it's called fractional reserve because the $10 deposit becomes the basis for $100 in unbacked loans. banks do not lend deposits. if all banks did was lend deposits they wouldn't be inflationary. every dollar of a loan spent would represent real productive value already earned.
an unbacked loan, in comparison, injects future money into today (for some fee). It represents value not yet actually created and is thus inflationary.
ok. do banks loan out $9 of a $10 deposit at all?
or do they not loan out $9 of a $10 deposit at all?
if they do loan out $9 of a $10 deposit as a matter of actual policy and regulations what do they call that?
individual deposits aren't accounted that way. banks balance assets and liabilites. so say I am a bank and I need to have more assets than liabilities (to stay solvent). I take your $100 deposit and promise it back to you anytime you want it. Knowing that on average you keep, say, $75 in the bank at all times (banks use running averages of demand deposits and make up any differences with small inter-bank trades) I use that $75 as a basis to make unbacked loans of $750 to other people. Due to legal tender laws I am allowed to simply write the amount of the loan into other people's accounts. these loans have value and become assets that balance with the liabilities of demand deposits.
of course assuming a price is dumb. price only exists when an actual sale took place. this is what we saw in the financial crisis. every bank assumed that they could sell lonas for X, when the time came to actually sell some loans everyone was trying to sell loans at the same time. the price tanked, boom, toxic assets. You were relying on the "paper price" of your loan to balance your liabilities and stay solvent, your paper price was an unjustified assumption.
nazgulnarsil: individual deposits aren't accounted that way. banks balance assets and liabilites. so say I am a bank and I need to have more assets than liabilities (to stay solvent). I take your $100 deposit and promise it back to you anytime you want it. Knowing that on average you keep, say, $75 in the bank at all times (banks use running averages of demand deposits and make up any differences with small inter-bank trades) I use that $75 as a basis to make unbacked loans of $750 to other people. Due to legal tender laws I am allowed to simply write the amount of the loan into other people's accounts. these loans have value and become assets that balance with the liabilities of demand deposits.
How is a $750 asset equal to a $75 liability? Do they multiply by the reserve ratio to treat the loan as $75 again, or...?
What happens when the loans are repaid? Is that $750 plus interest used as the basis of new loans at all, or does the bank keep it as profit?
banks aren't just liable for demand deposits, they're also responsible for the difference between the total value of a loan and its present value, and for various other investments the bank makes.
when loans are paid back checkbook money is destroyed, the only money the bank gets to keep is the interest.
12-27-90
the above linked info indicates that the maximum reserve ratio (if true) is 10 percent.
do many banks only keep the required reserve ratio for the specified amounts listed above? i dont know.
but that still certainly sounds like fractional reserves held in banks....maybe an asset is worth something one day and it is worth less the next....the balance analogy doesnt seem accurate to me.
There's no reserve ratio in Australia and our banks currently have $1.338 trillion worth of deposits and only $6.7 billion in notes, coins and deposits due from the reserve bank. That works out as a reserve ratio of 0.5%.
I might add that our central bank pumped plenty of cash into the banks between Sept - Dec 2008, increasing reserves 380% in three months (to a reserve ratio of a mighty 2.2%!).
Those reserves have since declined 436%. I wonder where all the money went? I might add that inter-bank loans, housing loans, personal loans, the share market and bonds (both government and corporate) have seen plenty of growth over the past 8 months -- hey, that was right after the RBA increased bank reserves. What a coincidence!
I was always confused as to fractional reserve banking. Is it:
A. A $10 deposit becomes a $9 loan and the $1 stays as reserve at the central bank?
or
B. A $10 deposit stays as reserves and allows for creation of $100 in loans?
Which is it? Of course either one means that loans become deposits at another bank and its inflationary either way.
The way I understand it is that when $10 is deposited, the bank creates a loan of $9, probably as another deposit. So now deposits equal $19 but total cash only equals $10, so basically $9 of the original $10 has 2 claims on it ($9 x 2 claims = $18 + $1 x 1 claim = $19). And since deposits can have checks written against them, there is no reason necessarily for cash to leave the bank. Anyway, that $9 becomes the basis for an $8.10 loan, which becomes the basis for a $7.29 loan so on until you get $90 of money created through this process and a total of $100 in deposits from the original $10 deposit. This sets up the possibility of a bank run, but only if those evil greedy depositors want to withdraw the cash the bank says they have some claim to. Only the first $10 can be withdrawn however because that's all there is.
below are some excerpts from the 'mystery of banking pdf at mises site.
"The amount of cash kept in the bank’s vaults ready for instant
redemption is called its reserves. Hence, this form of honest, noninflationary
deposit banking is called “100 percent reserve banking,”
because the bank keeps all of its receipts backed fully by
gold or cash...."
