Money creation question

[Horseradish]

I have been reading into money creation by the banks for a while. My entry point was the Bank of England's Money creation in the modern economy wherein they explain that commonly believed narratives like "the banks lend out deposits as loans" and "Fractional Reserve Banking" (taught in the textbooks, no less), are either naive or archaic. In reality, the bank creates the money, then works out how to fund the loan. I learned a great deal from Bland's free ebook "A goodbye to all that buy-to-let" (pdf and kindle), and also (I think this was via Bland's book), the excellent Where Does Money Come From? So I read up quite a bit.

So, as stated above, the banks create money and then fund the creation later. They do this "funding" in their reserve accounts. Say the money created gets transferred to someone who banks with a different bank, then the reserve accounts get changed to reflect this. That means that the lending bank now has a bit of a deficit. They can fund that deficit via the interbank money market, from the Bank of England directly (not the TFS - let's ignore that blip for the sake of this more general question), or via deposits. The Bank of England paper above indicates that the bank will move to fund via deposits; so if their lending grows they will raise savings rates in order to attract more capital.

But there's something that I don't quite get in all this. Why would the bank bother to fund this new money creation at all via deposits? Sure, initially they will have to turn to the interbank money market because you can't magic up deposits overnight - it takes time to change the rate, advertise it, get customers to deposit more, etc. But why bother doing that at all? They're paying very little for the money themselves, no matter whether they get it via the interbank markets or via the Bank of England itself - compared with what they are getting off the top of that mortgage. And, besides, they will usually securitise most mortgages away anyways (again, let's pretend that the TFS never happened, just for the sake of argument (because the TFS meant that banks didn't securitise much of their mortgage book for years)). I know that this smells of what Northern Rock were up to - lending long term and borrowing short term - but few deposits accounts are really "long term". Perhaps a year. But the 1-year LIBOR rate is super low so... why bother? I don't get it.

[guest_northshore]

I've found this a good overall explanation:

https://www.pragcap.com/loans-create-deposits-in-context/  - normalising reserve positions, settlement, potential reserve requirements, reserve and balance sheet management including maturity profile. I won't pretend to understand it all in practical terms, and not a blaggable topic, hence a cop-out link rather than an answer.

(original article is http://monetaryrealism.com/loans-create-deposits-in-context/  but the site is down atm)

 

 

[Bland Unsight]

1 hour ago, Horseradish said:

But there's something that I don't quite get in all this. Why would the bank bother to fund this new money creation at all via deposits? Sure, initially they will have to turn to the interbank money market because you can't magic up deposits overnight - it takes time to change the rate, advertise it, get customers to deposit more, etc. But why bother doing that at all? They're paying very little for the money themselves, no matter whether they get it via the interbank markets or via the Bank of England itself - compared with what they are getting off the top of that mortgage. And, besides, they will usually securitise most mortgages away anyways (again, let's pretend that the TFS never happened, just for the sake of argument (because the TFS meant that banks didn't securitise much of their mortgage book for years)). I know that this smells of what Northern Rock were up to - lending long term and borrowing short term - but few deposits accounts are really "long term". Perhaps a year. But the 1-year LIBOR rate is super low so... why bother? I don't get it.

northshore's spot on that it's not a blaggable topic. My knowledge of practical arrangements only extends a little beyond the material in the Postive Money book and some of m y admittedly rather sketchy knowledge rests on grunt audit work on major lenders over a decade ago, so DYOR warnings apply but taking on a few points you raise.

