It can be difficult to figure out whether the theoretical limit is 10x or 100x in my mind because there isn't a reserve ratio federally (well, there is one, but it's zero) , and the other regulations surrounding that aren't so cleanly understood in a neat formula.

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dghlsakjg 3 days ago | parent | next [-]

Extremely simplified:

When I deposit a dollar, the bank records a $1 deposit liability. If the bank makes a $1 loan, it creates a new $1 deposit for the borrower.

If that dollar is spent and redeposited, deposits increase even though the amount of base money has not. It looks like multiplication, but what’s really happening is that loans and deposits are expanding together on the balance sheet.

The bank is not creating wealth out of nothing. It now has matching assets (loans owed to it) and liabilities (deposits owed to customers), backed by capital that absorbs risk.

With reserve ratios effectively zero, lending is constrained by capital requirements and risk management, not by reserves. Banks cannot recirculate a single dollar endlessly without sufficient capital.

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LeanOnSheena 3 days ago | parent | next [-]

The bank of England has some incredible articles that explain this that have been circulated on HN before. Really fantastic reading for those wanting to understand the mechanics.

https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...

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mothballed 3 days ago | parent | prev | next [-]

They don't create wealth out of nothing. They capture, and potentially create, wealth by offering financial services including lending. The differences between the positive interest paid to depositors and the loan interest, after covering risk and other costs, is the wealth they've captured/created for themselves.

I don't think anyone is under the illusion that credit expansion itself creates wealth in the sense of more dollars moving around means more wealth.

I think the relavent point here is that this form of credit expansion does expand the numerical value of deposits ("create money") which has asymmetric advantages to the bank. Due to having a central bank, the banks are basically acting as arms of the federal government when they do this. The payoff the banks get from this is capturing the interest differential on these expanded credits as well as benefitting from the Cantillon Effect whereby they usually have prioritized access to new money entering the economy.

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eru 3 days ago | parent | next [-]

Mostly agreed.

> I don't think anyone is under the illusion that credit expansion itself creates wealth in the sense of more dollars moving around means more wealth.

Alas, lots of people have very weird, and very wrong ideas.

> I think the relavent point here is that this form of credit expansion does expand the numerical value of deposits ("create money") which has asymmetric advantages to the bank. Due to having a central bank, the banks are basically acting as arms of the federal government when they do this.

Yes and No. From the bank's point of view fractional reserve banking works pretty much the same way you have described it here under eg a gold standard as well.

> The payoff the banks get from this is capturing the interest differential on these expanded credits as well as benefitting from the Cantillon Effect whereby they usually have prioritized access to new money entering the economy.

I rather doubt the Cantillon effect in an economy made up of smart actors who anticipate that new money entering the economy. (Though experiment to illustrate: if the Fed announced today that they are going to double the amount of money in the economy in exactly 12 months, you would see prices going up today in anticipation. The Cantillon effect would require prices to slowly go up one by one starting at the earliest in 12 months as the money makes it way through the economy like some kind of hydraulic fluid.)

Btw, there are also plenty of shadow banks that provide similar services to the economy but are not regulated as banks. They serve as a release valve for the economy.

In a very loose sense my stock broker (IBKR) is a shadow bank: lots of people have uninvested cash in their brokerage accounts and IBKR lends some of it to me as a margin loan so I can buy more stocks. Money market funds are another sort-of shadow bank.

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qsera 3 days ago | parent | prev [-]

>They don't create wealth out of nothing.

Banks loans may not create wealth. But they promise its creation to the society. The value of the money that they lend out comes from that promise.

And the people who borrowed from the bank create wealth when they repay their loans. The responsibility of the bank is to track it and ensure that it is created. OR that the money lended out is not spent. Either one should happen when the loan is repayed, so the bank does not care which one.

If the banks does not do it (ensure repayment or collect collateral), then all the people who worked for the money loaned by the bank, got their work stolen.

In other words, when you take a loan from a bank, you are actually borrowing from the society.

So watch your banks very closely.

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jt2190 2 days ago | parent [-]

> But they promise [the creation of wealth] to the society.

It feels like you're trying to describe the "social contract" between private banks and the rest of society, but putting the full responsibility of "wealth creation" only on one party in the contract: The bank.

The other party, Society, is given access to capital when they borrow. The rate they're charged should be competitive since there is presumably more than one lender. By borrowing money they try to "create wealth", then to repay the loan principal along with a bit of the new wealth in the form of interest.

	▲	qsera 2 days ago \| parent [-]
		>"wealth creation" only on one party in the contract: The bank. No, I meant to say that wealth is create by people. Banks are supposed to enforce it.

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yfontana 3 days ago | parent | prev [-]

Reserves matter even if reserve ratios are zero. If Bank A lends too much money, then when its customers spend that money, a lot of it will end up deposited at other banks. These banks will then ask Bank A for reserves (as in, central bank money) to clear the inter-bank transfers, which Bank A will need to borrow from the central bank, at a cost.

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jcranmer 3 days ago | parent | prev | next [-]

> It can be difficult to figure out whether the theoretical limit is 10x or 100x in my mind because there isn't a reserve ratio federally (well, there is one, but it's zero)

I know what you're thinking of here, but it doesn't mean anything like what you think it means.

So the US used to have a rule that every bank hand to have a certain percentage of its assets stored in its account at a Federal Reserve bank; it is this percentage which was gradually reduced to 0 by I think 2020. Note that only the funds in that account meet the requirement; a literal pile of cash contributes not a single cent.

The way banks are primarily limited nowadays is via capital adequacy ratio, which is essentially that you need to set aside a particular pile of capital that can be raided to guard against assets falling in value to 0. It's complicated because this pile of capital doesn't come from the money a customer deposits in their account (which needs to be held as an asset to offset the liability a depositor represents), but rather from income the bank makes in other ways. If a bank sells $1 million worth of shares, they get to issue ~$20 million more loans.

If a bank gets $1 million worth of new deposits, they get to issue... $0 more loans. Well, maybe less: if a bank gets $1 million worth of new bitcoin deposits, that probably reduces its capital ratio because bitcoin is such a risky asset.

	▲	mothballed 2 days ago \| parent [-]
		>If a bank gets $1 million worth of new deposits, they get to issue... $0 more loans. Then it doesn't make sense for a classical deposit-lending bank to pay interest on those new deposits. They can't generate revenue from the new deposits since they cannot touch them to perform lending , and they are now a liability because they must perform banking services to the depositor, regulatory compliance, and insure against the risk something accidently happens to the money. Under your scheme maybe they could go park it at the fed and get interest that way but even that is technically a loan; they are giving up the notional money in exchange for interest in hopes they can collect it at a later time.

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eru 3 days ago | parent | prev [-]

Lots of places, eg Canada, never had a legally mandated reserve ratio.

Fractional reserve banking has economic limits, even when there are no legal limits.