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Comment by Aurornis | Hacker News Reader

I’m constantly amazed by how much the crypto community thinks they understand fractional reserve banking while getting it so completely wrong.

In fractional reserve banking, money that is loaned out is accounted for as liabilities. These liabilities subtract from the overall balance stored (reserved) at the bank. The bank is not printing money new money, no matter how many times this idea gets repeated by people who are, ironically, pumping crypto coins that were printed out of thin air.

I think it’s incredible that cryptocurrencies were literally manifested out of bits, but the same people try to criticize banks for doing this same thing (which they don’t).

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> The bank is not printing money new money, no matter how many times this idea gets repeated by people who are, ironically, pumping crypto coins that were printed out of thin air.

It is now widely accepted that bank lending produces new money[1][2]

[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

[2] https://www.youtube.com/watch?v=K3lP3BhvnSo

There's an inordinate amount of nonsense being espoused in this thread, when the answer is in that first link. I can only assume it's the miseducation that economics textbooks perpetuate.

Yes. That’s how it was taught to me years ago, that’s how it’s understood in the banking industry as well, incl the private sector.

From a large eurozone bank : https://group.bnpparibas/en/news/money-creation-work

The "liabilities" aren't subtracted from the deposit amount when counted as M1 supply. (Actually loans are accounted for as assets and deposits are liabilities, but that's beside the point).

If customer A deposits $100 in cash, and customer B borrows $100 from the bank and deposits it back in the bank, M1 goes up because there are now two checking accounts with $100 in it. That the bank's internal bookkeeping balances doesn't change the fact that the Fed considers that more money exists.

> That the bank's internal bookkeeping balances doesn't change the fact that the Fed considers that more money exists.

The Fed considers that more M1 exists and the same amount of M0 exists. Both are considered monetary aggregates, but M0 is the "money" the bank needs to worry about to stay solvent, and it can't "print" that.

Whilst it's semantically correct to refer to both M1 and M0 as money, it's pretty clear that it's wrong for people people to elide the two to insinuate that banks are printing themselves balances out of thin air like token issuers or insolvent companies that screwed up their customer balance calculations, which is what the OP was covering.

And the Fed wouldn't consider more money to exist if the bank's internal bookkeeping didn't balance...

I agree. The main point is that if B knows that they don't have to repay the $100 until 10 years in the future, then for the 10 next years everyone can pretend there are $200 in total.

> In fractional reserve banking, money that is loaned out is accounted for as liabilities.

Yes, that is how a fractional reserve banking works. But that is not how the current banking system works.

* https://www.stlouisfed.org/publications/page-one-economics/2...

* https://www.pragcap.com/r-i-p-the-money-multiplier/

Banks do not lend out deposits. This was called the "Old View" by Tobin in 1963:

* https://elischolar.library.yale.edu/cowles-discussion-paper-...

The Bank of England has a good explainer on how money is created:

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

See also Cullen Roche:

* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625

* https://rationalreminder.ca/podcast/132

Money that is loaned out is still accounted for as liabilities.

Sure, those liabilities are accounted for in an eventually consistent matter by reconciling imbalances on interbank lending markets at the end of the day with the government topping up any systemic shortfall rather than by counting out deposit coins in the vault

But that's fundamentally much closer to the "Old Money" view than to the OP's claim about fractional reserve being like an FBO inflating customer deposits by failing to track trades properly. All the credit extended by the bank is accounted for, and all of it that isn't backed by reserves is backed by the bank's obligations to someone else.

> Money that is loaned out is still accounted for as liabilities.

To be clear:

* Money is "loaned out" in the sense that a bank credits your account.

* Money is not loaned out in the sense that which "goes into" your account did not come out of someone else's account. Rather it was created 'out of thin air' by the bank without reference to anyone else's deposits.

To be clear:

I am familiar with your links, for quite some time actually.

I never said that the money came out of someone else's account.

What I did say was that it was accounted for as liabilities. It's the bank's liability to the loanee (or their bank), which the bank absolutely can be obliged to pay with reserves or cold hard cash (and it can only get these from borrowing, selling assets or customers paying cash into their account).

And so banks lend it out to people attached to a slightly larger liability repayable to them and keep track, because if they don't all this money they're "printing" represents losses in terms of obligations they can't "print" their way out of. That's quite different from the ledger screwup its being compared with, or indeed people creating tokens (not backed by debt or anything else) out of thin air to sell to other people

You're going to have to show the balance sheet movements because your wordy description is very woolly.