1. The reason core lenders with retail operations fund with deposits is ultimately because they are doing it anyway. The thing to keep in mind on this score is that cash (notes and coins) are virtually a rounding error in terms of the stock of credit money floating around so whenever a loan is made and the bank subsequently 'moves' money to another bank (when the money is spent by the borrower) there's credit money that needs a home. Simply by providing banking services they are attracting funding  in the form of retail deposits.
2. This 'everyday banking' credit money and similar instant access savings accounts, sometimes referred as sight deposits, is actually very cheap  if you set aside the sunk costs of staffing branches and operating an IT system - and as previously argued those are sunk costs because you have to do all that stuff if you want to be a retail bank offering banking services to your customers. For example, in the Q1 2018 Credit Conditions review the Bank of England are giving the rate on Instant access including unconditional bonuses as 0.21% (link).
3. They don't securitise most of their mortgages. I think you're right that part of the reason that there is less securitisation is that its so cheap to fund the lending in other ways that there's no point but that's not the only reason that in the past banks went if for securitisation, there are other (this Bank of International Settlements paper gives an overview, link). What the paper refers to as "regulatory capital requirements" were also crucial. Bank regulation requires that the equity owners have some skin in the game and that cannot be lent into existence, it's essentially retained profits (and in more desperate times cold cash from rights issues and other forms of capital raising). Securitisation enable the banks to pretend that the lending was no longer on their books so they no longer needed skin in the game in case that lending went tits up hence they could lend more given the size of their existing capital base.
4. The ability of lenders to fund using the wholesale money markets is also constrained by the amount of acceptable collateral that they have on the asset side of their balance sheet. The money the bank borrows (its funding) and its own capital are pretty much all lent out. Some of that money is lent to the government when the bank buys gilts. Financial instruments like gilts are used as collateral in so-called repos. Once you have offered all your suitable assets (usually gilts) as collateral and have none left you won't be able to borrow more from the wholesale money markets. (This was how the Funding for Lending Scheme worked; it was a collateral swap with a fee. The banks swapped their rubbish mortgage backed securities for gilts with the Bank of England and they used the gilts as collateral to raise  money  in the wholesale money markets, their own mortgage backed securities being too crappy to be accepted as collateral).
5. You can't have a business model where you fund yourself by borrowing from the Bank of England. If you ended up relying on them as a key source of funding they'd (eventually) shut you down. The Term Funding Scheme and other monstrosities like the Special Liquidity Scheme are not part of business as usual they are extreme measures for extreme times.

[Bland Unsight]

22 minutes ago, Bland Unsight said:

They don't securitise most of their mortgages. I think you're right that part of the reason that there is less securitisation is that its so cheap to fund the lending in other ways that there's no point but that's not the only reason that in the past banks went if for securitisation, there are other (this Bank of International Settlements paper gives an overview, link). What the paper refers to as "regulatory capital requirements" were also crucial. Bank regulation requires that the equity owners have some skin in the game and that cannot be lent into existence, it's essentially retained profits (and in more desperate times cold cash from rights issues and other forms of capital raising). Securitisation enable the banks to pretend that the lending was no longer on their books so they no longer needed skin in the game in case that lending went tits up hence they could lend more given the size of their existing capital base.

Sorry, forgot to finish this point off.

The events of 2008 revealed that the legal entities created to facilitate the securitisations were not really 'bankruptcy remote' and not really separate from the originating lender (and many of them have ended up back on the originator's balance sheet). If they're not really separate then the bank needs an adequate amount of skin in the game (capital).

Post-2008 as regulators partially repaired some of the worst shortcomings of the regulatory framework that provided the incentives to securitise, the incentives changed. The incentive to do a  bunch of idiotic lending and sell it on before it blew up reduced and there just isn't an infinite supply of genuinely prime borrowers wishing to take out genuinely prime lending so its no longer capital that is constraining lending - it's the willingness of suitable borrowers to borrow.

If, as pre-2008, the banking sector is willing and able to lend billions of pounds to the Wilsons and their ilk, and to any aspiring owner-occupier who can fog a mirror, then you're never going to run out of willing borrowers and you are eventually going to have your ability to lend constrained by your capital base and thus you'd be incentivised to securitise some of your lending if you can.

By way of an example, the Lloyds total secured lending is now at the £290bn mark, £50bn less than it was in 2010 (and only about £5bn of the difference can be attributed to TSB). We're no longer seeing the kind of explosive growth of secured lending that led to pressures on capital requirements.

Edited August 2, 2018 by Bland Unsight

[spyguy]

Economist's old Buttonwood columnist wrote a good book on banks and money:

https://www.amazon.co.uk/Paper-Promises-Money-World-Order/dp/0718192141/ref=sr_1_3?s=books&ie=UTF8&qid=1533226051&sr=1-3&keywords=philip+coggan

[Bland Unsight]

5 minutes ago, spyguy said:

Economist's old Buttonwood columnist wrote a good book on banks and money:

Agreed.

Bit tangential, but unless you have at least some knowledge of accounting the business of funding and capital is apt to become a little bewildering. For the lay reader I strongly recommend The Bankers' New Clothes where the authors make a compelling case that banks really ought hold vastly more capital than they do presently.

