I published the second video in the Economic Truths series this morning. In it, I note that most people think banks take in deposits from people and then lend that money to those who want to borrow from them. Nothing could be further from the truth. Banks take deposits and make loans, but they don't lend out depositors' funds. Nothing could be further from the economic truth.
The audio version of this video is here:
The transcript is:
It's an economic truth that banks do not lend out the money that people deposit with them.
Most people think that the role of a bank is to take money in from savers and to then lend that money on to people who want to borrow. And that, I've got to tell you, is complete and utter nonsense.
And it's not just me who says so. Almost every central bank in the world has now agreed with this, including our own, the Bank of England, which published a paper on this subject in 2014.
Banks are not intermediaries between savers and borrowers. That is not their role in the modern economy. And yet most people cannot get their heads around the fact that this is not the case, including almost everybody in government who somehow think that savers fund lending, which fuels investment. And the answer is no, it doesn't but let me explain why.
I've already done a video on why you haven't got money in the bank if you are a saver and in that video I explained that actually all money is debt and that if you are a saver with a bank then the bank owes you your money back. Now, how can they in that case, transfer your debt to somebody else you don't know, who can then use it to fund whatever they want to spend?
You don't know who that person is. You haven't agreed to lend them money. The bank hasn't got the right to transfer your debt to that person, not least because they still owe you the debt that they've acknowledged by printing a balance on your bank statement. It is technically impossible in accounting terms for the money that you are owed to be transferred to them without your consent.
But that's also impossible for another reason. And that's because there is a completely separate loan agreement between the bank and the person to whom they lend money. Just as the bank has a loan agreement with you because they have borrowed your money if you are a saver, they have a loan agreement with the person to whom they lend money because that person now owes them money.
And each of these loan agreements stands independent of all other loan agreements that the bank does and are actually represented by new promises to pay.
You and the bank have a promise to pay if you're a saver. They promise to repay to you whatever sum you deposited with them. And it's that relationship of mutual trust that is represented by the bank statement and, well, not by a lot else. The only thing that guarantees you will get your money back is, first of all, that the bank is good to make a payment, and most banks are, and secondly, that you can prove the balance you're owed because they've recorded it in their books.
Well, the relationship between the bank and the person who borrows money from them Is actually not that dissimilar. Of course, there's a contract. That contract between the bank and the person who borrows money is an exchange of promises, just as is the relationship between you as a saver and the bank.
The bank promises to the lender that in exchange for the lender's promise that they will repay the loan, the bank will make a payment of the value of the loan to whomsoever the borrower wants the payment made.
So suppose somebody goes into a bank and says I want to borrow £10,000 pounds, the bank agrees, and they do two things. They put £10,000 in that person's bank current account so that they can spend the money that is represented by the loan. And they put £10,000 in that person's loan account, which represents the money that the borrower has got to repay.
These two new bank balances, which add up to zero because one is a positive and one is a negative, and which can therefore be created simply by typing numbers into a computer keyboard, therefore represent the creation of money out of thin air.
Those two balances represent the promises made. One, from the bank to the borrower, that they can make a payment to whoever they like. And two, from the borrower to the bank, that they will make a repayment of the loan balance. And that's it. That's how a bank creates a loan, and it's got nothing to do with the money that you deposit with the bank at all.
So, the two sides of banking are entirely unrelated. And if you now want to know why banks are particularly reluctant to pay interest on money deposited with them, well, it's obvious, isn't it? Because they don't really need too many of your deposits in reality, because all the money that they lend is created by those promises that are exchanged when the balances on people's loan accounts that represent the loan are typed into the keyboard. They're not represented by anything that had anything to do with you as a saver.
Therefore, why do they want to pay you for your money? Well, only because regulation requires that they have a certain value of balances available to them to make sure that they can settle any obligations they have to other banks in respect of those payments that either you or the person who's borrowed money from them might have to pay.
But that's a bit technical at this moment. The important point is this one. Your saving and the loan that a bank makes are entirely unrelated to each other. So, when someone tells you, we've got to save more if we're going to invest by making new loans from banks because that's the basis on which our future prosperity depends, they're talking nonsense. There is no reason for savings to fund investment. All that is required is a bank willing to lend money to someone.
I'm not saying savings aren't useful, they are, but they're not related to the funds available for investment and that's the key point to understand. These things are independent. Don't get confused by politicians who claim otherwise. They're talking nonsense. You tell them what the truth is. Your money as a saver does not fund bank lending.
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It makes sense
But the more I look at it the weirder everything about money becomes.
