Talk:Fractional-reserve banking/Archive 3

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early discussions

There are two totaly different views on what FRB is:

If the bank holds 10% reserve.

The first view: The bank can loan out 90% of the money that is deposided in the bank. Deposit: $1000, Loans out: $900 (Many beleve this here and is in the article now)

The second: The bank have 10% of deposits in relations to loans. Deposit: $1000, Loans out: $9000 (This is beleved by for example Werner, Richard Princes of the Yen (book))

The first is realy strange, the bank would have a hard time earning money when he can not use all the assest, compare to loaning from a friend and not beeing able to use that loan.

The second one gives the bank loads of interest earning.

note: I would like to add that these two views are actually equivalent.

1. A Bank has Deposits of $1000, loans $900 to Person 1. 2. Person 1 buys a Good/Service from Person 2 for $900. 3. Person 2 Deposits the $900 into the Bank. 4. The Bank loans $810 (900*90%) to Person 3. 5. Person 3 buys a Good/Service from Person 4 for $810. 6. Person 4 Deposits the $810 into the Bank. 7. The Bank loans $ (810*90%) to Person 5

The above process of deposits, loans, and economics events continue until Total Deposits approach the limit $10,000 and Total Loans approach the limit $9,000. These amounts correspond to the first view; however, we must remember that only $1000 of the Deposits are "real", the rest has been created by the fractional reserve system so the second is also correct.

Because fractional reserve banking is an issue that can be viewed from several different points of view, I plead the editors to always state the reason for the change of tone and reasoning in the article.

For example the non NPOV "The process of fractional-reserve banking causes inflation because the amount of money supply in the system increases. To the different price indexes the effect comes with a delay. Extensive use of fractional-reserve banking might result in hyperinflation"

was changed to "The process of fractional-reserve banking may cause inflation if the money supply increases too quickly."

I plead the editor to state how increasing the amount of currency does not cause inflation and why it is not important to note that the effect has a certain delay before it shows up on macro-scale. Finlander

Increasing the money supply can lead to inflation, but not in all cases. If money supply increases faster than money demand (or GNE) this will tend to be inflationary. If the growth in the money supply matches the growth in Gross National Expenditure, then it is unlikely to be inflationary. The velocity of money also influences the issue. The reason fractional reserve banking can be inflationary is it has no inherent mechanism to keep money supply in balance with money demand. However, if used properly it can be a useful tool to provide an economy with the liquidity it requires to grow.mydogategodshat 01:39, 4 Jan 2004 (UTC)

I just wanted to add my ("Austrian") view to this:

There is no need for the money supply ever to change. Prices adjust to supply and demand of money just like to any commodity. In other words, whether you have $10,000 and pay $10,000 for your goods or have $100,000 and pay $100,000 for the same goods is totally irrelevant AS LONG AS the money supply doesn't change. IF it changes, it affects people differently depending on where the money is being injected. Ultimately, everybody pays for one person counterfeiting through increased prices, but those who receive the money later pay more than those who receive it earlier. The same is true, if banks issue additional money. Fractional Reserve Banking (in combination with Central Banking) introduces an artificial cycle of boom-and-bust through arbitrary expansion and contraction of the money supply that is entirely unnecessary under a system of sound money.

Money supply and demand for money are closely linked: An increase of money supply causes prices to rise (in a sense, the "demand for money" decreases). Saying "The process of fractional-reserve banking may cause inflation if the money supply increases too quickly" is like saying "The price of a commodity may fall, if its supply increases too quickly."

Dngrs 10:58, 3 September 2007 (UTC)

History

The fully-backed silvery notes discussion:

Agreed. This too is controversial and needs editing. But I'm not enough of an economist to feel happy doing it myself. Actually, the general outlines of what's going on are clear enough. Forty years ago, in the U. S., there was actually a sort of complicated multi-tiered system. You had coins, which were actually made of silver. You had, actually, several different kinds of paper money, although many were unaware of the difference. The commonest bills in low denominations were called "silver certificates" and said on them that they were "redeemable for silver on demand." If I recall correctly, the Treasury seal on them was blue, to distinguish them from Federal Reserve Notes (green seal), which were... whatever they are (all our currency is now Federal Reserve notes), and United States notes which had a red seal, only existed in, I believe, the $5 denomination, and nobody knew what they hell they were. But I digress.

The red seal were original greenbacks which President Lincoln first printed thru United State public bank and a part of the fiat monetary system that lacks the flaws which a private owned central bank has. The money was in circulation until rescently even though no more of those bills was printed when the Federal Reserve was instated 1913. Lord Metroid 07:41, 30 October 2006 (UTC)

According to http://www.john-f-kennedy.net/thefederalreserve.htm and several other google findings, it was John F. Kennedy put the silvery system in place. Quotes from the mentioned web page follows: "On June 4, 1963, a virtually unknown Presidential decree, Executive Order 11110, was signed with the authority to basically strip the Federal Reserve Bank of its power to loan money to the United States Federal Government at interest. With the stroke of a pen, President Kennedy declared that the privately owned Federal Reserve Bank would soon be out of business." ... "When President John Fitzgerald Kennedy - the author of Profiles in Courage -signed this Order, it returned to the federal government, specifically the Treasury Department, the Constitutional power to create and issue currency -money - without going through the privately owned Federal Reserve Bank. President Kennedy's Executive Order 11110 [the full text is displayed further below] gave the Treasury Department the explicit authority: "to issue silver certificates against any silver bullion, silver, or standard silver dollars in the Treasury." This means that for every ounce of silver in the U.S. Treasury's vault, the government could introduce new money into circulation based on the silver bullion physically held there. As a result, more than $4 billion in United States Notes were brought into circulation in $2 and $5 denominations. $10 and $20 United States Notes were never circulated but were being printed by the Treasury Department when Kennedy was assassinated. It appears obvious that President Kennedy knew the Federal Reserve Notes being used as the purported legal currency were contrary to the Constitution of the United States of America." ... etc. I suggest you read it yourself.

As Dpbsmith and Gandalf61 so claim, that fractional-reserve banking of private banks was so common knowledge, yet you say that: "... and nobody knew what they hell they were" All this means is that common people might have an idea of how banks operate, but they sure don't begin understand the banking system as a whole and what the new silvery backed U.S notes would have ment. Anyway the article continues to point out that Kennedy was assassinated shortly after and the new silvery backed notes were soon taken out of circulation. Now there's some good juice for conspiracy theory on the assassination on the light of fractional-reserve banking of private banks. --finlander

Anyway, you had: tier 1, silver in coins. Tier 2, "silver certificates," redeemable in silver on demand. Naturally we had mental pictures of silver ingots, but if our teacher was right all that it meant was that you had a legal right to present a $1 "silver certificate" and receive four $0.25 coins in change. Tier 3 was a bank account: you gave your silver certificates to the bank, they'd lend most of them out in investments, but promised that any time you wanted to withdraw your money they would manage to give you the same number of $1 bills you had deposited. (Now that I think of it, all three kinds of bill said "legal tender for all debts public and private" so I suppose you could deposit silver certificates and the bank would have the legal right to give you your withdrawal in Federal Reserve notes or United States notes...). Tier 4 would be a checking account. In each case, you had flavors of money, all of which were essentially promises by less and less trustworthy agencies as you ascended the ladder, each of which were promises to redeem the next most trustworthy kind of money. My check is my personal promise that I have money "in the bank;" my bank account is the bank's promise that I can withdraw paper money up to the amount I have deposited; my paper money was, in some cases, the government's promise that I could exchange the paper for silver coins.

What you say is very interesting to me. If I understand right, you (well the teacher is) are descripting full-reserve banking here. --finlander

In ordinary life, of course, the system worked and you didn't mentally distinguish tiers 1, 2, and 3. "Money in the bank" was money, and the bank would be happy to give you paper bills or reasonable quantities of coins or anything you liked. And you could get silver coins in change for paper money regardless of the color of the Treasury seal on them.

The non-neutral POV is, of course, what the silver itself represented. The notion that silver and gold are "real" money is, of course, highly political. Those familiar with U. S. history will remember the bitter debates over the role of silver vis-a-vis gold, with the western states in which silver was mined having a strong interest in the outcome. (They wanted the government to establish a legal equivalence of one ounce of gold = eighteen ounces of silver, as opposed to having silver fluctuate according to a market price. In the U. S. we all learn in school about William Jennings Bryan and his famous speech saying "You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold.")

There are probably other Wikipedia articles bearing on this point and I probably should read them.

(P. S. I just glanced at the Wikipedia article on Money is not bad at all and presents a lot of this material in what looks to me like a reasonable neutral point of view. Dpbsmith 13:59, 1 Jan 2004 (UTC))

I've taken a look at the Money too, and it does somewhat in economical terms descripe fractional-reserve banking created money, but fails to mention anything of the most important part, that is who has the right to issue it. --finlander

Incidentally, I have a problem with the notion that any kind of money truly represents a durable store of value, at least over periods of more than a few years. I can work so many hours and buy thus-and-such amount of gold with it and store it away. Thirty years from now there is absolute no way to predict what I will be able to buy with that same amount of gold....

As long as the state taxes in one specific currency there will be a continuous demand for that currency and so becomes accepted for money. The value as always is decided by the quantity of the currency available in public and the market. The citizens will with the system itself set the value of the money and so there is actually no need for anything to back anything up. Backing up money is actually quite stupid as there will be few people in control of the money rather then what is intended for a free nation where the public has control over the money. Backing money up with some rare commodity is in principal as stupid as backing up the money with say... The presidents hair, it will create a huge demand for his hair which is hard to get ahold of and hence he will be the one person that can control the whole market. Lord Metroid 07:48, 30 October 2006 (UTC)

I realise I am answering myself but... Not backing the money up and using the fiat money means that the people are at mercy under the state as it controls the flow and ebb of the money supply. While Precious metals stays reasonably about the same amount. It is also important for the philosophy of freedom to trade with property rather than valued paper. Because property always have value and paper are just paper even if it bonds, stocks or fiat money. There is a risk that the bubble explodes. With real property you will always have your property. But noone would want to trade gold for something one can eat at a depression. Because gold is not renewable and no use when you need to food. Lord Metroid 16:09, 10 January 2007 (UTC)

End of silvery discussion.

