Banking Explained For Idiots Like Me

[cells]

Yeah I know.

£60

Have some more, I can spare it. Legal tender cash I can't reproduce for you, sorry that's the mints job. I can produce as much electronic cash as you desire though.

Have fun with it!

fair enough, those electronical numbers may not be legal tender. but give it one court challange and the law will change to include electrnic money as legal tender (if it isnt at the moment)

[Injin]

fair enough, those electronical numbers may not be legal tender. but give it one court challange and the law will change to include electrnic money as legal tender (if it isnt at the moment)

Right.

So the courts will enforse my £60 as legal tender.

Cool.

[cells]

Er not sure that's quite right, but open to be corrected.

The way I understand it works is that (assuming a 10x ratio), if a bank has 10k, it can only loan out 9k, leaving 10% in reserve. Additional funds come from borrowings from elsewhere (ie other banks, central banks etc). Obviously, if this 9k is redeposited, 90% of that can be loaned out, leading to a number of interations until we reach zero. This in principle means that in theory the initial 10K can be loaned out over and over (for the number of iterations in the previous sentence), which becomes more or less a theoetical 100K. This is where the physical limitations occur. In practice a customer could borrow that 100k immediately, rather than go through all the steps above. It doesn't though become an infinite multiplier, as during each iteration the funds drop by the reserve amount (10% in this case)

what you are describing is a 10% reserve system, and you are correct, in such as system you can lend out roughly 10x overall.

but the majority of country do not have a 10% reserve system, they have a 0% reserve system, which means it can be infinite number. look at wiki for uk reserve %. it is a volentary reserve. so the banks can pick a reserve they choose. which in all practical terms means 0%

[cells]

Right.

So the courts will enforse my £60 as legal tender.

Cool.

so long as at the end of the day, you have a zero balance sheet. so say the law

so if you spent that £60 you would need to work and get £60 back or borrow £60.

in effect you are then a bank

[Mr H]

what you are describing is a 10% reserve system, and you are correct, in such as system you can lend out roughly 10x overall.

but the majority of country do not have a 10% reserve system, they have a 0% reserve system, which means it can be infinite number. look at wiki for uk reserve %. it is a volentary reserve. so the banks can pick a reserve they choose. which in all practical terms means 0%

Maybe I'm beginning to grasp the principle of this at last.

It seems though that even a 10% reserve is too risky for most banks, given that the shaky NR was the most extreme at 30ish%. As far as I can tell, the average is about 90%, meaning that our discussion is more theoretical than anything.

I'm hoping that's a good thing.

[Injin]

so long as at the end of the day, you have a zero balance sheet. so say the law

so if you spent that £60 you would need to work and get £60 back or borrow £60.

in effect you are then a bank

Why would I do that?

My act of borrowing created the £60, when I use it the banks books are balanced, as their own records show. The bank has stood no risk and suffered no loss.

Surely I should be prosecuting for attempted fraud when I am asked for "repayment"?

[cells]

Isn't the average deposit to loan ratio 90% or thereabouts?

last time i checked, and i just counted to the nearest 0.1 tril and the top 10 banks. there where 1.3tril in deposits and 1.3 tril in loans

the deposit to loan ration would have to be 100% or higher. or a bank somewhere out there would be going bust tonight.

any bank that has a non positive blanace sheet that day either needs to borrow from other banks, or bed the goverment/boe

that is what happened to NR. they only had some 24bil deposits and 110bil loansm, the other banks refused to lend them money at a decent rate so they went beging.

[the_austrian]

Why can't any of you explain the FR principle in terms those of us with more than a passing knowledge of numbers (real or imaginary) and finance can understand.

Never Mind the B*******, Here's the Sex Pistols

http://www.lewrockwell.com/rothbard/frb.html

why would they pay us money to lend them our money IF they can just print it!

In order to print it they need a customer to take out a loan.

but once you understand this little fact, the whole banking systems image turns from one of the devil to one of a relatively respectable business!

Fractional reserve banking insidiously takes wealth from the poor and transfers it to the rich.

What happens to all the interest the BoE gets on the money it prints out of thin air?