This bankster endorses this message.
Thank you, Richard.
Thanks
Slightly off topic but relations to a recent discussion..could you imagine what would happen if rent caps were introduced!!!
https://www.telegraph.co.uk/business/2024/07/20/buy-to-let-mortgage-market-smaller/?WT.mc_id=e_DM369715&WT.tsrc=email&etype=Edi_Cit_New_v2&utmsource=email&utm_medium=Edi_Cit_New_v220240728&utm_campaign=DM369715
I can’t access the Telegraph
Article saying Landlords leaving the market in droves..causing rents to rise… and no mention of rent caps!!!
But the properties are not being demolished, so this is short term aberration
It’s not a short term issue especially if rent caps are employed.. buy to let is then regulated to oblivion. Properties previously available to rent come on the market and will be bought by those who can afford to buy. Yes of course the properties continue to exist but stock available to rent will collapse. And the only way it will increase is if incentives for landlords return in scale.
Wrong
The way to deal this is not pay landlords £20 billion a year, as at present, but to build asocial housing
How did you get it so wong?
Of course social housing is a solution..let’s see 10s of 1000s of properties spring up out of nowhere shall we?..in the meantime you are hell bent on destroying the letting market it seems with your marxist dogma…and spinning a yarn that this a “short term” phenomena..you really make it up on the hoof and get more irrational when you get called out..
You do realise the state could but those properties private landlords are selling?
This is not Marxist, but you are time wasting.
Hi Richard,
So is it the regulation and the relationship between debtors and creditors, on paper, that makes a bank insolvent?
Regards
A bank is insolvent if it borrows short, lends long and has a massive call from depositors it cannot meet. BUT if the bank can call in funds from its central bank this does not happen. It’s 164 years since it has really happened here.
Thank you, Richard.
I have a cheque from the bank in the study.
I’m still confused! If Northern Rock didn’t lend out the money deposited with it (as you claim), then that money must still have existed to re-pay deposit holders, so how was there a run on the bank?
Because the people trying to withdraw their funds wanted to pay them to other banks and other banks did not believe Northern Rock could pay. Belief is what matters when it comes to debt. Northern Rock had run out of short term reserves, having lent long term. Now, with vastly more central reserves cleared by the BoE it would be very difficult for this to happen again. The mismatch between massive excess demand for repayment and an over extended long term loan book meant other banks withdrew credit from Northern Rock, and that killed it.
There is nothing more ephemeral than the concept of modern money.
It’s elusive but it effects are everywhere – especially where there is too much and too little.
Banks are not intermediaries between savers and borrowers. That is not their role in the modern economy. And yet most people cannot get their heads around the fact that this is not the case, including “almost everybody in government who somehow think that savers fund lending, which fuels investment. And the answer is no, it doesn’t but let me explain why.”
Banks must have deposits (plus their own capital) to match lending. Every day at 4.30 pm. That’s just the way the system works… you are wrong
You do know loans create deposits don’t you?
And you know this us why the BoE loans reserves, don’t you?
That’s a coming video…
I suggest stopping embarrassing yourself
Richard,
Sometime in the future, could you do a short video on what is a private investment bank?
Working Title: ‘Private Investment Bank Explained 4 Dummies”
I thank you in advance for your attention to my inquiry.
Carl Froch the famed British boxer joins the chat. More sports trolling for you Richard
Never heard of him….
“Banks must have deposits (plus their own capital) to match lending. Every day at 4.30 pm. That’s just the way the system works… ”
This is true (if one takes “deposits” to mean all borrowing and it is not just at 4.30pm… although the issues surrounding “daylight” credit are complicated and part of the reason that banks have to hold minimum reserves))…..
…but Richard IS right. The act of making a loan automatically creates a deposit. There is NO movement in the CBRA from making the loan. Now, if this borrower chooses to spend the money with someone that banks elsewhere then this WILL create a movement in the CBRA and this must be replaced by borrowing. But let’s be clear – the act of making the loan automatically creates the (required) deposit.
I will do a video on this
For goodness sake………..how else do you record the loan exists for both parties other than by depositing it into an account!!!
In the USA, if you have a federal back mortgage (Like a VA Loan or a HAP Loan) the government transfers the “money” to the bank (loan originator), the bank transfers the “money” to you, you buy a house transferring the money to a seller then the bank “sells off” the loan in 90% of the mortgage loan accounts. Over simplification of the process but it still amazes me.
The colonel, a big horse racing fan, asks if you could, please, use racing aliases.