General developing the article discussion:

Just babbling. The way to improve this article would be, I think, to put in real information about how real banks actually work and what the regulations on reserves are, and why the power that be assert confidently that this is totally safe and sound. The notion that fractional-reserve banking is somehow as scam needs to be dealt with much more carefully and labelled as, excuse me, a fringe viewpoint. If there are banks anywhere, in any country, at any point in history that actually practiced full-reserve banking that needs to be documented. (How would such a bank earn any money, by the way?) Surely the real argument is not whether fractional-reserve banking is OK, but how large the reserves need to be? Dpbsmith 13:59, 1 Jan 2004 (UTC)

I agree on the improve part. Google does reveal several articles on the issue. But one must remember the issue is very old. It simple is not in the modern world discussed anymore. But I don't think the real argument is how "large the reserves need to be" ie. 1/10 or 1/100, it is so to an economic, but whether private banks have the right to perform the act. Both should be mentioned of course. There was actually three privately owned banks having the right to create money. The document money masters also descripe it, but basically you had the first bank, which was abolished by the president, the secound which again was abolished and the modern one which U.S has today, which JFK seems to have challanged.--finlander

Another P. S. If there are recognized organizations or associations that are fighting against the practice of fractional-reserve banking and trying to promote full-reserve banking it seems to me that it would be quite OK and would enhance the article to describe them. Dpbsmith 13:59, 1 Jan 2004 (UTC)

I agree. But this is not an easy task, but some basic material should be found with search engines. But where do you find material that says, acknowledging the process and the issue, that it is acceptable and moral? I.e. someone speaking for the banking system. --finlander

Libertarian viewpoint?:

The initial contributor to the page speaks:

I don't myself think that the article is NPOV, but I believe it's essential that visitors understand the concept and I presented it how I could. Please clarify it if you can.

Fair enough. Dpbsmith 13:59, 1 Jan 2004 (UTC)

The mentioned persons fought against privately owned banks having the right to practice this banking process, that would, as it has, get nations and private persons in debt to the privately owned banks. See quatations from the mentioned persons at: http://www.themoneymasters.com/presiden.htm . National debt of U.S as of today? A little less than seven thousand billion (< 7*10^12).

The quotes at http://www.themoneymasters.com/presiden.htm are about who should have the right to issue currency, especially paper notes. This has little or nothing to do with fractional-reserve banking, and does not support the claim that "Many of the United States of America presidents and founding fathers fought against private banks having the right to perform fractional-reserve banking" Gandalf61 15:07, Jan 1, 2004 (UTC)

paper notes and making currency is exactly how I defined fractional-reserve banking there. Making money without reserves is fractional-reserve banking. When you have the power to issue currency, you have the power to perform fractional-reserve banking. And if you do not have the first, you don't have the latter. But you might have a point in how it is expressed there. --finlander

(my own thoughts:) Basically if you think what printing new money and loaning it with debt means as a whole (macroeconomics), is that the debter gets a provisional advantage over his competitors (and everyone), and hence the competition (nations, corporates) must also loan from the bank and hence everyone gets in debt to the bank, the process of which has not actually done nothing else but change the balance of money distribution in society ie. the bank has lost or invested nothing, only massively gained. I do believe that a 'scam' is a proper term to be presented as it was on the page, i.e. everyone can for themselves decide if it is a scam or not.

What is the most central reason to the Wall Street Crash happening? Banks practised massive fractional-reserve banking, everyone took loan over loan and society seemed to be in a massive boom, new businesses etc. Then suddenly banks increased interest rates and stopped loaning money. Of course businesses went down, people lost their jobs and banks made a fortune. Here's the "natural business cycle" than banks so advertise they are trying to eliminate!

What happens to developing nation when there are different militant groups fighting over control and let's say IMF decides to create a little money to the other group? The other one must too get loan, both get in debt and what we have in the end is two bankrupted nations massively in debt to international banks where the weak, i.e. the poor and the children are suffering.

As to what goes to this all being general knowledge, I don't know where you did your schooling but in here Finland the actual banking process, it's techniques and especially the consequences was never ever teached during my comprehensive school, or high school or even in the few Helsinki university course material economics books I've been reading. The books just state that it is the tendency of economy to go in cycles. Perhaps, but you could also say that it is the tendency of people to get in the war. ie. as if there would be no logical reasons why people get in wars.

I can assure to Dpbsmith, that even if banking process would be brilliantly teached in schools, the average person would still be completely unaware and confused of it and hence the 'scam' addition would be apropriate in anycase.

Anyway I believe it's important that natural wikipedia evolution happens to this page as well, as I'm not too used to discussing economics in english and there are, I believe, major flaws in how it is presented. Suggestions anyone? btw. The excellent documentary The Money Masters can be found at indymedia to download, it really ought to be mandatory in elementary school history class. And I don't say that because I believe it to be the ultimate truth, but because it would surely stir up some healthy discussion.

I've written a new start to the article.

I've retained the old article as a section under the title "Objections to Fractional-Reserve Banking." I looked at the old article and rewrote one sentence in a way that I think preserves the meaning while making the point of view neutral.

I believe the old article confuses two different practices. One is the practice of ordinary commercial banks, which in the U. S. lend out 90% or more of their deposits, holding only a small percentage as a reserve to meet withdrawals.

The second refers to the practices of central national "banks" with regard to backing currency with precious metal. In the U. S. and I believe just about everywhere else, all national currency is absolutely and totally "fiat money." It's not that only a percentage of it is backed by precious metal, there's no backing at all. That's been true since, oh, the 1970s or 1980s or so.

Both practices are similar in the way they involve balancing a complex web of trust, but they are not the same thing, and I think the old article mixes them beyond my ability to separate them.

I'm hoping that ultimately the article will present and clearly identify both the reasons why the use of fractional reserves is customary and widely believed to be safe, and the objections to it.

Dpbsmith 18:22, 1 Jan 2004 (UTC)

Figuring out the two-defination problem:

"Fractional-reserve banking is a term referring for the customary banking practice of lending out for investment most of the money deposited with the institution, and holding only a small percentage of the deposits as a reserve to meet demands for withdrawal. The term is used mostly by those who oppose the practice."

I believe you miss the point here, to an extend that does require fixing. Also most of your claims needs some evidence or extension*. Yes, in literal meaning, fractional-reserve banking could also mean that the bank invests what people deposit and only holds certain fraction of it in the vaults. But this is also possible while practising full-reserve banking. When every dollar you have is backed by fixed amount of gold, and so there is certain amount of dollars in existance, bank can still invest by *really* loaning the money, ie. taking it from the reserves and loaning it out with interest (or not interest, but that would be mad to an economic). What you understand by fractional-reserve banking, is that the bank has the right to invest the money you have deposited in. This is not what fractional-reserve banking means and your defination is deceiving and not coherent with the actual practice.

"Opponents of fractional-reserve banking thus charge that the practice is deceptive, sometimes going so far as to characterize it as a "scam". It is unlikely that consumers are really that naïve, because simple explanations of the practice form part of the usual U. S. high school curriculum."

You fail to see why fractional-reserve banking is 'deceptive' and in so also get deceived by it. The latter part about U.S schooling I would like to have some evidence on.

"Still, when a consumer deposits money at a bank, it is reasonable to ask what he believes about his ability to withdraw those deposits at any time. Does he believe it to be absolutely certain? Almost certain? Or just extremely likely? If there is a difference between what he believes, and what the practices of the bankers and the government actually achieve, then there is cause for concern."

While that speculation is healthy, it doesn't at all explain why your credit (paper money) perhaps would not be worth anything when you next time visit the bank. If you deposit credit and raise credit, it could not be worth anything and the bank could just print you any amount of credit (paper money) to keep you happy. So once again "missing the point".

I'm going to do some more research on the matter and change the page accordingly. I suggest you do the same.

See below. In the United States, when I "visit the bank," I am visiting a commercial enterprise that has a complex legal relationship with the Federal Reserve. I can't visit the Federal Reserve--well, I can tour it and see big stacks of paper money, but I can't open an account there or deposit or withdraw money from it myself.

There's no issue with "printing money." The bank I visit can't print money. The Federal Reserve can print money, but it isn't a bank in the usual sense and I can't bank there.

The bank I visit can and does lend out most of my deposits, retaining a small reserve to cover depositors' needs for immediate withdrawals. (There's also an insurance mechanism called FDIC which means that small depositors don't get hurt if the bank screws up, or if the Feds don't force them to keep enough in reserve). As I now understand it, you are not taking issue with this.

What you're taking issue with is the fact that the money I deposit at the bank is, itself, fiat money. It is not even partially backed by precious metal. It is not backed by anything at all, except the U. S. government's assertion that it is "legal tender for all debts, public and private"—i.e. the government says it's legal to use it to pay for stuff.

Right? Dpbsmith 20:32, 1 Jan 2004 (UTC)

As Dpbsmith has said, the article and this discussion use the term fractional reserve banking in two different senses. One is the process of "credit creation", under which commercial banks only have to keep a fraction of their deposits on reserve with the central bank, and are free to lend the rest out again. This is the sense in which fractional reserve banking is used at http://www.investorwords.com/5581/fractional_reserve_banking.html, for example, which gives the following definition

"A banking system in which only a fraction of the total deposits managed by a bank must be kept in reserve. The amount of the deposits equals the amount of the reserves times the deposit multiplier."

The other sense refers to the extent to which a central bank, when issuing paper money, needs to (or should) ensure that this paper money is backed by tangible reserves such as gold.

Fractional reserve banking in the first sense is the normal practice of any bank, and I cannot see how a banking system could work without it. Fractional reserve banking in the second sense can only be carried out by central banks. The second sense seems to the be the type of fractional reserve banking to which the original author of the article was objecting.

