 February 2008 (UTC)
The statement does not make a distinction between internal or external investments. So investment into the firm, such as investment into information systems, still works with the statement in the source. While profitable investments are normally preferred due to risk, I will agree that profitability does not matter for a general definition of fractional reserve banking. --EGeek (talk) 01:17, 22 February 2008 (UTC)
The statement focuses on a few possibilities which are not necessarily more important than others. Even financing borrowers seems to me questionable as an example in the intro since this is not necessarily the core business in times of high interest rates, but I suppose it's the best example. The more accurate way to describe the system in a short sentence is to describe it for what it is; i.e. banks can use the money to whatever ends they want. Besides, the statement in the source says no more than in FR, deposits can be used to finance illiquid investments. It does not say this is an important function. See below. --Childhood's End (talk) 02:07, 22 February 2008 (UTC)
If you disagree with the examples I gave, then we can add to or modify them; however, I do not think we should list every type of investment. Yes, the citation does not elaborate on the importance of fractional reserve banking; it only defines it. --EGeek (talk) 02:11, 23 February 2008 (UTC)
Besides, the book you point to as a reference appears to be quite interesting. But I do not find the quote in it. --Childhood's End (talk) 22:10, 21 February 2008 (UTC)
See page 20 under "Liquidity Insurance" about midway down starting with "This is the basis for the 'fractional reserve system,' in which..." -EGeek (talk) 01:17, 22 February 2008 (UTC)
Got it, thanks. But the "basis" of the system refers to what comes before this sentence (total cash reserve needed increases less than proportionnaly with N...). --Childhood's End (talk) 01:50, 22 February 2008 (UTC)
I object to the phrasing "to whatever ends they want." This sounds biased to me, as if the banks can spend it on liquor and fast cars. In most jurisdictions, there are considerable prudential regulations, and the essence of the business of banking is that they finance longer-term, less liquid assets (with higher return than shorter-term, liquid assets) while attempting to keep exactly the right amount of liquid assets for customer demand. This is not "whatever ends they want." (In other words, liquor and fast cars comes after)--Gregalton (talk) 07:14, 22 February 2008 (UTC)
What prevents a bank from buying cars or liquors is its board and its internal management. Not the fractional-banking system. Unless you want to add "to whatever ends they want as authorized by the board" (which would be adding the obvious) there is no bias in this sentence; any reader understands that a bank is not going to buy nuclear weapons with the deposited money. Dont be paranoiac... --Childhood's End (talk) 13:13, 22 February 2008 (UTC)
Besides, banks do buy liquors (for visiting clients) and cars (for their officers)... :) --Childhood's End (talk) 13:17, 22 February 2008 (UTC)
The author explains the reason why the system works (the total reserves required increases less than the total deposits), then defines the system (where banks can use a fraction of these deposits "to finance profitable but illiquid investments."). For an encyclopedia, the subject should be defined first. --EGeek (talk) 02:17, 23 February 2008 (UTC)
I prefer EGeek's formulation. As for paranoiac, I think we should be extra cautious when the topic is a favourite of conspiracy theorists. What "any reader" understands is a point belied by the outlandish claims of many internet sites, and the frequent seizing of matters that are largely considered non-issues in mainstream economics, and so I'd argue there is a need to be extra cautious in establishing neutral phrasing. A bank that spent "on whatever they wanted" - without regard to prudential, etc - would no longer be fractional reserve banking, but simply a pyramid scheme.
I could argue about the fractional reserve part; the 'fractional' depends on its license, and hence on prudential regulations. At any rate, I reiterate the point that I don't believe the phrasing you're proposing comes across as neutral as it could and should be.--Gregalton (talk) 13:28, 22 February 2008 (UTC)
I really cannot see what is not neutral in a sentence that is accurate. The bank is free to invest or spend the money wherever it deems wiser. Not only is it misleading to point to a few specific examples, but it is also misleading to not mention the fact that the bank is not restrained.
The existence of conspiracy theorists should not force us to lower the standards of this article, nor to make it inaccurate or misleading.
Prudential guidelines do not monitor want banks do with the funds in the sense of what this sentence looks for; to suggest this would be misleading or would require long explanations. Banks usually have top-notch boards and officers, and this is where the internal controls are set. If you think a mention of this should be added, fine, but I really think it amounts to stating the obvious. --Childhood's End (talk) 13:46, 22 February 2008 (UTC)
Actually they are quite restrained in terms of asset type and quality, and particularly how it affects capital adequacy ratio. In other words, they cannot invest in "whatever they want." I don't think using EGeek's more neutral language is inaccurate or misleading. And this is in no way "lowering standards" due to conspiracy theories; it's simply avoiding loaded terminology.--Gregalton (talk) 13:55, 22 February 2008 (UTC)
Hey no, no, no! Capital requirements of banks restrain them in no way in what kind of investments banks can make. It only restrain them in their portfolio distribution. Of course a bank could not invest all its funds in junk bonds, but it can invest in junk bonds, and all banks actually do so. Riskier investments provide higher yield returns, and banks would strongly oppose any regulation that would prohibit them from investing in BB-rated debt for instance. --Childhood's End (talk) 14:30, 22 February 2008 (UTC)
Of course. But that is not "to whatever ends they want." Severe restrictions in investing in equity, real estate, and a number of others, depending on jurisdiction. At any rate, I don't think we are disagreeing on substance much - I'm simply saying the phrase sounds biased and odd to me, and alternative phrasings would (IMO) be better. We wouldn't say about any other company that they can borrow funds "and invest it to their own ends." As you put it, it's stating the obvious.--Gregalton (talk) 15:01, 22 February 2008 (UTC)
What makes it not so obvious here is that we're talking about funds that are not the bank's propriety. The ability to use such funds is not common to other companies.
True that in a sense, banks cannot invest in "whatever they want" but that's not what the sentence says. I wonder what you think is biaised in saying that banks can use the funds "to their own ends". I would perhaps understand a part of your concern if it said "to whatever ends" but "to their own ends" simply states the facts without being loaded, imo. If you want, we can work on adding qualifiers about the existence of internal controls and portfolio limits which are made necessary in part by regulatory guidelines and also by good business practices, accounting standards, shareholder accountabiliy and client demands, but to reach something that is accurate would probably be more complicated than anything else for the purpose of a short intro. --Childhood's End (talk) 16:08, 22 February 2008 (UTC)
I thought of something. Do you think that "to ends of their chosing" would be slightly better? --Childhood's End (talk) 16:09, 22 February 2008 (UTC)
Please give a reasonable example of what else the bank can do with deposits that differs from a bank that reserves all of its deposits. I provided a textbook source and directly quoted that source; however, you are still not satisfied. --EGeek (talk) 02:35, 23 February 2008 (UTC)
Almost all firms borrow money, and then do things with it - that borrowed money is not their property. And other companies that borrow money also use those funds to ends of their choosing.
I'll think on it;the more I look at this the more it seems to me the point is that it is a system effect, not a bank effect. So I don't have a better suggestion right now.--Gregalton (talk) 17:08, 22 February 2008 (UTC)
You're mixing apples with oranges then. The usual purpose of a loan is to allow the borrower to use it to his own ends. But the usual purpose of a deposit is safekeeping - if you deposit money in a trust, for instance, the trust may not use it as a bank is allowed to. This is really a banking privilege. --Childhood's End (talk) 18:04, 22 February 2008 (UTC)
No. Just because a "deposit" to an interest-generating account uses the same WORD as a deposit to a safe-deposit box (say) doesn't mean they are the same action. When you get paid interest on money you "deposit" into a savings account, it is understood that you're being paid for the use of that money by the bank, as loans. Deposits into a deposit box return no such interest, and are clearly just safe-keeping. SBHarris 06:46, 23 February 2008 (UTC)
Please re-read your legal books. Bank deposits or deposits in another fashion are considered "deposits" by law, not by you or me. The first obligation a bank has towards a deposit is not to invest it, it is to safekeep it. The banks have the privilege to use the money, and accounting practices allow for double-entry bookkeeping, etc., but deposits to a bank fall under the legal concept of "deposit". --Childhood's End (talk) 15:46, 23 February 2008 (UTC)
Ummm - so what? It's still a loan in economic terms; just a loan with special features. I agree with Sbharris: some people may think it's like a safe deposit, but it is a loan; and I think most people who think about it understand that distinction. (In fact, I think one could also argue that many don't trust the theoretical difference between a trust account (where it is technically off-balance sheet) and a deposit account - because they would also understand that that money also tends to get deposited with a bank, and generally a bank within the same group.)--Gregalton (talk) 15:58, 23 February 2008 (UTC)
It's like a loan in economic terms, but it's not a loan legally. This is what causes all the confusion among profanes and brings you to think deposits are "loans". They're treated as loans by banks, but that's not what they are, and banks are well aware of this. --Childhood's End (talk) 20:53, 23 February 2008 (UTC)
Not being a lawyer and hence one of the "profane", clearly my non-sacred thinking counts for little. However, my reading of at least some of the credible legal material on bank deposits would suggest a bank deposit is a special type of loan, but a loan nonetheless. See page 85: "Such solutions do not undermine the objective character of the bank deposit as a loan transaction...a special type of loan." But I'm not about to engage in Talmudic debate about this.--Gregalton (talk) 11:58, 24 February 2008 (UTC)