Private banks borrow fractional-money from the central bank interest-free.

[cells]

Why would I do that?

My act of borrowing created the £60, when I use it the banks books are balanced, as their own records show. The bank has stood no risk and suffered no loss.

Surely I should be prosecuting for attempted fraud when I am asked for "repayment"?

thier books are not balanced, they need to borrow that money from another bank or from a saver. or if they already had a positive balance, they have a less positive balance.

just use 60bil instead of £60 to make the idea clearer.

[Injin]

thier books are not balanced, they need to borrow that money from another bank or from a saver. or if they already had a positive balance, they have a less positive balance.

just use 60bil instead of £60 to make the idea clearer.

If they go to someone else for the money, they use my "borrowing" as collateral, so they owe me for doing it. The money didn't exist before I acted, therefore I am it's creator. The bank makes no loss, suffers no risk and lies to me about what it's up to.

How can you say that they have a 0% fractional reserve system and then say that my cash must have come from another saver? Makes no sense. If they go to another bank, then they didn't lend me anything, someone else did and they are misrepresenting what happened for their own gain.

Looks like a cracking court case to me, but not in the way you are thinking, obviously!

[cells]

In order to print it they need a customer to take out a loan.

sub company?

another bank?

the bank CEOs wife?

the take loans from you and pay interest as that is the only way to have a positive balance sheet at the end of the say, if they create £10 and lend it to themselves there are where they started as 10 minus 10 is zero so they havent changed their balance sheet!

Fractional reserve banking insidiously takes wealth from the poor and transfers it to the rich.

no it doesnt, inflation does that. reserve banking in itself doesnt cuase inflation. if they set the rate at the correct level we will get zero % inflation, infact if the BOE tomorrow set interest rates at 10% i can garantee you we will get deflation for at lest a while, but we still have fractional reserve banking. so it is not the FRB that is to blame but the incorrect rate chosen (which can be political or just incorrect)

Private banks borrow fractional-money from the central bank interest-free.

private banks dont borrow from the BOE, before NR it was over a decade since a private bank in the uk borrowed from the BOE!

[cells]

If they go to someone else for the money, they use my "borrowing" as collateral, so they owe me for doing it. The money didn't exist before I acted, therefore I am it's creator. The bank makes no loss, suffers no risk and lies to me about what it's up to.

you are correct! but that is why they offer interest to savers. so you could potentially put that £60 into a good savings account and end up paying extreamly little interest (if the system was perfect, and competition was high, you would pay so little interest it will be almost zero). ie the interest you pay on the loan is only a tiny bit higher than the interest you would get depositing the money

How can you say that they have a 0% fractional reserve system and then say that my cash must have come from another saver? Makes no sense. If they go to another bank, then they didn't lend me anything, someone else did and they are misrepresenting what happened for their own gain.

i was talking about a closed system, you and your bank, overall you are right, you are their creditor. Although there is some slack in the system, money that was not created by the bank in the first place, but this is low in comparrision to the total money. so specing theoriticly they could have used this non bank created money to finance you ect

Looks like a cracking court case to me, but not in the way you are thinking, obviously!

no it would be a simple case

you are the crditor, you give the bank £60 (which you printed/got from nothing). the bank givces it to you. Now if you destroy it there and then, you might have a case. but the bank wants it back, so it can destroy it.

legally it has to do that and is regulated, you are not.

[Injin]

you are correct! but that is why they offer interest to savers. so you could potentially put that £60 into a good savings account and end up paying extreamly little interest (if the system was perfect, and competition was high, you would pay so little interest it will be almost zero). ie the interest you pay on the loan is only a tiny bit higher than the interest you would get depositing the money

i was talking about a closed system, you and your bank, overall you are right, you are their creditor. Although there is some slack in the system, money that was not created by the bank in the first place, but this is low in comparrision to the total money. so specing theoriticly they could have used this non bank created money to finance you ect

no it would be a simple case

you are the crditor, you give the bank £60 (which you printed/got from nothing). the bank givces it to you. Now if you destroy it there and then, you might have a case. but the bank wants it back, so it can destroy it.

legally it has to do that and is regulated, you are not.