I think the two uses of the term need to be clearly separated in the article, as Dpbsmith has started to do. Gandalf61 20:07, Jan 1, 2004 (UTC)

Thanks for the link to http://www.investorwords.com/5581/fractional_reserve_banking.html .

With regard to "the extent to which a central bank, when issuing paper money, needs to (or should) ensure that this paper money is backed by tangible reserves such as gold," unless I'm totally offbase Nixon took the United States completely off the gold standard some three decades ago... yep, see Gold Standard#The United States. I don't see how its meaningful to complain of "fractional-reserve banking" when the United States is practicing ZERO-reserve banking. The dollar is not backed by precious metal at all, nada, zip, zero, zilch.

I think the term for the second practice is "fiat money," not "fractional-reserve banking." Dpbsmith 20:32, 1 Jan 2004 (UTC)

The commercial banks fractional-reserve banking:

Do U. S. citizens understand that commercial banks have only fractional reserves?

I made some remarks about its being common knowledge in the U. S. that commercial banks only keep fractional reserves for the money on deposit. Specifically, I said, "It seems to me that we went over this in seventh-grade civics class and that it is hard to imagine that "many are unaware of it." Later, "simple explanations of the practice form part of the usual U. S. high school curriculum." Finlander challenged me on this: "The latter part about U.S schooling I would like to have some evidence on" and "As to what goes to this all being general knowledge, I don't know where you did your schooling..."

Let me address this as best I can currently. I tried to find some examples of educational curricula recommended by various states in the U. S., and while the ones I found make reference to economics and banks and banking being taught at the junior high school (age 12, 13) and high school (14-18) level, they weren't detailed enough to make it clear whether fractional reserves were discussed.

(I personally learned about this in a public school in New York State, I believe at age 14).

But I did find something bearing on the issue. The giant commercial bank, Citigroup, publishes curriculum material for schools to use. I don't know how extensively it is actually adopted, but I think you can assume that Citigroup is part of "the establishment" and very typical of what any sort of mainstream teaching of the subject would be like, if it is taught at all. That is, if anyone wanted to hide or conceal or downplay the practice, Citigroup would. Big corporations frequently publish educational programs or materials, distribute them for free to schools, and hope the schools use them. (They don't do this any more, but when I was in high school, science teachers used to hand out comic books put out by GE that explained how nuclear energy worked and, of course, how safe it was...) Anyway, at

http://www.citigroup.com/citigroup/financialeducation/curriculum/downloads_en.htm

I found a "Citigroup Financial Education Program: Curriculum and Facilitator's Guide." I downloaded the PDF entitled "Basic Banking Services" and found this:

SECTION OVERVIEW Commercial banking, based on the fractional reserve system, has an ancient origin. The system allows a bank to keep a percentage of the money on reserve and use the remaining amount to make loans. Therefore, the two principal functions of today's commercial banks are to oversee deposits (such as checking and savings) and lend money. Their income comes from interest on loans, investments, and various service charges. Many banks in the United States failed in the years prior to 1933. However, since 1933, when the Federal Deposit Insurance Corporation (FDIC) and improved regulation restored depositors' confidence in banks, few people have lost money deposited in banks. Over the years, additional financial legislation and regulations have worked to make the U.S. banking system strong and reliable.

[i believe the gold standard in US was removed around 1932; banks do not loan other people's deposit, they actually create new loan money or credit out of other people deposit out of thin air via fractional reserve system. "The modern international ``fractional reserve banking system is actually equivalent to ``legalized economic parasitism by private bankers. This is the case because, contrary to conventional wisdom, the proceeds of inflation are not actually spendable by the state [1]". Search Google or Youtube for Ron Paul and FED, watch 'Money as Debt' and 'Money Masters' videos]- user:Isis07 sep5,07

So, first of all, I have to retract my remark about the term "fractional reserve system" is used primarily by those that oppose it.

But, second of all, I think this is a reasonable piece of evidence that U. S. banks, at least, positively want high-school students to understand that commercial banks have only fractional reserves. I think you can assume that Citibank's language is a good example of how the subject would be presented in U. S. schools. Dpbsmith 22:55, 1 Jan 2004 (UTC)

In response:

I appreciate your diplomatic tone, but we have to sort a few things out:

Do you understand the difference between the two definations of fractional-reserve banking and how very different their meaning is and how the other one can be considered as a fraud, and as it wasn't legal at the time, actually was a scam historically. Good. Now we have to decide which of the definations is the more often used one. Since the defination the schooling report points to is a very common bank practice, which is very little controversial (only the question whether taking debt of a loan is considered, something which catholic church historically banned) I think it would be good to have a mention of the two definations problem at the top and point the "bank using a fraction of its reserves" to just simply loan and investment. And have the rest of the page discuss the other defination that is used in economical discussion/critic.

Let it also be said that I never doubted that schools teach that banks invest and loan some of it's money from the reserves, but it's the other historically very important meaning of fractional-reserve banking that is not being teached.

Also the claim that "The dollar is not backed by precious metal at all, nada, zip, zero, zilch." is not exactly accurate according to the wikipedia page. It says that U.S doesn't redeem dollars to gold from foreign Governments.

Fair enough? I'l begin to do the changes and you revert back if you disagree or want to improve it.

I have done a bit of a re-write. Hopefully it is more NPOV and more accurate. I considered giving a more detailed description of the deposit multiplier (currency drain ratios,safety reserve ratios, foreign currency reserve ratios, etc.) but I don't know if it is needed. It is hard to know what level of detail the average Wikipedia user is looking for. I'll leave it at that for now:maybe I'll add these later. mydogategodshat 05:31, 2 Jan 2004 (UTC)

Yes, it looks better but makes no sence. According to your description a fraction of the money is kept in reserve and the rest can be lent on until the money in the system runs out. ie. reaches its geometrical sum. But that doesn't create any money by itself, that just increases the entropy in the system. New currency *must* be created ie. new bills printed or in the electrical times a new figures put in a bank account for the money supply to increase. But when does this happen in your writing? Please clarify the text. Also are you absolutely sure there isn't two different concepts mixed up here? See the discussion above^.

Also the claim that full-reserve banking has never been practiced is plain wrong. It has been practised even in the United States of America and also historically in Europe.

Also those book sources that have been used in the article should be separated from the rest. ie. external sources and "see also on the matter" etc.

It's absolutely insane how this topic manages to confuse people. I hope you have the answers to my questions. -- Finlander

I think mydogategodshat is exactly right in his explanation of deposit creation/credit creation. If the central bank issues $1000 in currency, and this goes into a commercial bank as a primary deposit, and the bank then lends on $880 of this and keeps $120 as a reserve, then the money supply has been increased from $1000 to $1880. Only the central bank prints notes, but the commercial banks increase the money supply by lending money on, which in turn creates new deposits. The central bank can (attempt to) control the money supply by varying the minimum reserve ratio. Commercial banks have never practiced full reserve banking (in the sense of keeping 100% of their deposits as reserves) - if they did, they would be acting more like safety deposit boxes than as banks ! Gandalf61 13:42, Jan 2, 2004 (UTC)

Sorting out and identifying points of view

In any argument between responsible adults, it should be possible to reach a stage in which each party is capable of stating the other party's point of view in a way which the other party agrees is accurate. I don't think the discussants on this page are there yet, but perhaps we're getting closer.

I'm trying to figure out, not what is the truth about fractional-reserve banking, but what the term means (or whether its meaning itself is controversial). And I'm trying to figure out what points of view exist in the real world and what they are (on the assumption that the article should accurately reflect this).

I found a couple of interesting links.

I think that perhaps Finlander's position is similar to the one expressed here, in an essay by one Murray Rothbard which happens to be what I got as the top Google hit when I searched on "fractional-reserve banking:"

Fractional reserve banking

This other article

The Libertarian Case Against Fractional-Reserve Banking

seems interesting to me in trying to sort out points of view. Notice, however, that Gene Callahan identifies both himself and Murray Rothbard as "libertarians." That is, he is a liberatarian taking issue with what he says is a different libertarian point of view.

This gives me the impression that opposition to fractional-reserve banking could be described as a "libertarian point of view." Given the status of the Rothbard article as a high-ranking Google hit, and the status of libertarianism as a significant political camp, it might be reasonable to organize the article with a section identified as "libertarian objections to fractional reserve banking" or something along those lines—if we can agree that can be accurately as libertarian. (Finlander, would you describe yourself that way?)

Both of these articles seem to clearly lay out the cases for "fractional-reserve banking as fraud." The Rothbard article lays out the description in relation to medieval goldsmiths in a manner similar to the way Finlander describes it.

Just my $0.02 (fiat cents made of copper-plated zinc, to be sure). Dpbsmith 16:06, 2 Jan 2004 (UTC)

I did a most simplified simulation of 3/25 fractional-reserve banking on commercial banking level (ie. not printing any money) using natural language.

$1000 Deposit of notes in a commercial bank by Depositer(s) 1. Depositer(s) 1. is now keeping $1000 of his bills in the bank A.

$120 of the bills kept in the vault and $880 invested out.

Borrower(s) 1. borrows the $880 from the bank A thus he is now in debt to the bank A by $880.

Borrower(s) 1. now spends irresponsibly all the money.

All the money ends up in bank B by Depositer(s) 2. Depositer(s) 2. is now keeping $880 of his bills in the bank B.

Bank B now keeps $106 in vault and invests $774.

Borrower(s) 2. borrows the $774 from the bank B thus he is now in debt to the bank B by $774.

Borrower(s) 2. now spends irresponsibly all the money.

All the money ends up in bank C by Depositer(s) 3. Depositer(s) 3. is now keeping $774 of his bills in the bank C.

Bank C now keeps $93 in vault and invests $681.

Borrower(s) 3. borrows the $681 from the bank C thus he is now in debt to the bank C by $681

Borrower(s) 3. Decides to stuff all the money inside his pillow.

Now let's review the situation.