[edit] Sourced material vs. "accurate" material

Please do not revert sourced material to "accurate" material without backing it up with your own source. The context of your recent change does not match the source provided, so please change it back unless you can provide an appropriate source to replace it. --EGeek (talk) 02:25, 23 February 2008 (UTC)

First, your source does not say that in fractional-reserve banking, the only use banks can make of the deposits is "to finance profitable but illiquid investments" as you try to put it. It is given as an example. If, on the other hand, you can find a source that says this is the only use possible, or that banks cannot use the deposits to their own ends, I'll bow to your position. Second, let's try not to rely to random sources to try to fashion things out a certain way. Sources are needed for challengeable content. If you can challenge that banks can use the deposits to their own ends, please do, I'm all eyes. --Childhood's End (talk) 03:58, 23 February 2008 (UTC)
This is the direct quote from the source:

"This is the basis for the 'fractional reserve system,' in which some fraction of the deposits can be used to finance profitable but illiquid investments."</block>This is the statement that you reverted from:

Fractional-reserve banking refers to a financial system where banks can use a fraction of the deposits that they accept from depositors "to finance profitable but illiquid investments."

To this:

Fractional-reserve banking refers to a financial system where banks can use a fraction of the deposits that they accept to their own ends, such as financing borrowers.

Your statement is obviously not what is stated in the source. It is your burden to prove your statement with a source, not mine. It does not matter if your statement is "accurate", but it has to be verifiable. I will change the statement to directly quote the source, now. Again. The burden of proof is on you alone because you made the change. Provide a source if you change this statement again. --EGeek (talk) 06:34, 23 February 2008 (UTC)
  • There's a better definition in the cited book page 194, section 7.2: Fractional reserve banking is defined as "...a system in which the bank collects the endowments of consumers (deposits), and invests a fraction of them in long-term investments while offering depositors the possibility of withdrawal on demand." Is that acceptable to all for a LEAD? SBHarris 07:00, 23 February 2008 (UTC)
This is a good book, I'm not saying it's a bad source. The problem with these quotes is that they happen to focus only on the possibility, for the banks, to invest in long-term or "illiquid" investments while it is not true that this is the sole use the banks make of the money. They can lend it short-term, they can invest in BB, B, CCC bonds, etc., it's really up to them, and the description has to reflect this. We are not bound to use a quote from a source that we know is incomplete only because "it's from a source"... --Childhood's End (talk) 15:38, 23 February 2008 (UTC)
The point of illiquidity is not that they are absolutely long-term or illiquid, but relatively long-term or illiquid - that is, compared to the (theoretical) due date of the deposit base - instantaneous.
I prefer sbharris' version, and don't believe it's incomplete or inaccurate. If we wanted to get the balance, we could specify "invests in a fraction in investments that are long-term and illiquid relative to the legal term and maturity of the deposit base."--Gregalton (talk) 15:58, 23 February 2008 (UTC)

Here's a NYT reader who understands the business [2]. And here's a source that says that banks can use the money for their internal expenses [3] (see pp. 55-56). We should not use a partially complete quote from a random source to push some incomplete idea; we have to focus on accuracy. Again, if you can challenge that banks can use the money "to their own ends", do so now by showing your argument. But stop trying to obscure things for some obscure reason, this is getting time-wasting and most annoying now. I agree that the most commonly understood use that banks make of the money is lending it, and that's why I gave it as a specific example. But to suggest that this is the only use banks make of it is misleading. --Childhood's End (talk) 16:03, 23 February 2008 (UTC)