The bank has to legally. I do not. I signed a loan agreement, stating that if the bank loaned me money I would repay.

As this never happened, where do you think my legal responsibilities come from?

[cells]

The bank has to legally. I do not. I signed a loan agreement, stating that if the bank loaned me money I would repay.

As this never happened, where do you think my legal responsibilities come from?

i never signed no loan form that read. if we give you ...... you will pay is back

its more on the line with, you will give us back the sum of....

[cells]

im off to bed, the video is a good watch, but it doesnt give you a very good picture of the banking system.

a simple question to ask youself at the end of the video is, if a bank can create money out of nothing, why is it bothered to offer us money to put our money into savings accounts.

[Injin]

i never signed no loan form that read. if we give you ...... you will pay is back

its more on the line with, you will give us back the sum of....

Which means they have to give you something first and they haven't!

Well done, you got it!

[DabHand]

im off to bed, the video is a good watch, but it doesnt give you a very good picture of the banking system.

a simple question to ask youself at the end of the video is, if a bank can create money out of nothing, why is it bothered to offer us money to put our money into savings accounts.

Because this money is created against a real deposit. Every pound you deposit lets them lend out and collect interest on nine others, for example.

Anyway, someone somewhere is creating money from somewhere, there are a lot of loans making up those massively inflated asset prices across the globe (what are they fractionally lent against?) and consider where the "extra" money is going to come from on top of the principle to pay the interest?? Currently from an ever increasing amount of new lending. Well that sounds sustainable dunnit?

[the_austrian]

a simple question to ask youself at the end of the video is, if a bank can create money out of nothing, why is it bothered to offer us money to put our money into savings accounts.

Because they think the answer to this question "If a bank has 10% reserves and more than 10% of the depositors ask for their money back does that mean the rest lose out because the bank has run out of cash?"... is yes!!

[Mr H]

last time i checked, and i just counted to the nearest 0.1 tril and the top 10 banks. there where 1.3tril in deposits and 1.3 tril in loans

the deposit to loan ration would have to be 100% or higher. or a bank somewhere out there would be going bust tonight.

any bank that has a non positive blanace sheet that day either needs to borrow from other banks, or bed the goverment/boe

that is what happened to NR. they only had some 24bil deposits and 110bil loansm, the other banks refused to lend them money at a decent rate so they went beging.

I agree, but I read somewhere online last night (and whether it's true or not is a moot point) that the average deposit to loan ratio of all the banks (presumably UK) is roughly 90%. The additional 10% comes from additional borrowings from other banks. This 10% isn't considered a deposit in terms of the Deposit to Loan ratio.

[UncleMeat]

It is indeed excellent (but too long to watch in one sitting). Is it downloadable anywhere?

You can download the cartoon in Divx format from here:

http://stage6.divx.com/Zambucas-Mix-Channe...4/Money-as-Debt

[bearish_rat]

My first post, so I'd better make this good. I was watching this last night and enjoying the debate but there seems to be a single factor missing in the equation which most people are missing and which makes a lot of the debate revolve around the concept of 'creating' money. I would also suggest that the trying to provide a simple overview using pseudo balance sheets is simply impossible and that it needs to be explained in a logical way that helps people understand the flow of money rather than the actual amounts.

So firstly, the factor I think is missing in a lot of the debate is:

The value of the property or asset that the bank holds as collateral against the loan that has been made.

In summary: The idea of a fractional reserve is not to create money or to fool people but to minimise the risk that a bank will be left with no money for day to day trading.

Think of a bank as a type of foreign money changer but instead of exchanging dollars for euros it exchanges houses for pounds (or whatever the currency of your country). It will actually exchange anything of value you care to bring to it - gold coins, works of art, company bonds. It actually does this very efficiently and to the benefit of the customer will actually lend money on the basis of the value of the asset whilst allowing the asset to remain with the 'owner' - as long as the owner signs over the right for the bank to take over the asset as their own in the event that the customer defaults on the loan.