[Locke]

16 hours ago, Bland Unsight said:

banks really ought hold vastly more capital than they do presently

Is/ought, right?

The fact is, banks provide two fundamental and distinct services to society: keeping your stuff in a vault and providing a stable currency to facilitate accounting of labour.

Fiat currency is largely faith based, with a flavour of State violence. You trust the constant value of pounds/dollars/euros to fairly account for the wealth you generated. In this sense, it doesn't matter what physical goods the bank holds, because that is not the service you want from them. If the bank is responsibly managed, then you don't run into hyper-inflation or -deflation and the value of the currency remains relatively constant.

The problem is that flavour of State violence, where they compel you to use their currency, forcing out any competition which would otherwise keep currencies honest. When you have no choice, the government/banks can skim off the top, which manifests as inflation and eventually hyperinflation.

The "2% inflation is good" horseshit is a mere smokescreen for their theft.

[spyguy]

6 minutes ago, Locke said:

Is/ought, right?

The fact is, banks provide two fundamental and distinct services to society: keeping your stuff in a vault and providing a stable currency to facilitate accounting of labour.

Fiat currency is largely faith based, with a flavour of State violence. You trust the constant value of pounds/dollars/euros to fairly account for the wealth you generated. In this sense, it doesn't matter what physical goods the bank holds, because that is not the service you want from them. If the bank is responsibly managed, then you don't run into hyper-inflation or -deflation and the value of the currency remains relatively constant.

The problem is that flavour of State violence, where they compel you to use their currency, forcing out any competition which would otherwise keep currencies honest. When you have no choice, the government/banks can skim off the top, which manifests as inflation and eventually hyperinflation.

The "2% inflation is good" horseshit is a mere smokescreen for their theft.

Youre muddling central banks and retall banks.

No currency has ever had a constant value.

State violence is a bit 'freemanofthepeople' lunery.

.

 

 

[Bland Unsight]

53 minutes ago, Locke said:

Is/ought, right?

The fact is, banks provide two fundamental and distinct services to society: keeping your stuff in a vault and providing a stable currency to facilitate accounting of labour.

Any money that you deposit with a bank is being lent out to somebody else. That's what funding means. Your deposits (savings) are the funds the bank hands over to its borrowers (loans). The odd thing about how funding practically operates is that it's reasonable to argue that they make the loan first, crediting the borrowers account with credit money, then set about funding it by finding some willing depositors.

For simplicity's sake, set aside the bank's own capital (i.e. the liabilities to its equity owners that makes up the various related balance sheet reserves, e.g. called up share capital and the P&L reserve). When that simplifying assumption is made you can see the bank's balance sheet clearly; on one side there's the bank's assets - loans (i.e. money owed to the bank by its debtors) and on the other side there are customers' savings (i.e. money owed by the bank to its depositors - who are the bank's creditors). There is no money in the bank, there is no stuff in the vault. In its essence an individual bank is purely an intermediary; a UK mortgage bank is just an intermediary which borrows from its depositors and lends the money on to its mortgage borrowers.

Taking the story in the simplest order, consider a transaction where a saver deposits £100k in cold cash and a borrower takes out a mortgage for £100k and then takes away the money as equally cold cash. These are all balance sheet entries so a debit represents the increase in the value of an asset (e.g. more cash in the till) or the reduction of a liability and a credit represents the increase in the value of a liability (e.g. you owe some money to someone) or the reduction of an asset (e.g. you took some cash out of the till).

Retail depositors deposit:

Dr Cash 100k, Cr  Liabilities (money owed to retail depositors) 100k

Mortgage borrower borrows:

Dr Assets (money owed by mortgage borrower) 100k, Cr Cash 100k

 At the beginning, before the depositing customer walks in, there was no cash in the till and at the end, after the borrower walks out, there's no cash in the till. However, at the end there the bank has offsetting assets and liabilities represented by the deposit and the loan; the deposit has funded the loan.

[Horseradish]

@Bland Unsight @guest_northshore @spyguy Thanks for the excellent replies and resources. It's going to take me a while to digest, and I don't have anything useful to reply with yet, but hopefully will once I have managed to read through.