What's annoying is misusing sources: the second says "banks use the money deposited with them to lend to borrowers. They charge interest, and use this money to pay their expenses." The second sentence is clearly talking about using the interest, not the deposits, to pay expenses. Your first source is speaking about insured deposits; not all deposits are insured. If you're going to be strident and accusatory, at least have the courtesy to not misrepresent your own sources when blathering on about accuracy.
Perhaps you could explain why this obscure point of yours is so important to include in the lead?--Gregalton (talk) 16:15, 23 February 2008 (UTC)
True about this source, apologies. I read it fast as I am tired of spending time here to explain things again and again. As to insured deposits, most are, and those who are not are not really the point of this debate.
Sorry about my tone, but right now I feel there is some fringe revolution going on here, and I cant see the rationale behind it and why we should suggest that banks are restrained to use the money to "finance profitable but illiquid investments". This is clearly incorrect. I have no obscure point to make; I have explained more than one time why I think the lead is inappropriate right now. Banks are not restrained to use them for what the lead suggests according to EGeek's version. This is unchallengeable and does not come from some cherry-picked quote from a cherry-picked source. --Childhood's End (talk) 16:57, 23 February 2008 (UTC)
Okay the major use for deposits is in investments which are "relatively illiquid" and "relatively long term" with regard what the depositor's "sees", which is an account from which he/she can get any or all of his money any time, on demand (all banks have maximal rate withdrawal restrictions for large sums, much larger at the teller-window than ATM maz rates, but still legally in place. However, banks waive these except in temporary emergencies). So anything more illiquid than "have it available pronto for demand payment," counts as "illiquid." And yes, banks can use the interest from the deposit (since they are legally required to eventually return the base value of the deposit, more or less on demand) in any way they like. Example: some checking accounts pay interest, but most do not. However, the money in them is a deposit to the bank in every way, and generates interest for the bank, since the bank uses (a fraction of) that money for investment, also. What does it do with that interest money (and with the principal, also until you ask for it by writing a check against it which somebody presents)? It uses it to pay for the services associated with "free checking", for one thing. And for a bunch of other bank operating expenses. It's bank income, and can be directed anywhere. Which is why all educated adults know that they're losing out if they keep more than a few thousand dollars in a checking account, vs. doing something with the money which has a better return rate. But are all these qualifications necessary in the LEAD? Use of interest at the bank's pleasure is TRUE, but fails to communicate that most of the bank's pleasure, and need, is to move as much of the the money as it can, to uses where it generates interest for the bank's profit (obviously tricky, since the interest-returns to the bank vary with directly the illiquidity of the investment, which is why timed-deposit/money market accounts exist). How the bank divies up that provit into interest paid to the depositor, vs. operation of the bank, will vary according to the bank. It's something to be disussed later on. However, are we really in disagreement with the basic facts?

Look, we all know why it takes checks days to "clear" and the money to show up in accounts, even checks from other banks. And yet your credit available on your credit card decreases within seconds after you make a purchase (log in and see). Nobody's fooling anybody. It doesn't take a bank that long to electronically "see" if a check from another bank is good. But it wants to hang on to the money a few days more, since it profits from every second it hangs onto it, and during which it's not available to YOU. There's a delay in getting cash out of a bank at every step which the bank can think of putting one in. SBHarris 19:44, 23 February 2008 (UTC)

Where exactly are you going with this? I remember reading some similar stuff during college in my banking law classes, and thanks for showing that you know some very basics of banking services, but this is a non sequitur. Banks are not only allowed to use the interests; they'are allowed to use the deposits as well in other venues than 'illiquid investments', and that's where the current lead is misleading. --Childhood's End (talk) 20:25, 23 February 2008 (UTC)
I have no problem with your argument over long-term vs. short-term, liquidity, or even profitability. I do have a problem with your argument over investment. You have yet to provide an example of where the bank uses deposits to finance something other than an investment. Your statements "to their own ends" and "to ends of their choosing" are too vague and not informative. I do not see a reason to replace "investment" with your vague, uninformative statement until an appropriate example is presented that shows that "investment" is not correct. --EGeek (talk) 01:56, 24 February 2008 (UTC)

I believe that the word everyone is looking for is "stuff":

Fractional-reserve banking refers to a financial system in which some fraction of the deposits can be used to finance stuff.  :P Analoguni (talk) 21:15, 23 February 2008 (UTC)
It's actually more accurate. Only unencyclopedic... --Childhood's End (talk) 21:18, 23 February 2008 (UTC)
I don't see what it is you want. A bank can do indeed do anything legally with the deposits, including buy the president a Lambourghini and a gold toilet seat. But if they're smart, they don't. All this has been complicated by insurance, which tends to encourage fools. Banks are required by law to keep a fraction of the deposits in reserve against immediate demand; I have the feeling that this is less to protect depositors nowadays than to protect the FDIC and various lenders of last resort. Since otherwise the banks would lend it all out to buy crazy immediately-high-paying schemes like "AAA-bonds" backed by subprime mortgages, and then scream about liquiditity and need for lower Fed rates, when the pyramid-schemes quit running.

Oh, wait-- they did that. Well, at least without SOME fractional reserve requirement, it would have been even worse. SBHarris 01:09, 24 February 2008 (UTC)

You're actually beginning to get the point. Now, just imagine for one second that banks can also buy CCC bonds. Oh wait, they can and they do every day. --Childhood's End (talk) 14:42, 25 February 2008 (UTC)
Actually, there are limits on using deposits for liquor and lap dances - namely, if the bank doesn't have assets sufficient to cover deposits, it would run into major regulatory issues in very short order. So it can effectively pay for expenses only out of earnings and other components of owners' equity (capital). The problem is the old chestnut that "money is fungible" - no way to distinguish which money is being used for what.--Gregalton (talk) 12:03, 24 February 2008 (UTC)

Regulations are nation-specific and stray away from the concept of fractional-reserve banking. Analoguni (talk) 01:09, 25 February 2008 (UTC)

I cannot spend more time on this so I'll let you have the article as you like it instead of as it should be, because it would be "vague" (as if this was wrong). Fractional-reserve banking is, before anything else, a legal issue - it doesnt exist without its legal framework. EGeek's has no legal source whatsoever to support that banks are restrained to use the money "to finance profitable but illiquid investments" as the lead now suggests (as if the bank can know for certain in advance whether an indvestment will be profitable...). That is because the law actually allows banks to use the money in non-profitable investments, or in non-investment venues, and it is how it should be. According to all rating agencies, bonds rated BB or lower are non-investment grade; thanks to reality rather than EGeek's excellent book, banks can buy them nonetheless. Banks lose money every day in various undertakings. They make profits on the overall result of their different portfolios (consumer loans, commercial lending, treasury, etc.) and lines of business. I dont understand what the problem is in acknowleding that. --Childhood's End (talk) 14:42, 25 February 2008 (UTC)