In recognition of this service (lending money) the bank charges interest - or thought of another way, a service charge as a percentage of the value of the amount of money being lent, the percentage being based upon the prevailing market rate (central bank rate) plus an element for risk. Thus government bonds (no risk) it will lend money on at the central bank rate. Works of Art (high risk) it will lend money on at central bank rate + a number of points, to recognise the risk that the deal may go wrong.

In a modern economy cash is the ultimate 'liquid' asset - the lowest common demoninator, I can take it to anywhere and anybody will accept it (there are extremes at which this breaks down - Zimbabwe, but that's another debate) and the bank doesn't just deal with a couple of transactions a day but thousands or millions, therefore it needs an amount of liquidity to cover it during the day to day trading when levels of 'cash' fluctuate. The reserve fraction is this minimum level of liquidity that is required for the bank to hold in cash to deal with this day to day.

With regard to the 'creation' of money - via this method, whilst there can be 'imbalances' the banking sector is ultimately limited to loaning funds to a maximum value of all the assets on the planet which is rather glib but ultimately true.

To understand the current banking problems we need to look at 2 scenarios: A Run and Asset Overvaluation:

A run on a bank can occur at anytime if more money is required than the bank has liquid reserves - i.e. 11% of the money is attempted to be withdrawn when the bank only has 10% in cash. The other money is there - in the form of collateral against loans made but the average punter is not likely to accept being given a 1/1000% share in somebody's mortgage and told - take that down the green grocer and see if he'll accept it for the week's shopping. Now assuming that the asset valuations for which the bank holds collateral are correct (that is the value of the work of art or house that it holds as collateral and the risk is as expected) then eventually the bank will be able to sell on these obligations for cash to other people/banks and pay out all the customers the full value of their deposits but this may take weeks or even years and most people don't think this is acceptable and therefore runs become self fulfilling as the longer you leave it the more likely it becomes that you will have to wait years to be paid out.

Asset Overvaluation is the second and more difficult problem that occurs if the bank has lent money over the value of the asset...for instance in a house price bubble....where the price at the top of the bubble far exceeds the later (post bubble) value of the asset. If this occurs and after the bubble has 'pricked' the bank is forced to sell the collateral it it will only be able to do so for a lot less than it originally 'bought it for'. So for instance if I lent £1m to lots of people to buy houses, if the valuation of the houses and risk stays the same then the debt is 'liquid' and other people/banks will happily pay me £1m for these 'assets'. However, if the valuation decreases and/or the risk goes up, although I paid £1m for these mortgages nobody else will buy them from me at anything like this price and therefore I either have to accept the loss, in order to get the cash to maintain my fractional reserve OR I become insolvent - literally cashless whilst sitting on a great big pile of IOU's from the poor house owner who still owes the debt. So eventually the bank/collateral holder will get most of the money but over years not immediately.

And this is what has happened - the American housing bubble has burst - all the mortgage assets which the banks hold are suddenly worth a LOT less than they thought - both because risk has increased and the actual prices are decreasing. Therefore they have to do 2 things: get cash in to maintain their minimum reserve by persuading the public to deposit with them (putting up savings rates and by effect mortgage rates) AND by reducing their lending (as they have less money) and making it more expensive (to cover the increase in costs they face and the increase in risk in the market).

Just my 2 pennies and the usual caveats pertain - I'm not authorised to give advice, etc. I'm also not a VI and whilst naturally 'bearish' as in planning for the worst simply think that things go in cycles of optimism and pessimism and we're now at the cusp and going to go into a pessimistic phase in house price value.

RAT

[Mr H]

Excellent first post Mr Rat, it's refreshing to read an informed comment that doesn't hinge on wild conspiracy theories and conjecture.

[Injin]

The value of the property or asset that the bank holds as collateral against the loan that has been made.

No loan was ever made that's why it's fractional reserve lending.

If Bob doesn't fall for the con, they can't claim his property. That's why it's a scam. They feign lending to acquire property through Bob thinking he has failed to pay back a debt. They can take Bob's house, car or whatever and Bob will think it's his own fault for not repaying what was never lent in the first place.

If Bob asks where the money came from it's feet shuffling time from the bank.