Depositer(s) 1. has the right to raise $1000 from bank A. Depositer(s) 2. has the right to raise $880 from bank B. Depositer(s) 3. has the right to raise $774 from bank C.

Borrower(s) 1. is in debt to bank A by $880 plus interest. Borrower(s) 2. is in debt to bank B by $774 plus interest. Borrower(s) 3. is in debt to bank C by $681 plus interest.

Bank A has $120 in vault. Bank B has $106 in vault. Bank C has $93 in vault.

There is $318,528 of the original money in the banks A, B and C. There is $681,472 of the original money inside the pillow of Borrower(s) 3.

Has the money supply increased? No.

Yes, the money supply has increased - it is now more than $1000. The money supply consists of both notes and coins in circulation and bank deposits (this is in simplest terms - there are various technical definitions of money supply, some of which also include savings accounts and other assets with longer maturities) - Gandalf61 17:24, Jan 2, 2004 (UTC)

What has happened is that banks are making profit of borrowers 1., 2. and 3. as long as the situation continues.

I admit that the direct relation between Borrower(s) and Depositer(s) should be studied in more detail, but basically this just shows what is self-evident: commercial banks exist to make profit on speculation and at the cost of the people who have to loan from the bank.

Commercial banks connect parties with spare funds (depositers) with parties who need funds (borrowers). They make a profit from providing this service. If you can make shoes and people need to buy shoes, you will be able to make a profit by charging more for your shoes than the materials cost you. Banks do the same thing, but with money instead of leather. - Gandalf61 17:24, Jan 2, 2004 (UTC)

Now the other fractional-reserve banking, that is central banks creating new credit ie. printing bills and loaning them to governments and businesses is what I originally intended to point out. But the end result is very similar; the bank makes profit on the cost of the nation and everyone else forced to borrow from the bank. It serves the central banks profit making purposes to cause artificial inflation and deflation in the time of peace, and on the other hand war is the greatest income of profit as whole nations have to take loans over loans when their enemy also does it.

I am not aware of any central bank that "prints bills and loans them to governments and businesses". This is not the function of a central bank. A central bank will set a money supply target, then adjust variables such as interest rates and reserve ratios to encourage or discourage commercial banks to engage in loans (thereby changing the money supply through the credit multiplier), or change the amount of deposits it holds at commercial banks (thereby changing the moneysupply through the credit multiplier). mydogategodshat 01:07, 3 Jan 2004 (UTC)

Dpbsmith, I'l study your $0.02 soon.

Anyway what comes to the actual article, I believe the introduction is good, but later, after the history part, fractional-reserve banking has to be handled separately on the central- and commercial bank levels. Both the posite points (?) and the critic has to be shown.

Finlander, to clarify the relation between the central banks role and the commercial banks role, you might want to research "open market operations". The credit multiplier is inextricably intertwined with central bank operations. mydogategodshat 00:49, 3 Jan 2004 (UTC)

It is possible to convert this into two seperate articles, but I don't see how we would gain by doing this. mydogategodshat 00:53, 3 Jan 2004 (UTC)

How is this different from saying "we're no longer on the gold standard?"

Isn't the criticism of "fractional-reserve banking" by central banks just a complicated way of complaining that currency is no longer backed by gold... or a negligible amount of gold... or a negligible amount of paper redeemable in gold? Dpbsmith 04:05, 3 Jan 2004 (UTC)

No, although critics of fractional reserve banking are also often critics of fiat money. You can have a system under a gold-standard and fractional reserve banking, and you can have a fiat money system with full reserve banking. Fractional reserve banking refers to the practice of increasing the money supply in relation to its monetary basis, regardless of what that basis consists of.

Dngrs 10:58, 3 September 2007 (UTC)

Deleted text

I'm pulling this out of the history section because it is confusing at least four distinct issues:

Fractional-reserve banking, the practice of lending out some fraction of demand deposits at the risk of bank runs.
Non-convertible and/or partially-backed currency.
Early US controversies about private bank notes, which didn't really have much to do with fractional-reserve banking, since banks don't care if they are giving their debtors greenbacks or their own notes.
Insinuations that Kennedy was assassinated over silver certificates.

I suspect 2-4 would be better placed in other articles. Populus 05:56, 3 Jan 2004 (UTC)

When the central bank of England was created in 1694, its main purpose was to manage the government's debt by selling notes; however, it was not long before it started to engage in fractional researve banking. By the end of the 18th century the war with France had created a formidable drain on the countries finances and in February 1797 there were rumours of imminent financial collapse. On Feb 26, an Order in Council "temporarily" suspended the convertability of the pound.

The controversy that ensued has come to be called the Bullionist controversy. For more than 20 years economists and politicians debated. Commitees were established and in 1810 the Bullion Report was released. In 1821 the pound was again fully backed by the Bank of England and continued that way until the first world war.

A related controversy was the Banking school controversy. It occured primarily in England, but also in the US, and lasted from about 1820 to 1850. It dealt with the relative roles (and power) of the central bank and the commercial banks. There were three general schools of thought. The Banking school felt that central banks should be free to issue notes as they felt necessary. The Free banking school felt that it should be the commercial banks that should be free to issue notes in a competitive banking industry unincumbered by central banks or government regulations. The Currency school felt that the issuing of notes should be closely regulated by government through the tight contol of central banks. In England, the issue came to a close with the Bank Charter Act of 1844 which limited the ability to issue notes to the central bank of England.

In the United States of America several presidents and founding fathers fought against privately owned banks having the right to perform fractional-reserve banking. They opposed a privately owned bank having the right to issue new currency. See Thomas Jefferson, James Madison, Andrew Jackson and Abraham Lincoln. Also John F. Kennedy prior to his death signed a Presidential decree, Executive Order 11110, to strip Federal Reserve Bank of its right to loan money at interest to the United States Federal Government.

In the modern world, foundations such the World Bank, European Central Bank, the US Federal Reserve System, and other central banks have the sole right to print new money.

Please could you enlighten me, in what currency does the world bank print money, cos i think the US, UK or whatever other government of the country it printed currency in would be none too happy.

From the village pump

What do people think about the article on Fractional-reserve banking? I'm not enough of an economist or historian to judge, but I vaguely thought that ranting about fractional reserves was goldbug stuff and pretty far out there. Does this article have a reasonably NPOV? Dpbsmith 22:20, 31 Dec 2003 (UTC)

I'm uncomfortable with it, but i'm not an economist either. I do note that neither are any of the people promoting the idea that this is a 'scam' on the web, though. Morwen 22:24, Dec 31, 2003 (UTC)

At best, it's a poor article, full of poor grammar and spelling mistakes. So why don't I just fix it? Well, I'm not convinced I can fix it. It seems a bit POV to me.

Well, the original contributor is apparently not a native English-speaker. Dpbsmith 17:20, 1 Jan 2004 (UTC)

That said, I don't think it's a VfD candidate. It is a suitable article topic. Andrewa 10:34, 1 Jan 2004 (UTC)

Continue this on Talk:Fractional-reserve_banking There's now a pretty good discussion in process there... Dpbsmith 17:20, 1 Jan 2004 (UTC)

end of moved discussion

I believe the article is finally starting to make some sense and not being heavily biased to either naive admiration or over complication(1.) of the banking system, yet still not being prey to my humble tries to present the effort some of the Unites States of America founding fathers put at stopping the independent central bank from forming and the controversy in the morality (what it makes the independent central banks able to do) of the credit creation process. Also the history part could perhaps be moved to history of fractional-reserve banking to keep things more simple, but it is a very integral part in the description of the process.

1. I would like to hear people's (especially someone with better factual knowledge on the matter) comments on how accurately or unaccurately this description lays out the outlines of the money supply increasing bankings process. At least to me it now makes sence and also manages to explain the problematic controversy this topic has arisen having to do with the (alleged) double meaning of the term fractional-reserve banking. Finlander 13:32, 3 Jan 2004 (UTC)

Mydogategodshat, since you originally included the deposit creation multiplier, and now removed it, would you be so kind to either fix it back in to the article in a proper way, or let us all know how exactly it was inaccurate.

You said:

"with cash reserve ratio of 1/10, every $100 deposited ends up increasing the money supply by $900."

That is not true. Everytime $100 is deposited into an account, the money supply doesnt increase by $900. Only primary deposits have a multiplicative effect. Derivative deposits do not effect M1. mydogategodshat 04:36, 4 Jan 2004 (UTC)

You quote me wrong: "This process is described in more detail at deposit creation multiplier, but roughly with cash reserve ratio of 1/10, every $100 deposited ends up increasing the money supply by $900. Respectively cash reserve ratio of 1/6 will increase of money supply by $500 for every $100 deposited."

Yes, I should implicate primary deposit, but I wanted to put all the terms in the new page I created for deposit creation multiplier as not to make the matter too confusing. Perhaps that was a bad choice, but the fact remains that the version, which you quoted and in which I put good a amount of effort into is a lot more understandable than the ugly monster that Populus reverted back to. My effort clearly and logically follows the money and also clears any problems with how people understand different things when they hear the word fractional-reserve banking. Also the indroduction and history part which I believe you did, makes a lot more sense and is a lot more NPOV than the current 'love the banks and do not even try to understand' one. Finlander 05:40, 4 Jan 2004 (UTC)

I know you were trying to simplify the topic, but by illiminating the distinction between primary and secondary deposits the whole thing became inaccurate. mydogategodshat 06:07, 4 Jan 2004 (UTC)

Oh now you know that? But why didn't you then just put the word "primary" where it belongs? ie: "every $100 primary deposit ends up increasing the money supply by $900. Respectively cash reserve ratio of 1/6 will increase the money supply by $500 for every primary deposit of $100." Finlander 06:18, 4 Jan 2004 (UTC)

There was no point in doing that after you erased the paragraph that explains what a primary and secondary deposit is. mydogategodshat 06:45, 4 Jan 2004 (UTC)

Wrong again (in your very words): "The system starts with an initial deposit at a commercial bank. Because of this deposit (called a primary deposit), the bank is holding currency. To make a profit for it's investors, the bank loans this money out. The person who gets the loan spends the money, which will eventually end up deposited in a bank. This second deposit is referred to as a derivative deposit or secondary deposit. Any of these additional derivative deposits increase the amount of the money supply. This process is described in more detail at deposit creation multiplier, but roughly with cash reserve ratio of 1/10, every $100 deposited ends up increasing the money supply by $900. Respectively cash reserve ratio of 1/6 will increase of money supply by $500 for every $100 deposited."