[edit] Include the worldwide importance of fractional-reserve banking

Since fractional-reserve banking is the basis for financial systems worldwide, I think it would be necessary to include information about this in the intro. Analoguni (talk) 00:29, 25 February 2008 (UTC)

I do not consider worldwide use of fractional-reserve banking synonymous with its worldwide importance. There is also evidence on the Full-reserve banking and Islamic banking articles that not all banking systems in the world use fractional-reserve banking. --EGeek (talk) 01:18, 25 February 2008 (UTC)

At least include something of it's significance. For example, the Federal Reserve was founded as a direct result of fractional-reserve banking. Central banks around the world were founded because of fractional-reserve banking. I think some info on the significance of it would be appropriate and necessary. The euro and the dollar are the major world currencies and are affected by this system. This is a fundamental aspect of global finance so not mentioning this significance would make this article incomplete. Analoguni (talk) 01:35, 25 February 2008 (UTC)

The lead should not add anything more to the article. It should be a summary of the article. A short explanation of the fractional-reserve system's link to bank runs and the money multiplier as well as the criticism that the subject enjoys would work well. --EGeek (talk) 04:48, 25 February 2008 (UTC)
While I don't think it's necessary to have it in the lead, the evidence on full-reserve banking and Islamic banking is weak - most reviews I've seen have said that they are "in principle" full-reserve, but rarely in practice - just like Islamic banking is not supposed to have interest, almost every analysis says something like "if it looks like, smells like, acts like and tastes like interest - even if it's called something else - it's interest.--Gregalton (talk) 08:18, 25 February 2008 (UTC)

[edit] Definitions from other sources

I figure that definitions other sources use should help. Here are a few.

  • A banking system in which only a fraction of the total deposits managed by a bank must be kept in reserve. The amount of the deposits equals the amount of the reserves times the deposit multiplier. In the U.S., this system is maintained by the Federal Reserve Board. Source: http://www.investorwords.com/5581/fractional_reserve_banking.html
  • Monetary policy at the basis of the modern banking system. Under FRS, banks are required to hold only a fraction (typically 12 percent) of the depositors' funds as cash reserves. The remaining 88 percent of deposited funds can be loaned out to create new deposits which in turn create new loans ... and so on, exerting a multiplier effect on the total money supply. However, in case of a bank run, this policy can cause banks to suffer huge losses and may even push them into bankruptcy. Source: http://www.businessdictionary.com/definition/fractional-reserve-system-FRS.html
  • A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Most countries operate under this type of system. Many U.S. banks were forced to shut down during the Great Depression because so many people attempted to withdraw assets at the same time. Today there are many safeguards in place to prevent such an instance from occurring again, but the fractional-reserve banking system remains in place. Source: http://www.investopedia.com/terms/f/fractionalreservebanking.asp
  • In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest. Reserves are deposits that banks have received but have not loaned out. Source: http://www.whcbridge.com/ec7290.html
  • The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income. Some reserves support savings accounts and time deposits (deposits which earn interest but don’t allow you to write cheques on). Banking evolved so as to also permit a fractional reserve for “checkable deposits”. The majority of world banking systems today follow this model of fractional banking. Source: http://www.bankintroductions.com/definition.html

There is also a definition of full-reserve banking:

  • a full reserve bank is a bank that backs up all its loans and deposits with 100% of the funds promised to others, also called bank reserves. On the face of the definition, this would appear to be the same thing as today’s banking system, but it isn’t. Today’s banking system is called a fractional reserve banking system. The difference between a fractional reserve and a full reserve is huge. In the simplest terms, a fractional reserve bank is allowed to promise the same money to two people at the same time. Source: http://www.fullreservebanking.com/what-is-full-reserve-banking/definition-of-full-reserve-banking/

Analoguni (talk) 21:36, 5 March 2008 (UTC)

Good work, plenty of better material than what's currently in the lead. My choice would be "The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income." --Childhood's End (talk) 00:55, 6 March 2008 (UTC)

[edit] Numismatics Template

I do not think this article should be included in Numismatics. A banking system is more about finance than it is currency and coins. Even the money creation effect of fractional reserve banking does not create currency and coins. --EGeek (talk) 01:34, 24 February 2008 (UTC)

Agreed. Take it off! SBHarris 01:50, 24 February 2008 (UTC)

I think it is related because of the description on the Numismatics article:

Numismatics is the scientific study of currency and its history in all its varied forms. While numismatists are often characterized as students or collectors of coins, the discipline also includes a much larger study of payment media used to resolve debts and the exchange of goods

Since this description includes payment media and commercial bank money is payment media, commercial bank money is a part of numismatics. This is reinforced by some of the references about commercial bank money in the frational-reserve banking article:

"At the beginning of the 20th almost the totality of retail payments were made in central bank money. Over time, this monopoly came to be shared with commercial banks, when deposits and their transfer via checks and giros became widely accepted. Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. While transaction costs in commercial bank money were shrinking, cashless payment instruments became increasingly used, at the expense of banknotes". Source: European Central Bank - Domestic payments in Euroland: commercial and central bank money: http://www.ecb.int/press/key/date/2000/html/sp001109_2.en.html

And then there's the report from the Bank for International Settlements:

"But the central bank is not the only issuer of money in an economy. The multiplicity both of issuers of money and of payment mechanisms is a common feature in all developed economies. Commercial banks are the other primary issuers, their liabilities (ie commercial bank money) representing in fact most of the stock of money. A healthy, competitive commercial banking market is seen as an essential element of an efficient and effective economy."
"Thus central bank and commercial bank money coexist in a modern economy. Confidence in commercial bank money lies in the ability of commercial banks to convert their sight liabilities into the money of another commercial bank and/or into central bank money upon demand of their clients. In turn, confidence in central bank money rests in the ability of the central bank to maintain the value of the stock of currency as a whole (ie not only of the small portion it issues directly), or its inverse, to maintain price stability." Source: Bank for International Settlements - The Role of Central Bank Money in Payment Systems. http://www.bis.org/publ/cpss55.pdf