To understand the current banking problems we need to look at 2 scenarios: A Run and Asset Overvaluation:

There are three problems with banking, not two. The third problem is that the bank folds, is seen as the con job it is and the game is up. Depositors lose almost everything, but all "debtors" are free. This is (overall) amazingly good for the economy if it ever occurs.

Your analysis assumes that the bank has to be there and is legitimate. It does not and is not. You also assume that the bank has a right to the collateral if it hasn't actually made a loan. It does not. Who in their right mind would give someone an asset worth the value of the house, then the same again + interest?

The easy way to understand it is to ask a simple question - if the market were totally free and everyone knew what was going on, would any bank be able to fractionally lend?

Answer - not in a million years. "Borrowers" wouldn't fall for it, "savers" wouldn't want their savings eroded through inflation either.

All banking is fraud, and banking is win/win for the bankers and lose/lose for everybody else. It's the world on a stick and the moon to wave it at in exchange for a few pieces of paper and the ability to keep a straight face.

The logic was good, just the premise flawed (imo).

[Mr H]

No loan was ever made that's why it's fractional reserve lending.

If Bob doesn't fall for the con, they can't claim his property. That's why it's a scam. They feign lending to acquire property through Bob thinking he has failed to pay back a debt. They can take Bob's house, car or whatever and Bob will think it's his own fault for not repaying what was never lent in the first place.

If Bob asks where the money came from it's feet shuffling time from the bank.

Either I'm not understanding you (quite likely), or you're leaping to a bit of a conclusion that perhaps isn't correct.

As I understand it, the funds a bank loans out come from either deposits (from savers), or from loans from other banks, which is in essence the principle behind frational reserve lending. In short, they're borrowing short and lending long. They're not creating money from nothing, they're creating it on the premise of either raiding someone's deposit or borrowing from elsewhere. It's kind of circular, in that all the banks borrow from each other to meet their short term needs (ie the difference between their deposits and loans). The only additional monies come from central banks as and when they're authorised to release those funds.

[bearish_rat]

Ok, Injin you got me - it is a con,

But in which case you're still wrong as you're looking in the wrong direction - if your premis is that the banks 'create' money, the con is that ANYthing has value that people are willing to trade on, is not a modern work of art simply a few daubs of pigment on a canvas? - about £30 in raw materials - why should it intrinsically have any value greater than that at all?

Why should a house be worth more than the cost of the labour which went into it plus the materials (which of course should be shared equitably according to need) ? Why should a Ford Focus cost so much less than an Audi A3? They are equivalent cars doing the same job.

The point is that you're not looking to discuss 'house price crash' which is an asset bubble within the current economic system but either:

1. A conspiricy theory related to some 'un-named' body who are controlling banking for some nefarious purpose...in which case alt.economic conspiricy would be a better place.

2. Looking to overthrow the capitalist freemarket, in which case alt.communism or alt.new world order who be more appropriate.

The reason I've jumped into this thread and wrote what I did is because teaching people that the current system is a con won't help them deal with it or understand the type of fluctuations that may occur as it plays out and I'd really like to debate that with people in a sensible way, not simply throwing everything up and refusing to play because it's a 'con'.

And to respond to Mr H's question:

As I wrote originally, what you're missing is the fact that the bank is holding the value of the asset in the form of the mortgage. So if the bank is a traditional style bank - the loan's it's made are backed by the collateral it holds in the properties.

The situation in a number of 'new style' lenders is that rather than arract depositors they've found it easier to bundle up these holdings of collateral and income that they produce and sell them on as packages to other bank, hedge funds and increasingly 'wealthy individuals' (companies or states). By selling them they basically take the loan off their books, realise the cash back in which enables them to go and write more mortgages. The problem is that this cycle is no-longer working - nobody wants to buy their packages of mortgages which means that they can't liquidate the assets and thus don't have anymore cash to write more business.

The Bank of England by offering the loan to NR has in effect guaranteed to buy these mortgage assets from the NR allowing them to liquidate them, realise the cash and thus carryout more business - albeit at a MUCH reduced rate and on much more stringent terms (i.e at terms which the market is willing to buy it from them on).

RAT

Edited September 19, 2007 by bearish_rat