[Captain Kirk]

2 hours ago, Bland Unsight said:

Any money that you deposit with a bank is being lent out to somebody else. That's what funding means. Your deposits (savings) are the funds the bank hands over to its borrowers (loans). The odd thing about how funding practically operates is that it's reasonable to argue that they make the loan first, crediting the borrowers account with credit money, then set about funding it by finding some willing depositors.

For simplicity's sake, set aside the bank's own capital (i.e. the liabilities to its equity owners that makes up the various related balance sheet reserves, e.g. called up share capital and the P&L reserve). When that simplifying assumption is made you can see the bank's balance sheet clearly; on one side there's the bank's assets - loans (i.e. money owed to the bank by its debtors) and on the other side there are customers' savings (i.e. money owed by the bank to its depositors - who are the bank's creditors). There is no money in the bank, there is no stuff in the vault. In its essence an individual bank is purely an intermediary; a UK mortgage bank is just an intermediary which borrows from its depositors and lends the money on to its mortgage borrowers.

Taking the story in the simplest order, consider a transaction where a saver deposits £100k in cold cash and a borrower takes out a mortgage for £100k and then takes away the money as equally cold cash. These are all balance sheet entries so a debit represents the increase in the value of an asset (e.g. more cash in the till) or the reduction of a liability and a credit represents the increase in the value of a liability (e.g. you owe some money to someone) or the reduction of an asset (e.g. you took some cash out of the till).

Retail depositors deposit:

Dr Cash 100k, Cr  Liabilities (money owed to retail depositors) 100k

Mortgage borrower borrows:

Dr Assets (money owed by mortgage borrower) 100k, Cr Cash 100k

 At the beginning, before the depositing customer walks in, there was no cash in the till and at the end, after the borrower walks out, there's no cash in the till. However, at the end there the bank has offsetting assets and liabilities represented by the deposit and the loan; the deposit has funded the loan.

I also like to think of it in terms of double entry accounting. Say you are a new customer wanting to borrow a £100K from Bank A. The bank creates 2 accounts for you, a loan account and a deposit account. All the bank has to do is debit the loan account and credit the deposit account. Money has now been created in the deposit account and could, at this point, be used to pay off the loan and destroy the money created. No savings or other assets need to be touched at this stage.

Now, when you spend the money, the money is transferred to the seller's account. If the seller is with Bank A, then nothing else much needs to be done. If the seller is with a different bank, Bank B, then the money has to be transferred to Bank B. The transfer of funds from Bank A to Bank B is what happens overnight via the BoE, since all banks have reserve accounts there. Since there will be a lot of transfers back and forth, only the nett balance is settled.

Bank A has to get the money from somewhere to settle the £100K with Bank B. It can owe it to the BoE I assume for a short period. It could use savings (maybe) but it has to maintain a certain savings to loans ratio.

This is my very basic understanding but I'm sure a lot more goes on.

[zugzwang]

22 hours ago, spyguy said:

Economist's old Buttonwood columnist wrote a good book on banks and money:

https://www.amazon.co.uk/Paper-Promises-Money-World-Order/dp/0718192141/ref=sr_1_3?s=books&ie=UTF8&qid=1533226051&sr=1-3&keywords=philip+coggan

Not read that one but I'd happily recommend 'The Money Machine: How the City Works', also by Coggan. Concise and ideology free.

 

[cnick]

5 hours ago, spyguy said:

State violence is a bit 'freemanofthepeople' lunery. fact.

 

You can test this assertion by withholding 'your' taxes and see how long it takes for TPTB to send in the heavies. They will use unlimited violence to get you to comply. Bankers use this coercion to underwrite potential losses. Imagine the effect if share holders or even banking directors  had to stand any loss? Why bother with lending due diligence when tax payers present & future are collateral.

[frederico]

If only we could create our own digital currency that could replace all the digital currency banks create.

[spyguy]

5 hours ago, Horseradish said:

@Bland Unsight @guest_northshore @spyguy Thanks for the excellent replies and resources. It's going to take me a while to digest, and I don't have anything useful to reply with yet, but hopefully will once I have managed to read through.

2007 was a big wakeup for me, on myunderstanding of banking.

Im not a banker, or economist. But then neither were the people running the banks as it turned out.

The 3 rules of banking are:

Get your capital back.

Get your capital back.

Get your capital back.

Banks up til 87 were pretty derisked by the way the operated esp building sociites - 10% deposit, saving with BS, then aloan of no more than 4x income, paid back over 25 years.