"the system offractional reserve banking, in which more than one warehouse
receipt is backed by the same amount of gold or other cash in the
bank’s vaults."
"It should be clear that modern fractional reserve banking is a
shell game, a Ponzi scheme, a fraud in which fake warehouse
receipts are issued and circulate as equivalent to the cash supposedly
represented by the receipts."
"....fractional reserve banking, where total cash reserves are
lower, by some fraction, than the warehouse receipts outstanding."
"the Rothbard Bank has had $50,000 of gold coin or government paper deposited in it, and then proceeded to pyramid on top of that $50,000 by issuing $80,000 more of fake warehouse receipts and lending them out to Smith. The Rothbard Bank has thereby increased the money supply in its own bailiwick from $50,000 to $130,000, and its fractional reserve has fallen from 100 percent to 5/13."
"Bank is practicing fractional reserve banking. It has pyramided $5 million of warehouse receipts on top of $1 million of reserves. Its reserves consist of its checking account with the Central Bank, which are its own warehouse receipts for cash. Its fractional reserve is 1/5, so that it has pyramided 5:1 on top of its reserves."
"Now suppose that depositors at the Martin Bank wish to redeem $500,000 of their demand deposits into cash. The only cash (assuming that they don’t insist on gold) they can obtain is Central Bank notes."
here is a mises.org site that says http://mises.org/story/363
"When Joe deposits $1000 with a bank, the accepted practice is to regard the deposited $1000 as part of the bank’s balance sheet. The $1000 is registered on both the asset and liability sides of the bank’s balance sheet.
By registering the deposited $1000 this way, the banks states that Joe supposedly lent the bank $1000. In reality however, the $1000 was never lent to the bank and consequently the ownership on the $1000 was never transferred. So long that deposits are fully backed up by cash, the bank is said to be maintaining a 100% reserve ratio.
Now, if the bank extends a loan of $900 to Chris, the bank creates a deposit and thus new money of $900. For Chris could now pay with a check, when buying goods and services, against the $900 deposit. On the asset side of the bank’s balance sheet we will now have a $1000 in cash plus a $900 loan. On the liability side of the balance sheet we will have $1900 of demand deposits."
"Observe that the $1000 of cash (in deposit account) is backing up only a fraction of deposits, i.e. $1000/$1900 or 10/19. In other words fractional reserve banking gives rise to inflationary credit or "credit out of thin air.""
i assume the author of the article to be describing something close to reality...a fractional reserve process of banking. deposit is made, loan is made from deposit, a fractionj of original is deposit remains but there is a creation of bank-credit added equal to the amount of deposit that was loaned out.
"fractional-reserve banking, in which a bank is permitted to create credit in excess of the deposits that have been made to it. The bank is required only to maintain a certain ratio between deposits on hand and its credit expansion. "
http://mises.org/story/3034
i dont know if this is true or what banks actually do...it is what people at mises.org sites say.
You know that 9 out of 10$ is just a figure of speech. In reality there's no limit to how many loans the banks can make so long as they don't get a run on their deposits.
Microsecession as a strategy for revolution | Challenge to minarchist | How would a private road system work?
Isomies: I was always confused as to fractional reserve banking. Is it: A. A $10 deposit becomes a $9 loan and the $1 stays as reserve at the central bank? or B. A $10 deposit stays as reserves and allows for creation of $100 in loans? Which is it? Of course either one means that loans become deposits at another bank and its inflationary either way.
If you were a banker and had the choice of A. or B., which would you do? A. gets you interest on 9 bucks, B. gets you the same interest on 100 bucks.
I think Rothbard writes [in what has gov done to our $] that historically banks started out with A and then realized that B is even sweeter. The video here about the Fed seems to say they do B as well.
my bank provided this response to me about a question concerning deposits:
"We cannot provide large amounts in cash to a member on demand, but we can certainly at the time of the request order the funds for delivery at a later period."
this would seem to me that only a fraction of a deposit is kept.
this was also posted earlier...
redemption is called its reserves...."
if you need additional info on your is it door a or is it door b wonderings.....this link http://mises.org/story/3556 say:
"The Depository Institutions Deregulation and Monetary Control Act of 1980 had begun phasing out interest-rate ceilings on deposits and modified reserve requirements in complex ways. Combined with subsequent administrative deregulation under Greenspan through January 1994, these changes left all the financial liabilities that M2 adds to M1 — savings deposits, small time deposits, money market deposit accounts, and retail money market mutual fund shares — utterly free of reserve requirements.........."
Ludwig von Mises Institute | 518 West Magnolia Avenue | Auburn, Alabama 36832-4528
Phone: 334.321.2100 · Fax: 334.321.2119
contact@Mises.org | webmaster | AOL-IM MainMises
Mises.org sitemap