So if you give them $1, the bank can now lend $5 (without actually having it) and then make many times that $5 in interest.
So sure, they will pay you a little, so they can make a lot.
At least that's how it works today.
Sigh
This is not how it works. (It’s a common misconception, however.) Loans create deposits, not the other way. Most money is created by banks, not the central bank or mint [1].
From a consumer perspective, imagining a bank as taking your $1 and lending it out five times is okay. But systemically speaking, it’s a misleading model. The truth is the bank created $5 in loans, and through that $5 in deposits. About $4 of those deposits were then spent and ended up in other banks or bank accounts as deposits.
The loan always comes first. The BoE has a good primers on this [2].
[1] https://www.bankofengland.co.uk/knowledgebank/how-is-money-c...
[2] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
But for that the bank needs to hold $1 (or whatever) in reserves, so either they had excess reserves already (because “someone gave them $1, the bank can now lend $5”) or they a) get new deposits, b) get them from another bank (i.e. the money comes from previous deposits elsewhere) or c) new money is created by the central bank.
Because a dollar dealt results in a deposited, this system is self-reinforcing.
It is. It’s the difference between picturing a rocket propelled by expanding gases versus a vessel thrust forth by Newtonian dynamics.
It is correlation versus causality. Loans cause deposits. Deposits correlate with loans. This discrepancy is the source of money supply estimation error.
$1 deposited doesn’t create $5 in loans. $5 in loans prompts about $1 in reserves. The difference in these models explains the interbank market, per se and in terms of rates; reserves as a stochastic versus deterministic phenomenon; bank runs and much more.
Loans create deposits. Not the other way. Modern banking makes sense once you internalise this difference.
Banks are not forced to loan out as much as they could, they have a choice. And because the system is not working at “full capacity” the central bank cannot control the money supply adjusting the minimal reserve requirements. They use other mechanism like short term rates (including through the interest the Fed pays on reserves since 2008).
“Loans create deposits” is of course true in the standard description as well. If banks create money (by lending out, if they want, excess reserves) that necesarily means that the total amount of deposits increases. Because the total amount of deposits (plus the relatively less important amount of physical money in circulation) is what we call money!
No.
Banks compete for deposits and compete to lend. The spread between those rates must pay the bank’s costs, cover its risks and turn a profit. When central banks reduce the return on safe assets banks hold, their income from lending to the government goes down. The banks thus seek to replace that income with other lending. Unfortunately, everyone in the system is doing the same thing. This competition forces lending rates down.
Savers are competing for investments next to the banks. There are lots of them crowding into bank deposits; this lets those banks lower the rate they pay. (Nobody forces savers to deposit Euros only in German banks.)
This is a system of feedback loops. Nobody is charging a tax, though banks may charge a fee for a service it costs them to provide. Depositors are free to take their business elsewhere. And entrepreneurs who think they can do better are free to launch competing financial services.
If that £100 is spent into the economy but is not returned, did the total volume of available £100 not increase, reducing the buying power of any £ stores? Perhaps it is not a tax because it isn't used directly by the government, but it is a burden that such a lender can enforce upon currency holders with the authority that is given to it by the organization controlling the currency.
>entrepreneurs who think they can do better are free to launch competing financial services.
Entrepreneurs cannot lend out money they never had. How difficult is it for a new company to obtain a piece of the volume of money that the currency regulator deems available for creation within a timeframe?
Loans create deposits. The only way the deposit isn’t returned is if capital is destroyed.
> Entrepreneurs cannot lend out money they never had
With a banking license, yes. They can.
Once you have a banking charter, you can lend to your heart’s content. At the end of the day, you borrow to make your reserve requirement. (If you’re deficient, you die.)
Lending creates deposits. Not the reverse.
There is almost a zero-cost to storing the money and as the account size grows the cost to transact on this account per dollar of storage also approaches zero.
Meanwhile the lending power of the bank multiples by large whole numbers.
They aren't storing your bills or gold coins.
Bitcoin is zero-cost^ to store for any dollar amount. So are gold bars.
Insuring them against theft and loss is not zero-cost.
A shovel for burying gold in your yard is cheap (high capex, low opex), but if a sinkhole opens up and eats your gold, you’re probably out of luck. A hard drive for your Bitcoin is cheap (high capes, low opex), but if a lightning bolt burns your house down and you aren’t paying for offsite backups, you might be out of luck.
What degree of loss do you wish to insure against (accident, damage, theft, loss) — and what percentage of your money are you willing to spend on that?
^ “I bury coins on my land” seems zero-cost, but it just means that you’re paying property tax to insure against treasure hunters uncovering your hoard with a metal detector. External costs need to be accounted for.
I never said anything about storing bills or coins.
Broader interest rates are low, too. The revenue potential for banks is limited. Particularly European ones.
European banks have failed to compete for investment opportunities. Negative rates push that onus back onto savers.