How could you fux it up?

Easy. Take more risk and leverage. And get big, really big

For various reasons, the uk is in a funny position with banks.

The us has loads of banks. Bar the investment - which thanks to glass seagall - were not deposit taking, us regulator shuts fown loads, none are big enough to cause problems.

Germany has multiple regional banks, none too big to be a problem - despite them trying WestLB.

The fact that RBS rang chsncellorto say thryd be running out of money soon was damning on all parties involed - BoE, treasury bank management.

The rekairty tgat RBS had expanded to 3x size of uk economy more so. For comparision, no us bank got near 30% of us economy.

[cnick]

11 minutes ago, spyguy said:

The 3 rules of banking are:

Get your capital back.

Get your capital back.

Get your capital back.

 

Yes, but what if the 'capital' is created from feck all?

The capital you earn from your effort, luck etc ..... has the exact same value the banks capital newly created thin air credit?

Werner time....

 

[Bland Unsight]

1 hour ago, cnick said:

Yes, but what if the 'capital' is created from feck all?

The capital you earn from your effort, luck etc ..... has the exact same value the banks capital newly created thin air credit?

I suspect you've misunderstood what bank capital is.

If it can be loaned into existence in the same way that customer deposit balances (and offsetting customer loan assets) appear in the bank's books when loans are made then its not bank capital.

If you follow this link it will take you to a page titled "Capital Raising - Rights Issue Pricing" which gives the detail of the Lloyds TSB rights issue in November 2009.

Quote

LLOYDS BANKING GROUP ANNOUNCES A PROPOSED 1.34 FOR 1 RIGHTS ISSUE OF 36,505,088,579 NEW SHARES AT AN ISSUE PRICE OF 37 PENCE PER NEW SHARE

Unless otherwise defined in this announcement, capitalised definitions shall have the same meaning as in the rights issue prospectus (the “Prospectus”) published on 3 November 2009 by Lloyds Banking Group plc (the “Company” or “Lloyds Banking Group”) in connection with the Rights Issue.

Lloyds Banking Group is pleased to announce that the Issue Price at which the New Shares will be offered pursuant to the Rights Issue has been set at 37 pence per New Share.

The Rights Issue comprises the offer of 36,505,088,579 New Shares at an Issue Price of 37 pence on the basis of 1.34 New Shares for every 1 Existing Ordinary Share held at the Record Date. The expected gross proceeds of the Rights Issue receivable by Lloyds Banking Group total £13,506,882,774.

The Issue Price represents a discount of 59.5 per cent. to the Closing Price of the Company’s Ordinary Shares on 23 November 2009 (being the latest practicable date prior to the publication of this announcement) and a discount of 38.6 per cent. to the theoretical ex-rights price based on this Closing Price.

The New Shares will represent 57.3 per cent. of the enlarged share capital of Lloyds Banking Group immediately following completion of the Rights Issue and Share Subdivision.

In order to increase their capital in the absence of profits they had to sell 1.34 new shares for every existing share. That meant 36,505,088,579 share at 37p a pop and you'll not be surprised to read that 36,505,088,579 x £0.37 = £13,506,882,774.

Ultimately our money reflects credible promises. Debt money is money based on promises. By allowing private banks to dominate money creation we assign to private banks the right to decide whose promises are credible (and the banks' appetite for secured lending indicates that they're pretty sceptical about our promises and appreciate having an asset to flog when we come up short).

However if a bank keep getting it wrong and lending money to people who don't keep their promises, particularly if the bank is undertaking secured lending against assets they can't flog for as much as they thought they could, then they go bust.

Losses burn through capital just as profits add to capital. Banks cannot lend capital into existence and they cannot continue if they have no capital. If a bank, or rather its equity owners, have no capital (no skin in the game) then nobody in their right mind will lend to them and the regulator will shut them down.

Edited August 3, 2018 by Bland Unsight

[Bland Unsight]

Worth noting that anyone who has any kind of funded pension scheme almost certainly indirectly owns some bank shares. The bank's capital represents money that, via your pension savings, you have effectively invested in the bank. It gets lent out just the same as the rest of the bank's money but when the bank makes losses it's the equity investors who take the hit so that people who lent the bank money can get all their money back.

[Bland Unsight]

1 hour ago, cnick said:

Werner time....