But it would probably be better to have this debate on the "Numismatics" page instead of this page. I figured that since fractional reseve banking is so fundamental to modern economics there should be at least one template in a wikiproject that this article belongs in. Perhaps there is a better one for it or maybe it could be a part of several projects. This subject is too fundamental to economics to be left out of other projects. Analoguni (talk) 06:12, 24 February 2008 (UTC)

P.S., In case some of you didn't notice, these are also references to information that was removed from the article. It was in the description after the table that showed how fractional reserve lending works. There weren't requests for citations, it was just removed. Well, here are the sources. Analoguni (talk) 06:23, 24 February 2008 (UTC)

The Numismatics only describes physical medias of payment. Commercial bank money is not a physical form of payment. The article even refers to stocks and bonds only in their physical certificate form. I also disagree with including a numismatics template only because commercial or central bank money is mentioned in this article. This article is on a financial system, not currency. If you think this article needs a template of some sort, then use a banking or financial template. It makes more sense than the current Numismatics template.
  • Precisely. Save the numismatic template for the Banknote page which covers physical manifestations of commercial bank debt-money, used as currency. THIS article is about the system of banking, not the nitty-gritty mechanics of it. There's no more reason to talk about numismatics here than there is to talk about ATMs or timelock vaults. SBHarris 06:19, 25 February 2008 (UTC)
P.S. Editors do not have to ask for sources before removing unsourced material. It is best to include the citations when new material is added. See WP:V--EGeek (talk) 19:24, 24 February 2008 (UTC)

I changed it to 'finance' which is probably more appropriate. As for removing unsourced material, wikipedia policy does say that the burden is on the editor so I guess that's fair. Analoguni (talk) 21:34, 24 February 2008 (UTC)

No, it's not fair. Challenging unsourced material you don't believe, is what {{fact}} tags are for. They produce that [citation needed] note in the text and give people time to come up with a source. If you simply deleted all unsourced material in Wikipedia you'd destroy large parts of good articles, and piss off everybody. So don't do that. If it's a reasonable statement and unsourced, you have an obligation to improve, not delete. Simply deleting, as "unsourced," a statement without at least a spirited TALK defense of why you don't believe the statement and think it should go, is close to vandalism. SBHarris 06:14, 25 February 2008 (UTC)

[edit] The lead is too small.

Single sentences are inappropriate and it uses technical terms which aren't appropriately explained.

I expanded it. For any gold bugs here or for Karmaisking's sockpuppets which have yet to be caught, this:

In other words, fractional-reserve banking is a form of banking where banks are only required to hold a fraction of customers' deposits in reserve, as opposed to full-reserve banking, where banks must hold 100% of all customers' deposits, or free banking, where there is no legal requirement for banks to hold any reserves at all.

is just a non-technical reiteration of the first sentence and doesn't need to be sourced.

This is common knowledge:

Virtually every modern banking institution in the world today uses fractional-reserve banking.

And thus doesn't need to be sourced either. Thanks. ☯  Zenwhat (talk) 22:11, 7 March 2008 (UTC)

This last sentence needs to be sourced. It's usually true in Western economies, but Wikipedia must hold a worldwide perspective. --Childhood's End (talk) 13:21, 13 March 2008 (UTC)

[edit] Austrian soapboxing

What is this silliness?

The business cycle theory was recognized by the Royal Swedish Academy of Sciences, which awards the Nobel Prize in Economics[4], but is not universally accepted; at least one mainstream economist, Paul Krugman, considered it unworthy of serious study.

Austrian economics is not just "universally accepted." It's marginalized, because it's heterodox. The passage above treats it like mainstream economic theory, worthy of the Nobel Prize. The ABCT and the mainstream business cycle theory are literally contradictory to one another, because the former assumes a classic relationship between saving and borrowing, while the latter assumes Keynesian theories on interest that are so old and well-accepted (about 75 years now) that they're standard economics and taught in Econ 101.

There is no citation to support this, but there won't be. Just as you won't find a citation for the non-existence of unicorns in Biology. The reason (similar to the unicorns example) is that there is no dialogue between Austrian economists and mainstream economists, because the former reject the the modern scientific method in favor of ancient Greek philosophizing to the point that they're shunned.

Anyone here who disagrees, please cite any modern econ 101 textbook (I have my own I could cite) and just tell me: What, in the glossary, mentions Austrian economics? You won't find it. ☯  Zenwhat (talk) 22:21, 7 March 2008 (UTC)

Zenwhat's strange obsession with deleting Austrian economics from the face of planet earth continues...--Lagrandebanquesucre (talk) 06:42, 8 May 2008 (UTC)
His actions and motivations have been clearly explained: there seems to be an obsession in spamming Austrian points of view out of all proportion to their prevalence in academic studies.--Gregalton (talk) 07:06, 8 May 2008 (UTC)

[edit] Incompatible with a gold standard? How so? And other non-documented criticisms

The criticisms sections here is mostly undocumented, and with a fair bit of nonsense. The statement that it is incompatible with a gold standard - despite all the historical evidence - is just bizarre. I'm going to flag this for now with a view to deleting eventually unless there's some content added.--Gregalton (talk) 10:26, 8 March 2008 (UTC)

I've discussed this in much further detail on the debt-based monetary system talk page. It's clear that historically there is an inherent antagonism between frb and the gold standard. There was never a harmonious and peaceful co-existence. The reason is simple: it's difficult to print gold, and when there is a bank run and depositors begin to distrust the integrity of the banking system, all hell breaks loose, because the game is up and there ain't enough gold to go around. That is the very DEFINITION of frb - having a FRACTION of (gold) reserves on hand even though you promise to pay out in gold if "at call" depositors ask for gold in specie. Gold exposes the game and therefore is a threat to the on-going viability of frb. It's as simple (and as obvious) as that.--Lagrandebanquesucre (talk) 06:39, 8 May 2008 (UTC)
I am reminded of the Princess Bride: I do not think that word means what you think it does. If the basis of FRB is based on a gold standard, clearly they are not incompatible. Your claims of inherent instability are an interpretation, and not at all obvious. If fractional reserve banking was used in systems where there is a gold standard, clearly they are not mutually incompatible.--Gregalton (talk) 07:02, 8 May 2008 (UTC)
User:Lagrandebanquesucre is documented sockpuppet of indef blocked user.--Gregalton (talk) 19:02, 8 May 2008 (UTC)

[edit] Lead: text suggestion

I find the current lead a bit weak. I have found this in the Bank Credit Analysis Handbook by Jonathan Golin (Wiley and Sons):

"The customary form of banking system prevalent worldwide in which banks need only keep a fraction of their deposits in reserve and may lend out the remainder."