I just didn't think that what I wrote here gave a clear picture of the concepts without the remainder of the definition: In particular what is missing is the notion of multiple iterations. But maybe I am wrong, Maybe people can understand this concept without the complete description. mydogategodshat 10:33, 4 Jan 2004 (UTC)

You should just admit that you have made a mistake. The paragraph made a perfect sence, as a whole, until you cutted the bottom half off. Though, yes, the ending could use better wording. Anyway this is nothing but a pointless quarrel. It doesn't matter what you do or whether you have any change of an opinion, as there will always be the next guy in a row ready to revert at his lack of understanding. Finlander 09:41, 4 Jan 2004 (UTC)

We've already gone through this. It may make perfect sence to you but we have established that the last two sentences as they are written here are incorrect. mydogategodshat 10:33, 4 Jan 2004 (UTC)

In the end, one dollar worth of gold deposited at the central bank might lead to a final increase of $100 in the money supply. The term fiat money is used to refer to money created by this process.

Also I thought the part about $1 turning into $100 is quite a possible scenario if you consider that the money would be spread by the commercials banks until it all end up in banks vaults. Finlander 16:23, 3 Jan 2004 (UTC)

You do the calculations. For an exogenous change in reserves of $1 to create a total change in the money supply of $100, the reserve ratio would have to be .01 That is unrealisticly low. mydogategodshat 01:59, 4 Jan 2004 (UTC)

Did you even read what I wrote? I basically stated that if first the cenral bank would print extra $9 dollars for every $1, practising 1/10 fractional-reserve banking (which is a very realistic scenario), and then the commercials banks do their magic with cash reserve ratio of 1/10 (which also is a common figure), then one dollar can end up being $100 in the total money supply ie. 1/10 * 1/10 = 1/100 if it is not already clear to you. Finlander 04:21, 4 Jan 2004 (UTC)

Sory, It was not clear that this was a continuation of the example several paragraphs earlier in a different section. mydogategodshat 04:47, 4 Jan 2004 (UTC)

I considered creating a new header-sized topic for it, but I think I made myself perfectly clear even without it: "In the end, one dollar worth of gold deposited at the central bank might lead to a final increase of $100 in the money supply. The term fiat money is used to refer to money created by this process." Finlander 05:48, 4 Jan 2004 (UTC)

I give up. You can all do whatever your wish with the article, Populus, Mydogategodshat and whoever. Yes that's right, just pop in and revert the articles the way you like. Yes I understand now that it is pointless to justify ones action when anykind of ignorant pleb can do whatever she/he wishes.

Wikipedia is excellent, but it is not a good idea to try and introduce any concepts that tax the little unused processor sitting inside most people's heads.

worthless without explaining Bank for International Settlements

Articles on fractional-reserve banking and Federal Reserve and any other major central bank make no sense whatsoever without explaining how the rules of the Bank for International Settlements constrain these practices in these institutions. This is the global rulebook. Criticisms of fractional-reserve banking are sometimes specific to the US because they affect events in the US, and the same for any other central bank: you can't separate criticism of such a fundamental practice from the context in which it has its effect.

I think you're exaggerating. It can make perfect sense to talk in general terms about fractional reserve banking without mentioning the BIS, as fractional reserve banking existed long before the existence of the BIS. Capital ratio regulations are largely based on the work of the Basel Committee on Banking Supervision, and this may be worth a mention, but whilst that committee's work is supported by the BIS, they are not formally a BIS institution. The BIS does not, as far as I'm aware, have any formal power at all over the world's central banks. - Crosbiesmith 20:17, 12 January 2006 (UTC)

"However, if used properly it can be a useful tool to provide an economy with the liquidity it requires to grow.mydogategodshat 01:39, 4 Jan 2004 (UTC)"

this is fundamentally a flawed statement, you could just as easily use the euphemism that "only sugar soft drinks are a useful tool to help young children quench their thirst."

- the point here is that under a full reserve system the money supply could grow at exactly the amount that the issuer (at that time a federal treasury, or government run bank) wished, providing exactly the amount of liquidity, liquidity is related to among other things "flow" of money, which is largely related to acceptance and is not to be confused with expansion of money which is amount based.

So the summation that a fractional reserve system causes inflation is absolutely correct, the system is based on inflation, and debt.

And the theory that this fractional system is a helpful tool for liquidity is absolutely flawed, it is not any more helpful than it is helpful to where a red coat on Sunday instead of a green one on Monday, because it is about as relevant to that point as it is to the original statment.

digitalindustry

.

Tags added

I've added a couple of tags to this article, which appears to have been somewhat overrun by monetary eccentrics. As the intro points out that this is a "near-universal practice", in such a vital and historical area as banking, the fact that over half the article is devoted to "Criticisms" raises a red flag to me as a general reader that something is amiss. Specifically, the "History" section seems to have no reference or consistency with the History of banking article, while the "Inadequate government regulation" section reads like some sort of anti-Federal Reserve pamphlet, with no indication of the nature of the "critics" or how accepted their views are. - Quietvoice 18:10, 20 August 2006 (UTC)

Disputed

I have a dispute tag becourse the article contains two different views that make the article contradict it self in numerous of ways.

In the correct view the first banks had a reserve in gold. For every bar of gold the bank holds the bank could write a bank note for the value of that gold and lend it to loan takers and receiving interest. This is a full reserve system. The bank can only lend out the save amount of bank notes as it has in gold.

Fractional reserve banking is when the bank gives out more banknotes than it has reserves in gold. This causes a multiplier of circulated capital and a inflation. With the hope that all the loaner do not cancel the loans at the same time and tries to get the gold back. This would cause a bank run. Yhe bank don not have gold for all customers.

100% backing means that every bank note has a 100% backing in gold (or other value)

10% backing means that 10% of the bank note has backing in gold. The other 90% is fiat money and has no backing. this is fractional reserve banking.

The wrong view try to imply that it the bank gets $10 in deposits it can gives out $9 in loans. It is impossible to create inflation using this version: The bank actually creates deflation as it keeps money from circulation. Under this model it is impossible to use full reserve banking (100% reserves). Sense that would mean that the bank holds $10 of the $10 in deposits and have $0 dollars to use for loans and thus cannot operate at all. (This is obvious nonces)

This article is a mix of both models resulting in contradictionary statements. The history part is partly correct, but most of the other parts is totaly wrong.

Sources:

--Crash site 23:01, 9 September 2006 (UTC)

When comparing fractional to full reserve banking, it is not kept clear that a reserve is the money kept on-hand for withdrawals from demand-deposit accounts (checking, savings), while the bank may(will) still have additional assests to lend/invest under either model (CDs for example, and the bank's own money). Any profit from fees & intrest goes into this second set of assests. My POV deals strictly with the local bank down the street, and not the high-level banks that only deal with other banks (and countries). The "popular myth" fractional reserve is what I was taught in both high school and Econ101, so I'd like to see where the bank gets the money to create $900 from a $100 deposit. 172.134.2.176 20:54, 19 September 2006 (UTC)

It is indeed strange that there is two diferent views held by high ranking economics. But there is a reason. If the bank could create money this would be a thing the population would not like and thus the population does not now it. This is how Werner explains it.

The creation of the $900 is actually only a number in a computer. The physical money and the didgital is two separate things. The bank creates a new credit of $900 and that money is then deleted after the loaning is completed.

--Crash site 00:42, 27 September 2006 (UTC)

Hi there,

I have no knowledge of this area, but just looking at the logic...

'The wrong view try to imply that it the bank gets $10 in deposits it can gives out $9 in loans. It is impossible to create inflation using this version: The bank actually creates deflation as it keeps money from circulation. Under this model it is impossible to use full reserve banking (100% reserves). Sense that would mean that the bank holds $10 of the $10 in deposits and have $0 dollars to use for loans and thus cannot operate at all. (This is obvious nonces)'

Can I just ask what happened to the original deposit? You seem to imply that thebank burns the deposit when it lends out the money. But the bank still owes money to the depositer. Therefore under full reserve banking, you the depositer would retain their holdings at the bank and money supply would remain unchanged.

That seems to make sense for the simple 'guy saves money/ guy borrows money' scenario. However if the money is not lent out, then it may still be deflationary. As for what happens with the Fed, I don't know, you might be right. How would money in circulation increase if the banks receive money from the Fed but can't lend any of it?

Needless to say if the Fed prints money, gives it to the bank and allows the bank to loan out ANY of it, then money has definitely been released into the system and this increases the money supply, so long as the rate of release is sufficiently high.

I am likely to be wrong since this is all off the top of my head.

Some clarifications that might help / and on Inflation

--JC 11:42, 17 October 2006 (NYT)

First, a clarification in the article must be firmly made differentiating types of deposits. There are 1.) demand deposits - e.g. cash / checking accounts deposits, where the bank client is under the impression said deposit is immediately redeemable upon demand. Then there are 2.) contractual deposits of duration - where the bank client agrees to forgo use of his money for a specific time in exchange for an agreed upon interest payment, ala a 5-year CD.

Therein lies the differentiating factor of fractional reserve vs. full reserve banking. Fractional reserve banks lend out demand deposits and contractual deposits in order to earn interest.

Hereafter - for the purpose of simplification -- I will speak of both systems in a vacuum, absent government regulation or deposit insurance, etc., and generally in terms of the U.S. system.