 

General misgivings about RT set aside, that video is, unsurprisingly given that it's Richard Werner talking about banks, spot on - but it doesn't address bank capital. He's talking about the link between 'lending' (or the issue of "promissory notes" as he argues banks don't lend!) and money creation. It's a welcome addition to the thread but it doesn't support your suggestion about capital.

Edited August 3, 2018 by Bland Unsight

[spyguy]

1 hour ago, cnick said:

Yes, but what if the 'capital' is created from feck all?

The capital you earn from your effort, luck etc ..... has the exact same value the banks capital newly created thin air credit?

Werner time....

 

They raise capital by equity and bonds.

Cant magic it.

https://www.cml.org.uk/policy/policy-updates/all/funding-capital/

'Under Pillar one, lenders calculate the minimum level of capital needed by assigning a risk weight to a particular asset. Under the Standardised Approach, the appropriate risk weight is proscribed.  For mortgages, with a Loan-to-Value (LTV) below 80% the risk weight under the Standardised Approach is 35%. Lending above 80% LTV attracts a higher risk weight (75%) for that portion of the mortgage above 80% LTV. '

[Ah-so]

5 minutes ago, Bland Unsight said:

General misgivings about RT set aside, that video is, unsurprisingly given that it's Richard Werner talking about banks, spot on - but it doesn't address bank capital. He's talking about the link between 'lending' (or the issue of "promissory notes" as he argues banks don't lend!) and money creation. It's a welcome addition the thread but it doesn't support your suggestion about capital.

Just finished watching it. I wasn't sure about his assertion that loans are in fact securities, although it was a rather irrelevant diversion on an interesting observation. I was also dubious about his claim to be the first person to show that banks create money out of thin air, or whatever he said. But it was a good explanation. He polished it off with a claim that the City of London is neither in the UK or EU - clearly nonsense. It was a pity.

[Ah-so]

10 minutes ago, spyguy said:

They raise capital by equity and bonds.

Cant magic it.

https://www.cml.org.uk/policy/policy-updates/all/funding-capital/

'Under Pillar one, lenders calculate the minimum level of capital needed by assigning a risk weight to a particular asset. Under the Standardised Approach, the appropriate risk weight is proscribed.  For mortgages, with a Loan-to-Value (LTV) below 80% the risk weight under the Standardised Approach is 35%. Lending above 80% LTV attracts a higher risk weight (75%) for that portion of the mortgage above 80% LTV. '

Equity is definitely capital, and for a time a portion of subordinate bonds could be counted towards a portion of your credit requirements. The rules have now been tightened and bonds were removed from capital.

There is still a type of bond that gets some capital benefit, which is called a contingent capital instrument (or "coco"), although I can't remember quite what benefit you get from them, but essentially they are bonds until capital levels fall below a certain point at which they are converted from a bond into equity.

[Ah-so]

On 02/08/2018 at 13:59, Horseradish said:

But there's something that I don't quite get in all this. Why would the bank bother to fund this new money creation at all via deposits? Sure, initially they will have to turn to the interbank money market because you can't magic up deposits overnight - it takes time to change the rate, advertise it, get customers to deposit more, etc. But why bother doing that at all? They're paying very little for the money themselves, no matter whether they get it via the interbank markets or via the Bank of England itself - compared with what they are getting off the top of that mortgage. And, besides, they will usually securitise most mortgages away anyways (again, let's pretend that the TFS never happened, just for the sake of argument (because the TFS meant that banks didn't securitise much of their mortgage book for years)). I know that this smells of what Northern Rock were up to - lending long term and borrowing short term - but few deposits accounts are really "long term". Perhaps a year. But the 1-year LIBOR rate is super low so... why bother? I don't get it.

In reality banks always have more than sufficient deposits on their books to fund their loans.

Interbank money is pretty worthless from a liquidity perspective and there is next to none done these days. Most wholesale money flows come from "real money" sources, such as asset managers, pension funds and large corporates. However, this money tends to be quite short term and our Basel III liquidity regime gives it relatively little credit. It is the first to fly if there is a hint of trouble. Also, wholesale money is much more expensive than retail deposits.

Retail deposits are much cheaper and more stable. Retail depositors know that there money is relatively safe, and even if they do not, will be the last to ask for it back - see Northern Rock for example.