Is this better?--Gregalton (talk) 12:12, 13 March 2008 (UTC)

Imo, the most accurate description so far that could be used for a lead has been suggested above : "The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income" http://www.bankintroductions.com/definition.html --Childhood's End (talk) 13:24, 13 March 2008 (UTC)
Let's use that then.--Gregalton (talk) 14:09, 13 March 2008 (UTC)
Alright. --Childhood's End (talk) 14:21, 13 March 2008 (UTC)
I do not a problem with using this context, but is the source reliable? --EGeek (talk) 19:33, 13 March 2008 (UTC)
If we agree that the text is fine, there's no need for a source actually (except perhaps for copyright issues). Why? --Childhood's End (talk) 19:45, 13 March 2008 (UTC)
The problem is that this text is likely to be challenged; thus, the text must have a citation due to policy. Also, as you stated, there will be a copyright issue with this text even if we paraphrase. --EGeek (talk) 23:56, 13 March 2008 (UTC)
For the purposes of a lead, we can combine the two and cite. For example,
"The practice of keeping only a fraction of deposits in reserve (in cash or cash equivalents) in order to meet short-term obligations (withdrawals), while investing the remainder in loans and other assets so as to generate interest income. Fractional reserve banking is the customary form of banking system prevalent worldwide."
comments?--Gregalton (talk) 07:52, 14 March 2008 (UTC)
I like the first one by Jonathan Golin. It's simple and covers what I think are the main points. If there aren't copyright issues I would say to use that one. If that one doesn't work I think the last one above can be an alternative, but it may need a little fine-tuning. Analoguni (talk) 07:07, 19 March 2008 (UTC)

[edit] Please archive this page and restrict discusion

Wikipedia is not an appropriate venue for extended debate between "experts" nor for attempts to educate uninformed editors. Please archive this talk page and avoid extended discussion that is not constructive to this encyclopedia. Thank you. 64.181.90.43 (talk) 03:06, 29 March 2008 (UTC)

  • What? It's a talk page. where else do you want discussions between editors and authors to go? Protonk (talk) 07:40, 17 April 2008 (UTC)

[edit] Clarification

If the net redemption demands are unusually large, the bank will run low on reserves and will be forced to raise new funds from additional borrowings (e.g. by borrowing from the money market or using lines of credit held with other banks),

is "borrowing from the money market or using lines of credit held with other banks" different from borrowing from the central bank? Chendy (talk) 22:07, 9 April 2008 (UTC)

In my understanding, borrowing from the central bank is last recourse, although there may be other cases. Note that, except if the bank's liquidity crisis is due to bad management, it is likely that other banks face pressure on their liquidities when one does. It might then be difficult to borrow from the market. --Childhood's End (talk) 13:59, 10 April 2008 (UTC)
This is correct to the best of my understanding as well. I'd link you to an explanation from the fed's website but they are hopelessly pedantic.Protonk (talk) 07:27, 18 April 2008 (UTC)

[edit] M0

Correct me if I'm wrong, but doesn't most central bank money exist only as a digital record, rather than as actual paper and coins? <eleland/talkedits> 01:19, 10 May 2008 (UTC)

This section of the article is actually quite bad ("the cumulative effect" bit needs to be looked at, and the M1 definition does not look right). That said, both M0 and M1 are wikilinked and you can check in their main articles.--Gregalton (talk) 01:40, 10 May 2008 (UTC)

I think the "M" stuff would be covered better in a later section. The "how it works" section explains the theory and philosophy about how it works. Putting in the M0 and M1 stuff is useful, but I think it makes more sense to explain the general theory first then show later how it's applied to the money supply. Also, "central bank money" and "commercial bank money" are terms that are used by the Bank for International Settlements and the European Central Bank. Both of these sourced terms were removed and this section is turning into one that is about the money supply, which it partially is, but this is about fractional reserve banking first and it's under a section titled "how it works". Even though M0 is central bank money and M1 tends to be loans created with central bank money, this system of "M's" doesn't have to exist and it's not universal. Fractional reserve banking can exist without this "M" category system so I think it might be better to bring up the "M" stuff a little later and just stick to "central bank money" and "commercial bank money". It keeps it simpler and is easier to understand. Analoguni (talk) 00:41, 16 May 2008 (UTC)

Also, Gregaltron, I disagree with your assessment that this section is "quite bad". I can agree that it can use some more improvements but it is sourced and gets to the heart of what fractional reserve banking is all about. Saying that it is "quite bad" gives me the impression that it needs undergo a significant overhaul, which I don't think it does since it is sourced by the Federal Reseve, the Bank for International Settlements, and the European Central Bank. Analoguni (talk) 00:49, 16 May 2008 (UTC)
I do agree with Gregalton that "the cumulative effect" could be expanded upon. both the images [1] and [2] show currency increasing at something greater than linear. This is an artifact of Fractional-reserve banking and lending money at interest. --Zven (talk) 22:48, 16 May 2008 (UTC)

[edit] Question about fractional banking

I've read through the whole article, most of the talk page and a lot of the sources found here and from google and I still don't understand a simple basic aspect: Forgetting the "fractional reserve", is the bank allowed to lend more than it has(it's own money + money it has burrowed)? If the bank lend only currency, it physically couldn't - But most money can travel as "bank notes" or simply electronic.

So if I'm a bank and ALL I have is 100$ can I, considering the 10% reserve, lend somebody 1000$ by writing him a "bank note"?

Another example. I'm a bank and ALL I have at first is 0$. I then get a deposit from somebody, say John, of 100$ and I write John a "bank note" for it saying "100$". I than put the 100$ in my reserve and counting on it and considering the fact that I already have 100$ promised (to John) I can lend somebody else another fictional 900$ on a "bank note". Is this right?

I'm asking this because all the processes and tables in the article and in the talk above don't look like money "creation" because for the bank (or bank system) to get to "stage 2" (and lend 64$) it has to have the initial money (80$) it has lend come back to it as a deposit. So no extra money (currency or whatever) exists outside of the bank at any one time. The "free" money is actually less and less at every step as the bank reserves more.

When replying please keep things simple. Don't get into complicated explanations involving the Fed and other details. Leaving all details aside, is the answer to the above questions "yes"?