With contractual deposits of duration such as a CD, the depositor A is contractually giving up ownership of his deposit for a specific time in exchange for a stream of payments during that time. The bank lends out that money at a higher rate of interest to another borrower B for the specified period of time. The depositor A owns a CD, and not his money. At the end of the period, A's money is returned in full. The theoretical risk to A is the Bank's ability to manage its loan portfolio, hence the financial solvency of banks is important to monitor by depositors given that mismanagement of loans would (in a non FDIC world) cause loss of deposits.

With demand deposits, the system is similar on one level, but entirely different on another. Using a simple 10/1 reserve ratio, a deposit of $100,000 requires only a $10,000 to be kept on demand for depositors withdrawing their demand deposits. In this case, depositor A is under the impression that he may at any time call in for use $100,000 from his checking account. Yet the Bank may have loaned $90,000 of A's deposit to borrower B. Borrower B expects full use of $90,000. Borrower B will likely deposit his loan into a demand account for gradual use, and the same multiplying affect takes place with the new deposit, with $81,000 being available for loans and $9,000 on hand for demand. The theoretical potential of expansion (after over 100 iterations of loan and deposit - do a simple spreadsheet to test) of the initial $100,000 demand deposit is therefore 999,999, with the original $100,000 being converted fully from deposit to the 10% reserve.

Now, the system is obviously insolvent should all depositors attempt to withdraw their dollars at the same time. In fact, history demonstrates that this would often happen (for reasons explained later), hence, most private banking industries have demanded that their be a central bank to back the system. The argument is "in order to protect the depositors", but in reality, it is really to protect the bankers system of loaning out and earning interest on 90% of what their depositors' expect to redeem on demand. When there is a excessive withdrawal of demand deposits from one bank, the Federal Reserve is on hand to provide the bank with sufficient fresh bills to cover the shortfall. Those withdrawals are soon enough injected back into the banking system, hence, given the fluidity of the banking systems in developed nations, this tension is temporary and generally equilibrium between banks is restored.

Of course, there is always the possibility that a bank could suffer a massive "run on the bank" for many reasons - bad publicity about loans, fraudulent accounting, etc. In such a case, the central bank will step in and provide liquidity to a point - or, as is common in the U.S., close the bank temporarily and provide an organized bailout funded by fresh Central Bank injection of money supply on credit, ordinarily guaranteed by the taxpayers of the nation. It is important to remember that, in the case of the U.S. dollar, the currency is not guaranteed by the banks, but rather a transfer guarantee supplied by the taxpayer's of the U.S.

The effects of such a system are clearly inflationary in that $ 100,000 of initial deposit, in a worst case scenario, creates $1 million of demand potential. To understand the inflationary effects, one must understand how purchasing power is affected relative to circulating units of currency. The core issue is that, in our example, $999,999 was created out of thin air and its purchasing power is gained entirely at the expense of existing unit holders of said currency who lose purchasing power. That's basic supply and demand law, which tells you that as supply increases, value decreases. In other words, a the numbers of dollars in circulation increase, the dollar's relative exchange value for other items whose supply is not increasing commensurately will decrease: simply, it will take more dollars to buy the same basket goods.

One need only look at the history of the U.S. banking system to see how "official fractional reserve banking" backed by a "lender of last resort" Federal Reserve has enabled inflation. [2] Since 1914, the U.S. dollar has lost over 97% of its purchasing power as measured by the Federal Reserve's own CPI figures</a>. It should also be noted that since the 1980s, U.S.[3] , hence 97% erosion is understated.

It should be noted that such a system benefits huge debtors - such as governments - who are able to pay off debts in the future currency that retains a fraction of its purchasing power.

Inflation is all fine and dandy so long as holders of said currency don't begin to believe that storing the currency is a bigger risk than converting it to something else. (In every respect, this is functionally identical to the old fashioned run on the banks in the U.S. common in the early 1800s when a bank was discovered to have fraudulently issued dollar receipts for more gold than they had in storage, an act later made legal by a change of the banking laws in the 1850s.) Should inflation be perceived to be "out of control", it is likely that a run on the entire system of banks could take place as depositors race to hold more and more of their stored wealth in something other than the currency - preferably something in units that cannot be manufactured out of thin air with zero effort, thus preserving wealth. Such a systematic hyper-inflationary blow-up commonly hits third world nations with governments incapable of fiscal / monetary discipline.

Conversely, fractional reserve banking presents another risk to any economy. Given that money supply is expanded through lending, and given that the economy of a nation then grows dependent on continued expansion of money supply, what happens if everyone starts to suddenly pay off their loans - or if many of them go bad all at once? This leads to the inverse of the multiplier effect, where each loan paid off / written off contracts the money supply - in other words, a deflation. As the money supply shrinks, each unit of currency actually gains purchasing power. This leads to an environment where citizens find they might be paid a lower salary in unit terms, yet purchasing power is not diminished. For those with outstanding loans, this presents a massive problem - they will be required to pay off old loans with dollars that are harder to come by.

The complex causes and affects of either scenario are very elaborate and beyond the scope of this note / subject, but it should not be reflexively concluded that a deflationary environment is bad for an economy, or that by default, central banks should intervene to prevent a deflation from taking place by inflating the currency further. It is the author's opinion that monetary inflation dislocates precious capital destructively (ala the dot com bubble in 1998-2000, the current housing bubble, and even the go-go 1920s), and that such deflations are the necessary restoration of economic order lost during these periods of irrational excess. For more information on that discussion, see the Austrian Theory of the Business Cycle[4].

I hate to say it, but you managed to merge both version in that text, you stated that the bank needs to keep 1 out of 10 dollars, only being able to lend 9 of them, and at the same time, stated that banks may lend out more than they receive, in you own words "an act later made legal by a change of the banking laws in the 1850s". You cant have both at the same time. --Striver 14:36, 24 October 2006 (UTC)

Actually, a single bank must keep 1 out of 10 deposited dollars but after the other 9 dollars are lent out, they get deposited in another bank. Now the second bank has its reserves increased and is also able to offer more loans. The aggregate affect is that more money is lent out by all banks than exists as the sum of dollar reserve deposits in all bank vaults. So both statements are true. The first is true with respect to a single bank, and the second is true with respect to the cascade of loans by all banks collectively that is triggered when the original amount was injected into the system. --riromero 17:20, 24 October 2006

Page re-write

I will take on the task of re-writing this page from the start. With the numerous edits that have been made it has become inherently self-contradictory and impossible to understand as a result, as many on this talk page have commented.

I should just add that my background is in banking operations and audit, so I do come from a fractional reserve background and agree with it in principal. I am also fully aware of the objections to the system, particularly those made by Murray Rothbard and, while I disagree with them, I can understand them and will incorporate them into the piece.

The point I will emphasise, however, is that fractional reserve is almost universal in developed country banking systems and so the objections to it should not predominate over Wikipedia conveying a full understanding of the system, with critisisms noted and analysed, but contained as critisisms.

The other point to make is that, while the US a large part of the financial global system, it is not the majority, so discussions of US policy, while useful for examples, should be in other, more relevant and focussed, articles. These will be linked to where appropriate.

Please hold off any further major edits until I have re-written this. I will have it completed by Saturday 28 October.

Andrew Reynolds 02:43, 25 October 2006 (UTC)

Whoops, over-running a bit - this is a monster. I will need a couple more days. Andrew 17:20, 28 October 2006 (UTC)

Too hard for the moment - too much to do elsewhere. The changes in the last few days have improved it in any case, so I will leave it for the moment. Apologies. Andrew 13:56, 30 October 2006 (UTC)

–

Just a general comment

Not to make your lives more difficult, but I think one of the dominant assumptions of the discussion on Fractional Reserve Banking needs to be called into question: the notion that fractional reserve banking leads to a multiplying effect. Apparently, the effect is generated in the following fashion: money gets deposited and then a hefty proportion of that deposit leaves the bank in the form of a loan; in time, this loan amount ends up returning to the banking system in the form of a deposit, and then the process is repeated with this incrementally smaller deposit, and so on. Use any ratio you want, but the one that seems current, here, is 1/10. Consequently, as the process repeats itself, the limit of factorial expansion approaches the value of the denominator of our ratio, which is 10. Thus a $100.00 deposit would become in time $1000.00, and a $1000.00 deposit would become in time $10,000.00, and so on. At least, this is what the ongoing discussion, here, seems to be asserting concerning the multiplying and inflationary effect of fractional reserve banking. I contend that this assumption is completely erroneous. Let me attempt to clarify: the slight of hand that the resoning in this discussion is playing on you lies in ignoring what happens to the moneys loaned, namely, that it enters into a process of exchange for goods and/or services, and that as such the circuit of its travels through the money system is thereby brought to a halt. To quote an email I sent to a friend of mine, "...the $900.00 that the bank loans out from the original $1000.00 deposit is not the same as the $900.00 that comes back to the banking system as a result of the first $900.00’s getting spent. The two are logically distinct categories; there is no identity at issue. Here is how the process actually transpires: I deposit $1000.00. The bank loans out $900.00 of that $1000.00. Yes, on deposit, in reserve, there remains only $100.00. But that isn’t my $100.00, it’s the bank’s. From my perspective, I still lay claim to my original $1000.00 plus, in addition, the interest that I will make by lending my money to the bank. Here, it is important to note that the substance of the transaction is not the travel that the tokens of money or bullion will make, but the contract that says that my account at the bank is worth $1000.00 and whatever interest the bank has agreed is mine for putting my cash in circulation as a loan, not to anybody, but to the bank itself. Now comes the bank’s loan: someone borrows $900.00 from the bank, which my original deposit underwrites. The money that I had taken out of circulation by depositing it was $1000.00; the money that is now going back into circulation is $900.00, for a net loss out of (not an increase in) the circulating money supply of $100.00. Now the $900.00 gets spent, that is, $900.00 worth of goods and/or services comes into the possession of the borrower. An exchange has taken place: $900.00 worth of real (because originally earned by my labour, which produced that much in goods and/or services) potential goods and services is swapped for an immediate rendering of actual goods and services. Nothing has been created or annihilated in this transaction. Still, there remains only $1000.00 of currency at issue. Now the seller who receives the $900.00 is not receiving "MY" original $900.00, but "HIS" $900.00 "IN EXCHANGE" for goods and/or services that he has just sold. Nothing has been created or annihilated here, only exchanged. Now the seller takes his cash to the bank, with the emphasis on "HIS CASH." Like me, he gets the same deal: the bank borrows his money and pays him interest, and the cycle is repeated. I still have my original $1000.00 plus interest; the first borrower still owes $900.00 plus interest to the bank, and holds $900.00’s worth of actual goods and/or services; and the seller who sold to the borrower got his $900.00 in exchange for goods and/or services rendered. Nothing has been created, here, and nothing has been lost. The money in circulation still matches its equivalence in goods and/or services actually in existence in the market, and the loan’s eventual repayment corresponds to goods and /or services as yet but eventually to be produced by the borrower. This, however, is not to say that money is not sometimes created out of nothing -- but that is perhaps for some future comment.