No. Banks classify outstanding loans as assets, not liabilities.

Yes, the loan is the bank's asset. The deposit created aka "the money" is the bank's liability. I don't think we're in disagreement here.

A corollary of this is that contra popular suggestions otherwise, the accounts net to zero and the bank obtains no gain from "printing money", only from interest earned on repayments.

This is a good explanation, I've had to explain this topic a few times as well, it seems like it's one of those topics that is very missunderstood.

To just expand a bit, I believe some of the confusion around printing of money comes from the way some economics reports are built. As a micro example, Assume a 10% required reserve, If Alice deposits $100 and the bank lends $90 to Bob. Alice ($100 deposits) + Bob ($90 cash) think they have $190 in total.

This is mainly useful for economists to understand, study, and report on. However, when the reports get distributed to the public, it looks like the banks printed their own money, as we now see $190 on the report when there is only $100 of cash in our example system.

Whether the system should work on a fractional reserve is it's own debate, but we need to know what it is to debate the merits and risks of the system.

And how does that work when the 'required reserve' is zero as it is now, and has been in the rest of the world since time immemorial?

Nobody deposits in a bank - it's just a retag of an existing deposit. The bank Debits a loan account with the amount owed, and Credits a deposit account with the advance. It's a simple balance sheet expansion in double-entry bookkeeping.

I'm really not sure why this myth persists given that central banks debunked the concept over a decade ago.

Loans create deposits, and those deposits are then converted into bank capital when a deposit holder buys bank capital bonds or equity.

[0]: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

Most people deposit in a bank by transferring from another bank. There is more than one bank.

Now do the balance sheet journals for such a transfer. [0]

Then you'll see that for a bank to transfer to another bank the destination bank has to take over the deposit in the source bank (or swap that liability with another bank somewhere).

You have an infinite regress in your thinking.

[0]: https://new-wayland.com/blog/why-banks-pay-interest-on-depos...

In fractional reserve banking, the total deposits at a bank can be greater than the amount of physical money it holds. Since the rest of society is willing to accept bank deposits as an alternative to physical money, this is a form of printing money. Physical currency is not printed, but bank deposit currency (which is money, by de facto agreement) is.

>These liabilities subtract from the overall balance stored (reserved) at the bank. The bank is not printing money new money

Hi, this is factually incorrect and you should educate yourself before attempting any further condescending comments on Hacker News.

I just want the gold standard back.

It worked as an actual check on money supply and went implemented properly was harder to manipulate

The US Government formerly fixed gold prices by statute and prohibited US citizens from owning or trading gold anywhere around the world.

The idea such a system could function in todays world is strange to me.

First of all, I take offense to being thrown in as part of the crypto community, with which I have nothing to do, and for which I do not have much hope.

So now if you are unhappy with the monetary system you are automatically a crypto bro and can be dismissed?

Secondly, the problem with fractional reserve banking is as follows: Suppose Larry makes a deposit of one dollar, which the bank guarantees can be retrieved at any time. The bank loans this dollar to Catherine, which uses it to buy something from Steve. Now Steve has one dollar, which he deposits with the bank. The bank lends this dollar to Catherine2, which uses it to buy something from Steve2. And so on, up to CatherineN and SteveN

Now, in so far as transactions can take place in the economy with bank IOUs, which are considered perfect money substitutes, the amount of money in the economy has been multiplied by a factor of N. Where before only Peter had a dollar (or a dollar IOU, which are supposedly the same), now Pere AND Steve, Steve2, up to SteveN all have a dollar IOU. This leads to an inflationary pressure.

Now it is true that upon the Catherine's repaying of the debt, these extra dollars will go away. However, in reality there is no such thing as negative dollars. The supply of money has been increased by the bank.

An objection could be raised that Catherine's extra demand for money to pay off her debt will exactly offset the extra supply of money. This is nonsense! Everyone demands money all the time. If Catherine did not demand money to pay off her loan, she would demand money in order to satisfy her next most urgent want which could be satisfied by money. The increase in the demand for money is negligible.