As a side note, somebody was arguing above that this discussion page shouldn't be about educating uninformed editors. I disagree. I think uninformed editors - like me - should stay away from the main article but should use the talk page as much as possible as this is the way the article can be steered by the folks who know this stuff towards it's intended audience: non-experts. On the other hand it would be great if non-experts would abstain from making positive, determined affirmations about things that they don't know enough about. A "maybe" put in front of a phrase can do wonders in figuring out what is certain and what is not. --Cosmin 20:48, 29 May 2008 (UTC)

I think in theory a commercial bank can only lend out a fraction of its deposit balance so in your example if the fractional reserve is 10% and $100 is deposited in the bank then it can only lend out $90. At this point you need to think of money recursively, you started in the closed world example with $100 in the system, now for every lender there is a borrower, money is spent in the system, and ultimately ends up in other banks where they can re-lend it to someone else. The sum of the recursive re-lending of money in theory is 1 over the factional reserve a 10 times multiplier on the money in the system creating $1000 (but in practice inefficiencies mean the real multiplier is less than that, somewhere around 8 times). This is the creation of money in the form of credit. Added to this issue is that interest is charged on all the money in the system each year. The act of lending money creates money, money disappears when someone pays back a debt. When times of credit expansion there is creation of wealth, in times of credit contraction there is destruction of wealth. --Zven (talk) 07:37, 29 May 2008 (UTC)
Let's keep this simple guys, so everyone can understand the basic idea of frb.
This is a common confusion and people get so puzzled by the creation of money out of thin air or from "nothing". It is incorrect that banks lend more than they have on deposit. People get confused because they focus on the numbers and don't realise it's the "speed" and "timing" of the flow of money that creates more money. Let me explain.
Forget about amounts and $$$$s and think about time and commodities and trust. I am a banker. I have been given 100 gold sovereigns for safekeeping by an old grandma, because I am the only one in the village with a gun, so she entrusts me with her precious money. I give her a solemn promise that whenever she calls back, I'll have her money sitting here, just like I promised. Any. Time. She. Wants. That's called an "at call" deposit account, immediately redeemable for cash (in this case, gold sovereigns). Got it?
She then gets a little piece of paper saying "redeemable for 100 gold sovereigns". The little piece of paper "represents" 100 gold sovereigns. She tucks the piece of paper carefully under her pillow and occasionally kisses it, thinking to herself "What a lot of money I've got in safekeeping with that reputable young banking gentlemen in the nice suit with the nice car."
I then keep 10 gold sovereigns "on tap" just in case she calls to ask for some money back. If she asks for 10, I proudly give them to her, saying "here you are darling, here's your money back, just like I promised." However, I then lend out her 90 gold sovereigns in the local village to earn myself interest (praying to God that she doesn't call back for all her money. If she does, I'll feel like declaring a bank holiday immediately).
I don't lend out more than I have in deposits, but I keep for immediate payment (for all "at call" depositors) a fraction of their savings/deposits in cash, even though I have the legal and moral obligation to pay these depositors back immediately if they walk through the door and ask.
Doing this over and over "accelerates" the money supply exponentially - until there's a run on the bank with all the grandma's coming into my store at once. Then the game is up - I don't have the 100 sovereigns like I promised and I go out of business. In the banking game, you say "I've sunk like a Rock".
To use another simple analogy to get the point across. Assume I'm a sharebroker/custodian for your shares. They are mixed with other shares in the same company. You can't tell the difference between one share and another share. I estimate that there's a very small chance all shareholders will ask for the shares back at one time. Although I have the obligation to supply the shares immediately you ask for them, I play the sharemarket in my spare time, whilst you're not looking, "shorting" these shares. I sell your shares on the stockmarket and hope to God I can buy them back cheaper, before you notice. That's just like frb, and it does happen in financial markets today. It's very, very simple. In a standard commodity market it's normally called embezzlement, but for historical reasons (the British govt made a deal in 1694 to legalize the practice and support it through the introduction of the Bank of England), it's legal in the financial world because you can't tell one dollar from another and you can't tell one share from another (if they were diamonds it would be different). And this little game is the foundation of modern Western finance and, by extension, Western Imperialism.
This ends the lesson for today.--Socppt15 (talk) 07:42, 29 May 2008 (UTC)
Sorry to still bug you but I think this is a very important point. Scoppt15, you say "It is incorrect that banks lend more than they have on deposit.". Is it incorrect in the sense "not important" or in the sense "they do not do this, they are not allowed"? —Preceding unsigned comment added by 79.114.13.250 (talk) 11:12, 29 May 2008 (UTC)
Not allowed (literally) - in the initial round of fun and games. Recall that I mentioned you need to think of money in terms of flow. In the first round, you embezzle 90 sovereigns of Grandma No. 1's life savings, by lending that 90 to Speculator 1, who then spends it on Landowner 1 who (inevitably) deposits it right back in your bank. Whoopee! You can then take 9/10ths of this deposit and lend to Speculator 2 (also at interest). Think of a boomerang. You throw it, it looks as though you're letting it go - but magically it does a full circle and comes right back. Magic! You then throw 9/10ths of it out into the market and you can be (reasonably) sure it will come back. And so on. On each throw you're only throwing 9/10ths of existing deposits, but by throwing this stuff out into the market you are creating money because all of the deposits being created are on deposit "at call" (none of them are term deposits) and these deposits (created by the issuance of debt to Speculator 1 and 2) can be used as money and can be withdrawn at any time on demand.
In the initial throw, you can, as Mr Legit Banker, say you are not lending more than you have on deposit: "I had 100 sovereigns of Grandma's dough. I only lent out 90. What's the problem???" Well, problem number 1 is that several Grandmas may come into the store at any time and ask for it all back. Problem number 2 is that Speculator 1 or 2 may go bust or run away with the gold sovereigns. Problem number 3 is that you have to pay off the cops if Grandma starts screaming you stole her money when she finds out what you've done. Lesson 1: Only take the savings off Grandmas without guns. Lesson 2: Lend your money to people who will pay you back (hard-nosed alpha male business-types with a predominant recessive greed gene work best here). Lesson 3: Always have your luggage packed and a flight booked to a tax haven. After all, you're on borrowed time (literally).
Note that no one (not even Murray Rothbard) has a problem with banks "investing" money they have been given on term deposit. Let's say you have $15 billion lying around and want to leave it with the bank for 5 years and have them pay interest. If they then lend it out for the same 5 years and have the borrower pay interest - no problem. Everyone knows that the term of the deposit matches the maturity of the loan. It's a potentially fatal gamble when the maturities do not match. And that's what frb is: a dangerous gamble. As a banker you're playing with fire and hoping your depositors don't "test" your integrity. If they do, you're immediately insolvent because you have borrowed the money "short" but lent "long". You haven't got the money on hand you have promised all your depositors. It's as simple as that.
There's some controversy over this video, but I find it helpful in explaining these concepts. It may also help your understanding. Warning: some consider the video "controversial" in nature, so please don't watch it with the kiddies around. It's strictly adults only. Perhaps have a whiskey in one hand and the mouse in the other (to pause it if it gets too much for you).--Socppt15 (talk) 12:35, 29 May 2008 (UTC)
All hyperbole aside, the original question was "can a bank lend more than it has on deposit?" as a way of getting to "can banks create money?". It also said "no extra money (currency or whatever)". The distinction is crucial: regular banks cannot make money in the sense of currency. Their actions do lead to the creation of money substitutes - in this sense, meaning something that is (can be, may be, will be) accepted in payment of debt (see money supply). (In fact, non-banks can do this too, but most people won't accept notes from "Bob's Rigamarole and Fishing Shoppe.")
A bank can lend "Tom", say, $900, if Tom will accept promissory notes instead of cash. Tom might do this if everyone else also accepts the bank's promissory notes in payment of debt. It is not currency, but may be convertible into currency relatively easily. This is not all that different from (for example) the bank selling bonds, promissory notes, or whatever for cash, and then lending Tom the money directly. The costs will be different (interest, discounts, liquidity/convertibility, etc).
Most of the discussion about banks lending the money it does not have (the deposit/cash movements) is about technicalities of how it happens, but glosses over this point: that bank deposits are NOT money, they are money substitutes. (Or, if you prefer, a different type of money).--Gregalton (talk) 14:22, 29 May 2008 (UTC)
This point above arguing that (some say that) banks should always match pretty much misses the point of financial intermediation. Taking almost any random bank's financial statements, the auditors will usually have a statement to this effect: "The matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to management of the Bank. It is unusual for banks ever to be completely matched since business transacted is often of an uncertain term and of different types. An unmatched position potentially enhances profitability, but can also increase the risk of losses. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature, are important factors in assessing the liquidity of the Bank and its exposure to changes in interest and exchange rates." (My emphasis)
In other words, bleating that banks should always be matched is silly: term transformation - i.e. controlled mismatching -(amongst other things) is a key part of what banks DO. If banks did not do this, there would be less medium/long term funding available in the market; if they were restricted from doing so, it would introduce serious difficulties with transaction costs (bank can't give you your five-year loan until they have exactly that five year funding, and they would certainly not raise that five year funding in advance. It also misses the point that the ALM/interest rate and other mismatches are not fixed from day to day, but change due to prepayments, convexity/concavity and a bunch of greek letters. Exact matching is really not feasible for any dynamic portfolio (although the dimensions of the problem can be significantly reduced - which is what banks are actually doing most days). And what all those various regulations do (Basel etc) is to attempt - imperfectly - to ensure that the mismatching does not get out of hand.--Gregalton (talk) 15:17, 29 May 2008 (UTC)