Yes, Sir!!
@ Colonel Smithers,
Sir, No problem!
If the books don’t balance at 4:30pm then it will be because someone has failed to cover a loan repayment.
If I were to loan someone money and had a contract with them then that contract would act as having the value of the money owed. Debts are bought and sold with no connection to money deposited with an institution.
That first line needs correcting to: “It’s an economic truth that banks do lend out some of the money that people deposit with them.”
Worded as it is, it makes it sound like none of the deposits are lent out, and that would make a bank run impossible.
Banks return deposits in a bank run
They don’t make new loans
What I say is correct
What do you think happens in a bank’s Treasury department at close of business every day?
In fact, what do you think happens in the Treasury department of s bank?
Accounting
As I have easy explained
And some arbitraging
And the arrangement of overnight arrangements
Now, tell me what else
Bank Treasury IS actually an important job.
On the surface, they just have to check what payments are being made in and out of the bank and ensure that any net outflow is borrowed in the interbank market (and excess lent, if they care). This is a fairly simple (but not a trivial) exercise and any failure here is a very serious matter.
The real work is ensuring that the bank meets it regulatory requirements – mainly LCR/NSFR. These regulations are there to reduce the risk of a bank run and, if a run happens, ensure it does not spread more broadly. This is NOT a simple exercise but IS very important. By and large it has worked because (globally) bank failures have not spread and have not cost the State large amounts of money.
I don’t dismiss the job
But candidly, I don’t think managing an event that the government will not let happen is that hard, and may well be over rewarded.
Probably a much harder job than being a ‘professor’ who doesn’t actually do any teaching and who doesn’t appear to understand the terminology of the subject he’s supposed to be a professor of, hence he often uses the terminology incorrectly!
Just for the record, that’s your tenth name here in a fortnight
I think it may be you who has the problem with usinmg names properly
“Just for the record, that’s your tenth name here in a fortnight”
Some people should never leave the pub and attempt to circulate in public!
93 years ago the the Macmillan report said the same – section 74, page 34
“ It is not unnatural to think of the deposits of a bank as being created by the public through the deposit of cash representing either savings or amounts which are not for the time being required to meet expenditure. But the bulk of the deposits arise out of the action of the banks themselves, for by granting loans, allowing money to be drawn on an overdraft or purchasing securities a bank creates a credit in its books, which is the equivalent of a deposit.”
The governor of the Bank of Canada ageed in 1939
https://parl.canadiana.ca/view/oop.com_HOC_1804_1_1/165
https://en.wikipedia.org/wiki/Macmillan_Committee
— Keynes et al
Many thanks
Richard, do you think if you didn’t blatantly lie so frequently you might have fewer people coming in to her trying to ‘troll’ you?
I have never lied here but you seem to have multiple identities and genders, so I think you have.
I guess you’ll claim not to have blocked over 25,000 people on Twitter too?
To demonstrate the sort of bullshit you people write I have blocked 628 accounts in 16 years
Pretty low, I suspect, when I have 252,000 followers
To gull means to trick or cheat – seems appropriate
Indeed
Richard would you describe the business model of a credit union as intermediation?
Thanks
Yes
Your explanation is convincing.
And yet…. I don’t see real world examples. Would it be possible for my local building society to close down all its savings accounts but still be a mortgage lender?
(And if not, it would imply there is a necessary relationship – if not an accounting identity – between deposit and lending accounts).
Not trying to troll, merely understand an aspect of economics which seems simultaneously simple and complicated.
A genuine building society is not a bank
Hey Richard, great video. You’ll never believe this but I was just this boring going to write asking “what inventive is there for banks to pay interest on deposits given that they create money out of thin air”… and then found you had just created this video!!
Anyway, my next question is: why do we need a multitude of private banks with private shareholders? Why don’t we have a state bank?
And finally – if the banks don’t need deposits they won’t pay decent interest rates, but they are paying >0.. why? I appreciate there is a requirement for them to hold 10%. But in usa and Australia I believe there is no such requirement. And unless we go back to banks lending depositswhat is the future of having money? Nobody will really want to borrow it (or need to because they can conjure it up) so I’m not sure how you use it to generate a return. I think perhaps there’s a whole understanding I’m missing! Be grateful for your help!!
Too much to answer now, but all these questions have been noted
I follow you logic but recall that after 2008 there were calls to separate retail and investment banking as they used to be. What was that all about?
It has never really happened
Care to be less cryptic?
Some token gesture separation has occurred in regulation, but nothing of substance, IMO