Your explanation of fractional reserve banking is somewhat correct, but missing the big picture

Licensed banks can and do write loans at any time without having any deposits to 'lend out'. In doing so they create both the loan (an asset) and a deposit (a liability) simultaneously from thin air. The books immediately balance.

The deposit created is then paid to the borrower and the liability vanishes. The bank is left with only the asset - the one that they created from thin air.

For short term liquidity a bank can always use the overnight lending facility at the central bank. Doing so just makes all their loans far less profitable as this is at a floating daily rate.

In reality the limit to which the money supply grows is not dictated by 'fractional reserves', but solely by interest rate policy and the commercial viability of being able to make loans and demand in the economy.

Not quite. The deposit is paid to the borrower as an advance, and the deposit is transferred to the payee (or the receiving bank if the payee is at another bank)

The liability can never vanish - balance sheets have to balance. Bank liabilities are what we call 'money'. Hence how you are 'in credit' at the bank.

And when we look at the bank assets which back those liabilities, we find that (say) 10% are government-printed money, and the remaining 90% were created by banks.

We don't. What we see is both of those are loans made.

Technically the commercial bank lends to the central bank. That's why they receive interest on it.

That's just a loan like all the other loans on the asset side. The difference is that the interest rate is set by the borrower not the lender.

Holding a deposit is just different name for a particular type of loan.

Not really:

The loan will be accounted to loan book and deposit book on the local(!) banking system level; if the money moves out of the bank, it has to go through central banking money circle - on this level, the loan amount is _NOT_ created, this account can be "filled" only with incoming transactions from other banks (customer deposits!) Thats the reason why a bank needs deposists: to make payments possible, since the number on the central banking account is always smaller than the number of all loans on the local banking system level.

You might want to read this paper from the Bank of England

https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

Choice quote from page 1:

"Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposit"

The part you are talking about is illustrated in Figure 2.

The transfer of central bank reserves between banks doesn't change the fact that once a loan is written new money enters circulation.

Your mistake was saying Synapse merely did what banks do. Banks don't lose track of money when they increase the money supply.

My comment was meant as a tounge-in-cheek joke, with a dig at the banking system. It was not meant as a serious equivocation between what Synapse did and what banks do.

But Banks are increasing the money supply with fractional reserve bank. But that is of course on purpose and account for by the govt.

The bank IS printing new money. You are ignoring the money multiplier effect where the money lent by bank 1 is deposited into bank 2, bank 2 lends 90% of that deposit, which is deposited into bank 3, ... repeating the process over and over.

With a 10% reserve requirement, a 1,000,000 USD deposit will result in up to 10 times that much money being lent out.

The formula is 1/r, where r is the reserve requirement.

That´s not correct unfortunately, although it has been widely taught in economics text books, and you can blame Keynes for that. Keynes used that example to try and explain the process to parliament, and also to argue that the system didn't expand the deposit money supply over time. Ironically even the data (in the Macmillan report) he supplied contradicted him. It´s confusing as well, because the fundamental rules have changed over time.

Banks can lend up to an allowed multiple of their cash or equivalent reserves (gold standard regulation), and in the Basel era are also regulated on the ratio of their capital reserves to their loans. This acts to stop hyperflationary expansion, but there is a feedback loop between new deposits and new capital so the system does still expand slowly over time. This may be beneficial.

In engineering terms, Banks statistically multiplex asset cash with liability deposits, using the asset cash to solve FLP consensus issues that arise when deposits are transferred between banks. It´s actually quite an elegant system.

>Banks can lend up to an allowed multiple of their cash or equivalent reserves

And what is the current reserve requirement in the US? Zero.

https://www.federalreserve.gov/monetarypolicy/reservereq.htm

Edit: Whoops, someone beat be to it below.

The important part is:

> and in the Basel era are also regulated on the ratio of their capital reserves to their loans

Reducing the reserve ratio to zero doesn't mean that banks can create unlimited amounts of money out of thin air. It just means that regulation by capital requirements has now fully superseded regulation by reserve ratio.

In theory those capital requirements are a better and finer-grained regulatory tool, capturing the different risk of different classes of asset. In practice that can fail--for example, the SVB collapsed insolvent because it was permitted to value bonds above their fair market value if it claimed they'd be held to maturity. That failure was in the details though, not the general concept.

interestingly, the Fed's page on Reserve Requirements states:

    As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020.  This action eliminated reserve requirements for all depository institutions.