Socppt15, "Not allowed (literally)". If so, this should be included in the article - do you have a of law reference on it?
Gregalton, if Tom can burrow 900$ (as a promissory note, not currency) than it means that Socppt15 is wrong regarding the "not allowed" above and that a bank can lend more than it has ever been entrusted with. As I understand, this is also the point of your second "matching" post.
I think it's very important to distinct between just being required to have 10% in currency on all promissory notes the bank has issued on one hand (1) and also not being allowed to write more lend promissory notes than the currency it has received through deposit promissory notes on the other hand(2). So is a bank only required to abide (1) or both (1) and (2)? This is what I'm trying to figure out and I think it also needs to be cleared in the article. --Cosmin 16:33, 29 May 2008 (UTC)
I think the first sentence captures frb beautifully. I couldn't improve on it. This is all that's needed. If the article stated blandly "Banks can't lend more than they have on deposit" you'd be missing the flow of money creation, which Analoguni has explained (superbly) with the graphs. Someone needs to simplify the concepts for non-financial types on the talk page. The video mentioned above is OK. Take a look and see what you think. Murray Rothbard is also good at explaining it in simple terms (although non-Austrian economists find him distastefully blunt). Google "fractional reserve banking deposits lending" and you'll get loads of stuff on this. I think the article itself is OK as it is.
Oh, and Gregalton, I agree that borrowing short and lending long is what banking is all about, and what Basel II tries to address. However, the question is whether it's adequately addressed. Some say Basel II is a joke. Others are Keynesians.--Socppt15 (talk) 23:23, 29 May 2008 (UTC)
In an effort to answer the original question and follow the K.I.S.S. principle, instead of diving directly into the mathematics of the multiplier effect, the article should first show an example of fractional-reserve banking in action. For example:

Joe deposits $1,000,000 in People's Bank. People's Bank now has $1,000,000 in cash and $1,000,000 in accounts it is liable to pay on demand. People's Bank loans Bob $900,000 to build a house. Bob pays the builders $900,000, who deposit it in People's Bank. People's Bank now has $1,000,000 in cash and $1,900,000 in demand liability. People's Bank loans Sarah $810,000 to start her own business. She pays the employees and suppliers $810,000 in cash, who deposit it in People's Bank. People's Bank now has $1,000,000 in cash and $2,710,000 in accounts it is liable to pay to its depositors...

Although it may not be considered encyclopedic, this story shows that the total amount of currency never changes and the new money created is the liability of the bank to give cash back to its depositors when they demand to withdraw it. The bank does not, nor does it need to, issue new currency unless the government gives them the right to do so (e.g. a central bank, National Banking Act) otherwise it would be counterfeiting, which is considered illegal in most countries. --EGeek (talk) 05:08, 30 May 2008 (UTC)
"Illegal in most countries"?!? Name those where it's legal - I want to emigrate. Perhaps you mean it's legal in those countries where the central bank is spineless and panics and "saves" stupid banks by swapping Treasury bonds and $$$ for bad debt when the big banks go bust? Is that the subtle point you're trying to make? —Preceding unsigned comment added by 165.228.179.155 (talk) 06:20, 5 June 2008 (UTC)