In fact, if you do not accept deposits, you do not have to become a bank. There are plenty of mortgage companies that exist purely through wholesale funding. However, some of them subsequently choose to become banks to take advantage of the cheaper retail funding on offer - see Paragon Bank as an example. Not only is it cheaper, but it is less likely to fly out the door at the first sign of trouble.

 

[Bland Unsight]

13 hours ago, Ah-so said:

In reality banks always have more than sufficient deposits on their books to fund their loans.

Interbank money is pretty worthless from a liquidity perspective and there is next to none done these days. Most wholesale money flows come from "real money" sources, such as asset managers, pension funds and large corporates. However, this money tends to be quite short term and our Basel III liquidity regime gives it relatively little credit. It is the first to fly if there is a hint of trouble. Also, wholesale money is much more expensive than retail deposits.

Retail deposits are much cheaper and more stable. Retail depositors know that there money is relatively safe, and even if they do not, will be the last to ask for it back - see Northern Rock for example.

In fact, if you do not accept deposits, you do not have to become a bank. There are plenty of mortgage companies that exist purely through wholesale funding. However, some of them subsequently choose to become banks to take advantage of the cheaper retail funding on offer - see Paragon Bank as an example. Not only is it cheaper, but it is less likely to fly out the door at the first sign of trouble.

Interesting stuff.

It's useful that you've brought out the difference between liquidity rules (which mitigate the risk of a run on a bank as, for whatever reason, those who are funding the bank pull money out) and solvency rules (which mitigate the risk of a bank being unable to pay back depositors because the bank has lost the money, i.e. lent it out to somebody who then failed to pay it back).

Even a well-run bank that was making money and wholly solvent could, in principle, experience a bank run. In reality fears of possible insolvency (insufficient capital to handle anticipated losses) cause problems with funding (a liquidity crisis).

Quote

Almost every financial crisis starts with the belief that the provision of more liquidity is the answer, only for time to reveal that beneath the surface are genuine problems of solvency. 

Source: Mervyn King in the Telegraph, 27 February 2016 (link)

[Bland Unsight]

14 hours ago, Ah-so said:

Just finished watching it. I wasn't sure about his assertion that loans are in fact securities, although it was a rather irrelevant diversion on an interesting observation. I was also dubious about his claim to be the first person to show that banks create money out of thin air, or whatever he said. But it was a good explanation. He polished it off with a claim that the City of London is neither in the UK or EU - clearly nonsense. It was a pity.

He's one of the authors of the New Economics Foundation book Where does money come from? mentioned in the OP.

With regard to the promissory notes, I am guessing that he's discussing the ideas he treats in this article:

Quote

Abstract

Thanks to the recent banking crises interest has grown in banks and how they operate. In the past, the empirical and institutional market micro-structure of the operation of banks had not been a primary focus for investigations by researchers, which is why they are not well covered in the literature. One neglected detail is the banks' function as the creators and allocators of about 97% of the money supply (Werner, 1997, Werner, 2005), which has recently attracted attention (Bank of England, 2014a, Bank of England, 2014b, Werner, 2014b, Werner, 2014c). It is the purpose of this paper to investigate precisely how banks create money, and why or whether companies cannot do the same. Since the implementation of banking operations takes place within a corporate accounting framework, this paper is based upon a comparative accounting analysis perspective. By breaking the accounting treatment of lending into two steps, the difference in the accounting operation by bank and non-bank corporations can be isolated. As a result, it can be established precisely why banks are different and what it is that makes them different: They are exempted from the Client Money Rules and thus, unlike other firms, do not have to segregate client money. This enables banks to classify their accounts payable liabilities arising from bank loan contracts as a different type of liability called ‘customer deposits’. The finding is important for many reasons, including for modelling the banking sector accurately in economic models, bank regulation and also for monetary reform proposals that aim at taking away the privilege of money creation from banks. The paper thus adds to the growing literature on the institutional details and market micro-structure of our financial and monetary system, and in particular offers a new contribution to the literature on ‘what makes banks different’, from an accounting and regulatory perspective, solving the puzzle of why banks combine lending and deposit-taking operations under one roof.

As to the other stuff I'll confess that I used @cnick's link and thus began at 5:34 and stopped watching as soon as the topic seemed to have changed from the mechanics of money creation (at about 8:30). Presumably the claim of academic priority rests on some subtle distinction which escapes people outside the field and is contested by those active within it.