So in effect, the multiplier is infinity.

https://www.federalreserve.gov/monetarypolicy/reservereq.htm

I remember this. Have they ever rolled it back?

The Basel Capital rules dominate at the moment. If that ever gets rolled back... buy gold immediately.

Oh ok. So there’s a difference between reserve requirements and capital requirements. Capital requirements are still in place Basel III (Basel Capital Rules) 4.5% among other requirements https://en.m.wikipedia.org/wiki/Basel_III

Basel III also specifies liquidity requirements, which basically means banks need to hold sufficient loan assets in the government or central bank (generally bonds or reserves respectively), which act as a backstop if other banks stop lending to them (i.e. stop accepting deposit transfers without also being given an equivalent asset).

not really infinity:

there are tons of balance-sheet-metrics which have to be aligned, in theory you are right; in practice, there are a lot differences.

Clarifying question:

So for every $1 deposited, I can lend $0.90 but must hold $0.10 as my reserve?

It’s a bit more complicated than that.

At the point I make a loan, 2 things happen on my balance sheet: I have a new liability to you (the increased balance in your account), and I have a new asset (the loan that you’re expected to pay back). They cancel each other out and it therefore seems as if I’m creating money out of thin air.

However, the moment you actually use that money (eg to buy something), the money leaves the bank (unless the other account is also at this bank, but let’s keep it simple). Liabilities on the balance sheet shrink, so assets need to follow. That needs to come from reserves because the loan asset keeps its original value.

The reserve comes from the bank, not from you. Added layer here: Banks can borrow money from each other or central banks if their cash reserves runs low.

Finally: it tends to be the case that the limit on lending is not the reserves, but on the capital constraints. Banks need to retain capital for each loan they make. This is weighed against the risk of these loans. For example: you could lend a lot more in mortgages than in business loans without collateral. Ask your favorite LLM to explain RWAs and Basel III for more.

> However, the moment you actually use that money (eg to buy something), the money leaves the bank (unless the other account is also at this bank, but let’s keep it simple). Liabilities on the balance sheet shrink, so assets need to follow. That needs to come from reserves because the loan asset keeps its original value.

"Everything should be made as simple as possible but no simpler."

You're omitting the thing that causes the money to be created out of thin air. If the other account is at the same bank, now that customer has money in their account that didn't previously exist. And the same thing happens even if the money goes to a customer at another bank -- then that bank's customer has money in their account that didn't previously exist. Even if some reserves are transferred from one bank to another, the total reserves across the whole banking system haven't changed, but the total amount of money on deposit has. And the transfers into and out of the average bank are going to net to zero.

The created money gets destroyed when the loan is paid back, but the total amount of debt generally increases over time so the amount of debt-created money goes up over time as banks make new loans faster than borrowers pay them back.

Not correct:

Your loan is loan+interest; when your loan is created, we do not create the interest-part on it - the interest-part is the rest that you have to pull from someone else, since bank gives you loan X - but asks loan X + interest Y back from you -> thats the reason why there needs to be another fool somewhere else who is then again taking a loan.

its one of the main architectural choices of our money architecture :-D

Only the loan principal is destroyed when it's paid back. The interest goes to the bank, which then gets to spend it or distribute it to shareholders who then get to spend it etc.

Suppose a mechanic takes out a mortgage to buy a house. The bank uses the interest on the loan to pay part of the bank manager's salary. Then the bank manager pays the mechanic to fix his car. Nobody inherently has to take out another loan for the borrower to pay back the bank.

The main reason debt keeps going up is that housing prices keep getting less and less affordable, requiring people to take on more and more debt to buy a house or pay rent.

>> The reserve comes from the bank, not from you. Added layer here: Banks can borrow money from each other or central banks if their cash reserves runs low. << Not correct: it can be both - on your central banking account, you can receive money from other banks (lending on the "interbanking market") _or_ customers (when they send money to your bank).

The bank could also sell the loan instead of borrowing if they are in need of capital.

> So for every $1 deposited, I can lend $0.90 but must hold $0.10 as my reserve?

The GP is completely wrong on how modern finance works. Banks do not lend out deposits. This was called the "Old View" by Tobin in 1963:

* https://elischolar.library.yale.edu/cowles-discussion-paper-...

The Bank of England has a good explainer on how money is created:

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