Norm, 15November 2006, 15h43 209.167.194.156 19:56, 15 November 2006 (UTC)

Comment

Yet the multiplier effect still applies to the above example. What will the seller do with the $900 he receives for his goods and/or services? He will likely deposit that money at some bank. Or to make it more complicated, he could deposit $100 which represents his profit, and spend $800 to restock his goods. The entity who restocked the original seller would receive $800 and deposit that in a bank. You can see that we can go on and on, but the result in aggregate is the same. $900 will be deposited by the seller(s) of the goods and/or services pf which $810 then can be loaned out again after the reserve requirement is met. The multiplier effect is not invalidated by the example above. —Preceding unsigned comment added by 76.90.10.255 (talk) 11:22, 26 November 2007 (UTC)

Videos-Documentries

I came across these two videos tonight. Very detailed history of the US Federal Reserve up to its current monetary system. (my own opinion: Slightly conspiracist. States in plain terms the threat of the potentially nefarious power to print money in private hands; private bodies other than the citizenry. However, very informative.)

http://video.google.com/videoplay?docid=-2665915773877500927 http://video.google.com/videoplay?docid=-8753934454816686947 —The preceding unsigned comment was added by Michael.gorham (talk • contribs) 02:27, 4 December 2006 (UTC).

Supposed loaning of demand deposits and national banks reserve accounts with the Fed

I paraphrase much of this from the book "Debt Virus: A Compelling Solution to the World's Debt Problems" by Jacques S. Jaikaran. The most common misconception, that I still observe to be present here in this discussion, is that a typical bank loans out its customers' deposits. This is simply not true. Let's say a member bank of the Federal Reserve System (any national bank, for example Bank of America) has never made a loan. They collect ten $10,000 USD deposits for a total of $100,000. Pretend at this moment that the bank has a zero balanced account open with the Federal Reserve. They can take the $100,000, and deposit it into their account with the Federal Reserve. This is now their "reserve" amount. At a 1/10 minimum reserve level, I can walk into this bank, request a loan for $1,000,000, and receive it. The one million is created "out of thin air" and added to the M1, which is the transactional liquid money supply of U.S. dollars. If someone else then walked into the bank for a $10,000 loan, the bank, without another $1,000 deposit on hand, could do one of the following:

1. Sell assets (including U.S. bonds) to gain the $1,000 and deposit this into their reserve account 2. Borrow $1,000 from another bank or lending institution and deposit this into their reserve account. 3. Borrow $1,000 directly from the Federal Reserve at the discount rate (5.25% in April 2007). 4. Deny the potential borrower their funds.

Going back to the one million dollar loan; as I pay back the principle that money is REMOVED from the M1. The bank keeps the interest on this loan. So, without inflation in the picture, after paying back on a zero percent interest rate loan the money supply remains the same. The problem occurs at the macroeconomic level with interest. If the bank chooses option 3, or even the governments of the U.S. (both state and federal) choose to borrow money from the Federal Reserve, this money is made out of thin air by the Fed. The fed does NOT debit any account; they're making money out of nothing and lending it at interest.

The problem comes in the fact that if there are $1 Billion USD in existence (the [Money_supply#United_States M3] ) and ALL of this billion is created as debt at 10% interest to the Fed then where in the world can $1.1 Billion come from at the end of the year? There are, of course, only two options, borrow another $100 Million from the Fed (again, at interest) or default on the loan. Dr. Jaikaran contends that since the Fed will not introduce debt-free money into the economy, except small amounts used to pay its own expenses, not even to the U.S. government by which it obtained its charter to operate, that this is the root cause of the boom-bust economic cycle of expansion, inflation, recession, and depression (repeat ad infinium). Another issue to think about is "who owes the Federal Reserve." They are a privately held corportation which sells shares of stock. To whom do they sell these shares? The member banks. The U.S. government usually orders most of the Fed's yearly net income to be given back to congress; most not all. So, after our national banks accure interest on money that cost them little to nothing (just the cost of processing a loan application, which is usually a fee anyway) to create from zero raw resources, and after the national banks charge other fees to their customers, they also end up getting a share of the net income generated by what? The Fed loaning a zero resource, zero expense, intrinsically valueless object at interest to the national banks and the government (i.e. the tax payers; the Fed extends credit to the U.S. government based on the security that they can pay back the loan because they collect revenue from tax payers). So the larger national banks, those who hold more of the Fed's stock, recoupe the interest they lost in borrowing from the Fed at the discount rate, AND get a little extra by taking some of the interest that the governments owe.

That ends the paraphrase. Now, can anyone validate that banks actually loan out customer deposits? This tends to not make sense to me. How would the money supply grow by such a large amount if this were the case? In other words, if the only way the M1 grew was by the Fed giving loans to the member banks, this could not explain the rapid, huge increases in the M1. Not only that, but it doesn't make sense by the fact that the Fed destroys the principle that the member banks and the government pay back. Basically, if only the Fed could create money out of thin air, then the M3 money supply would be:

M3 = (The amount of M3 on hand at the end of 1913) + (the principle owed by the member banks) + (the principle owed by the governments of the U.S. and any foreign lenders).

That amount is too small to be true...

--Blue666man 20:46, 19 April 2007 (UTC) on 19 April 2007.

Rothbard on Fractional Reserves

The addition of Murray Rothbard's assertion that fractional reserve banking is fraudulent and inflationary completes the degradation and corruption of this article. Rothbard and his followers see no difference between fractional reserve banking and counterfeiting, despite the fact that the bank puts its name on the money it issues, recognizes that money as its liability, holds assets against that money, and stands ready to buy back that money with its own assets.

All bank notes are redeemable in lawful money on demand

It is irrelevant that the bank recognizes the money as a liability if it doesn't have the funds to meet the obligation.

A bank might issue $100 in a checking account, against which it holds $25 in greenbacks and $75 in bonds. The bank can use the $75 in bonds to buy back $75 of its checking account dollars. Then it will have $25 in greenbacks backing $25 in the checking account. The bank has $25+$75=$100 in funds backing $100 in checking account dollars. Furthermore, customers voluntarily do business with the bank, knowing that it operates on fractional reserves, and knowing this means that sometimes the bank won't have enough cash on hand. A counterfeiter, on the other hand, issues $100, against which he holds nothing. In spite of this, Rothbard's followers stubbornly, foolishly, and fanatically insist that fractional reserve banking is tantamount to counterfeiting.

Fractional lending is a powerful tool

A hammer can drive in nails or cause your thumb to throb. Counterfeiting is ancient, some of the first artifacts of money are fakes. Bonds are nothing but formal IOUs. Fractional lending --whether it be in gold, dollars, sheep, or salt-- means that an economy has a greater value in IOUs than the value of the property they represent. That is why it is called FRACTIONal reserve banking. These are the facts, and believe or not the Earth does revolve around the Sun. It seems Murray Rothbard's argument against the practice creating money out of nothing is rooted in simple economics.

If I gave you an IOU for $50000 would you accept it, probably not from a stranger. However, just to continue this line of thought, lets say that you do accept it. A few weeks pass and you want the dollars, well as it turns out, I do not have, nor have I ever had the money. You would be angry. What just happened was fraud. If anyone did this it would still be illegal, and banks are no different. If banks had the property assets to back ALL their liabilities, no one would care that worthless paper was the medium of trade. If the government than gave the banks a line of credit to cover emergency government spending (here is where the bonds come it), few would care.

What makes it "counterfeiting" is that lenders, whether they are banks or not, create notes (IOUs) in the form of government issue fiat currency in excess of the net total of all the property they possess, including government bonds. This is counterfeiting, keep in mind that governments have always been a prime counterfeiter of money; whether it was debasing the coins, or printing notes like they were going out of season. Just because the government wants to spend its self into an abyss of debt and lets the lenders off the hook, does not magically change the economics. I am not supporting any point of view, just listing the facts. It is a fact that fractional-reserve banking is, for lack of a better word, fraud.

