Feb 16, 2013Posted by on
Banks do not wait for a customer to deposit money before they make a new loan. Loans are made and recorded in a customer’s account as a debt to the bank. A customer’s debt also becoming a bank asset. The concept of ‘fractional reserve banking’ recognises that banks can lend out many times more than the amount of cash and reserves they hold at the central bank. This implies a strong link between the amount of money that banks create and the amount that they hold at the central bank. Something that is not true, any more than the assumption that the central bank has significant control over the amount of reserves banks hold with it.
The New Economics Foundation guide ‘Where Does Money Come From?’ offered the following as the most accurate description of what banks actually do.
“Banks create new money whenever they extend credit, buy existing assets or make payments on their own account, which mostly involves expanding their assets, and that their ability to do this is only very weakly linked to the amount of reserves they hold at the central bank.
Banks operate within an electronic clearing system that nets out multilateral payments at the end of each day, requiring them to hold only a tiny proportion of central bank money to meet their payment requirements”.
While the sheer complexity of modern banking works to shield the sector from difficult questions, a number of anomalies emerge with public intervention.
The government provided a bank with a public (tax funded) guarantee. This effective insurance against going bust gave it a commercial advantage over other financial institutions. By reducing the risk, a bank can borrow money much more cheaply than if it were ultimately underwritten by its reserves, assets and shareholders. This saves a participating bank large amounts of money. The benefit of the insurance against going bust, provided by the taxpayer, now goes to pay bonuses to senior staff for “performance‟ and dividends to institutional investors.
Banks make unearned profits, conservatively estimated at £30 billion annually from this hidden subsidy,
To create more liquidity, a central bank creates money electronically using ‘quantitative easing‘. The money so created is fed into the economy using a trading mechanism with a bank. This risk free arrangement make a bank more money, taken as a percentage of every trade. This gives a bank significant windfalls, simply by being there.
Failure to disclose sufficient information keeps the likely amount hidden.
At the same time as being required to rebuild capital, a bank is faced with the dichotomy of being under pressure to lend. A bank tries to manage this by increasing the gap between what it has to pay to borrow money, and what it charges people to borrow from it. Fraction reserve banking makes for a tidy “arbitrage” between the cost of paying bank savers and the income earned from debtors.
It’s another hidden subsidy which amounts to at least another £2.5 billion per year.