All that being said I do not blame the banks. Accrual capitalistic economics is, not in it's self evil, just powerful. N0 D1C4 16:12, 2 September 2007 (UTC)

Two 'views' of fractional reserve banking are not equivalent

The two "views" of fractional reserve banking are not equivalent. [true, rothbard is correct] If person A deposits $1000 into an account at bank A, then bank A can loan out up to $980 of that (with a 2% reserve requirement) to person B. Person B is taking the loan out to buy something, not to just have extra cash laying around. So person B gives there money to person C for goods and services. Person C wants to deposit his money, but in order for the two "views" of fractional reserve banking to be equivalent, person C would have to deposit his money into bank A. Person C might find that bank A gives too low an interest rate on his deposit, or he might find that bank A has excessive fees, and person C could very well decide to put his money on deposit with bank B. [but there is nothing to stop c putting it in bank a...] So what? Bank A is still competing for person C's deposit with other banks, its really not relevant what the source of person C's money is. which is why bank a can use the money issued by itself as a deposit for more loans

The amount of deposits that a bank has is related to their ability to compete in the market for depositors, not some magical ability to conjure up money. For every credit there is an equal an opposite debt, you can't just create credit out of nothing [if we all paid back our debts what would happen to the money supply?]. That won't happen. There isn't enough money for us to pay back all our debts. ok, if we paid back some of our debts what would happen to the money supply? For the federal reserve to make money they have to exchange that money for federal bonds for which they receive no net payment in interest. And when that money is created, it goes into the account of the person who deposited the bond, not the bank itself. [the money creation part happens when the bank starts lending based on that bond...] Money is also created by the purchase of bonds by the Fed. yes, but not as much as by the member banks

If you want a real financial catastrophe lets get back on the gold standard. Imagine years and years of deflation, what do you think that will do to debtors? Inflation is good for people who owe money, [and bad for everyone else] bad for people who are owed money [unless you are a bank who has borrowed the money]. If you'd truly like to hand the country to the robber barons then returning to the gold standard is the way to go. [you can have fractional-reserve-banking with a gold standard and full-reserve banking without a gold standard] And if you don't think loans can be a good thing, try to start a business bigger than a lemonade stand without one. [perhaps businesses should pay the market rate instead of being subsidised by the state]

I'm not quite sure what you're getting at there. When a person takes out a loan to start a business they generally get the loan from a private bank or investor, not the state. we are subsidising low rates with the reduced purchasing power of the dollar

And fractional-reserve banking with the gold standard reduces to the same thing - you're still going to end up with their being more money than there is gold to back it. If I deposit $1000 worth of gold in the bank, then the bank loans lout $900 worth of gold to a customer who then spends the money, both myself and the person who receives the money from the loanee will have a certificate representing a claim on $900 of that gold. With a 10% reserve, there could be as many as 10 times as many claims on the gold as there is actual gold. Fiat money just takes this to the next logical step - get rid of the gold. It makes the system a lot more flexible, and if you want to keep your money saved in gold or other things with intrinsic value, you're still quite free to do that. yes, but you can get rid of fractional reserve banking without having a gold standard

At least one of the editors of the 'fractional reserve' article has based his contribution on conspiracy theory mythology (as opposed to the conspiracy theories which really are true) [why does there need to be a conspiracy?]

User:SpidermanTUba 01:51, 20 September 2007 (UTC)

Disputed

I have a dispute tag because the article contains two different views that make the article contradict it self in numerous of ways.

In the correct view the first banks had a reserve in gold. For every bar of gold the bank holds the bank could write a bank note for the value of that gold and lend it to loan takers and receiving interest. This is a full reserve system. The bank can only lend out the save amount of bank notes as it has in gold.

Fractional reserve banking is when the bank gives out more banknotes than it has reserves in gold. This causes a multiplier of circulated capital and a inflation. With the hope that all the loaner do not cancel the loans at the same time and tries to get the gold back. This would cause a bank run. The bank don not have gold for all customers.

100% backing means that every bank note has a 100% backing in gold (or other value)

10% backing means that 10% of the bank note has backing in gold. The other 90% is fiat money and has no backing. this is fractional reserve banking.

The wrong view try to imply that it the bank gets $10 in deposits it can gives out $9 in loans. It is impossible to create inflation using this version: The bank actually creates deflation as it keeps money from circulation. Under this model it is impossible to use full reserve banking (100% reserves). Sense that would mean that the bank holds $10 of the $10 in deposits and have $0 dollars to use for loans and thus cannot operate at all. (This is obvious nonces)

This article is a mix of both models resulting in contradictory statements. The history part is partly correct, but most of the other parts is totally wrong.

Sources:

—Crash site 23:01, 9 September 2006 (UTC)

I don't think you're quite correct in saying that one one view is right and one view is wrong, Crash site: both are correct views of quite-different phenomena. However, though what you present I finally grasp why the confusion exits. It's all in the names, not the concepts. What you present here is an example of fractional-reserve banking, preceded by an example of "fractional-reserve money" (I'm not sure what the real name for that is, which is why I too had confused it with factional-reserve banking).

Bottom line: it's the difference between issuing paper money with less metal/etc. backing it than the face value, and loaning money multiple times resulting in a multiplication of total ledger amounts. —AltiusBimm 18:19, 30 November 2007 (UTC)

When comparing fractional to full reserve banking, it is not kept clear that a reserve is the money kept on-hand for withdrawals from demand-deposit accounts (checking, savings), while the bank may(will) still have additional assets to lend/invest under either model (CDs for example, and the bank's own money). Any profit from fees & interest goes into this second set of assets. My POV deals strictly with the local bank down the street, and not the high-level banks that only deal with other banks (and countries). The "popular myth" fractional reserve is what I was taught in both high school and Econ101, so I'd like to see where the bank gets the money to create $900 from a $100 deposit. 172.134.2.176 20:54, 19 September 2006 (UTC)

It is indeed strange that there is two different views held by high ranking economics. But there is a reason. If the bank could create money this would be a thing the population would not like and thus the population does not now it. This is how Werner explains it.

The creation of the $900 is actually only a number in a computer. The physical money and the didgital is two separate things. The bank creates a new credit of $900 and that money is then deleted after the loaning is completed.

--Crash site 00:42, 27 September 2006 (UTC)

Hi there,

I have no knowledge of this area, but just looking at the logic...

'The wrong view try to imply that it the bank gets $10 in deposits it can gives out $9 in loans. It is impossible to create inflation using this version: The bank actually creates deflation as it keeps money from circulation. Under this model it is impossible to use full reserve banking (100% reserves). Sense that would mean that the bank holds $10 of the $10 in deposits and have $0 dollars to use for loans and thus cannot operate at all. (This is obvious nonces)'

Can I just ask what happened to the original deposit? You seem to imply that the bank burns the deposit when it lends out the money. But the bank still owes money to the depositor. Therefore under full reserve banking, you the depositor would retain their holdings at the bank and money supply would remain unchanged.

That seems to make sense for the simple 'guy saves money/ guy borrows money' scenario. However if the money is not lent out, then it may still be deflationary. As for what happens with the Fed, I don't know, you might be right. How would money in circulation increase if the banks receive money from the Fed but can't lend any of it?

Needless to say if the Fed prints money, gives it to the bank and allows the bank to loan out ANY of it, then money has definitely been released into the system and this increases the money supply, so long as the rate of release is sufficiently high.

I am likely to be wrong since this is all off the top of my head.

Vandalism and Mindless Trivial Edits

Please edit from this version carefully. This is a very clear version that has recently been altered/vandalized. Removing the first section (with graphic) in particular is destructive as this first section is one of the best, clearest explanations of frb in existence. —Preceding unsigned comment added by 210.87.15.130 (talk) 07:27, 16 December 2007 (UTC)

Define "Reserves"! (or "banking" for that matter)

Some people who have commented on Fractional Reserve Banking seem to be under the impression that "reserves" simply refers to "money supply reserves" that a bank keeps to be able to pay back money it has borrowed from its costumers under a loan banking system. If that were the case, nobody could disagree with it. What they forget is that even fiat money is backed by something, namely the so-called "reserves", which are NOT a reserve of money supply, but its monetary basis (called "high-powered money" in the article - which doesn't have to be gold, it just has to be "different" money; it can be, and usually is, itself fiat money). When critics of Fractional Reserve Banking talk about "reserves", they mean the monetary basis for the money supply under what is essentially a deposit banking system. Fractional Reserve Banking is fraudulent, because it backs up an amount of money in the money supply with a fraction of that amount in the monetary basis.

Another important source of confusion is that many people think the money circulation starts with them: "I deposit $1000.00." However, as is clearly stated in the article: "A bank note is always an evidence of debt and none may be in the hands of a depositor until someone has written a check for cash to a lending institution to obtain them." In other words, the process starts with the bank: The bank creates(!) $1000.00. In fact, it creates as much money as it is allowed to do, being limited only by what has misleadingly been called "the Reserve Requirement". It doesn't need to print the money, exactly for the reason that only a fraction of it (a totally unrelated fraction) is ever needed in cash. So the answer to the question "Where does the bank get the money from to increase the money supply?" is simply this: It creates it out of thin air with the flick of a pen. Fiat money - let there be money.

Dngrs 10:58, 3 September 2007 (UTC)

Sigh. Anybody can create "money", inasmuch as money is defined by how it is used: as a representation of value. If my services are in well-known and constant demand, I can create money by writing a "Harris-note" which is an IOU for one hour of my time. If that thing trades on the open market for a certain value in other goods and services (gold, silver, whatever), then I've managed to create money out of thin air, as it were, just by my promise, my well known skill, my good reputation, and certain assuptions related to my health (redeemability of my credit-money).

Now, when I go down to the bank and ask for enough credit to buy a house, and they give it to me, I think everybody agrees that money is created in the act. But exactly at what point is the new money created? If I wrote out a wheelbarrow of "Harris-notes" and the bank took them in exchange for a house which (for some reason or another) the bank had title to, then there'd be no question that *I* had created the new money, and managed to buy a house with it! Or that the money had been created by myself and the bank in a joint act. Almost like counterfeiting, except that I promise to replace the funny-money with good money, later (i the meantime the bank keeps the funnymoney in the vault, along with my deed).

Of course, instead, in the real world, the bank saves me all of this effort, by pretending that I did all that work: instead of the wheelbarrow of Harris-notes, the bank takes a stack of signed documents from me which are basically equivalent, and promise a similar repayment and redemption of the Harris-notes over coming years, at a given rate, in terms acceptable to the bank. Again, the bank will take silver, gold, federal reserve notes, or whatever I can trade my personal FUTURE time for. But it's my FUTURE time that I'm agreeing to trade, make no mistake. The bank can't demand this value or redemtion from me, at more than a certain rate. So it's clear that it's still "Harris-notes" that are the money being created in the act, even if I don't actually create them one-by-one. It's MY future work that I'm mortgaging, even though it's secured by the house, in case I violate the promise to pay. In the case of a credit card, we don't even have a house, and the bank still gives me money in exchange for a promise.

Now, for the people screaming conspiracy and fraud, so far as I can tell, they're just folks who've looked at the banks and noticed that they don't have enough value in titles to real property or other kinds of money (gold, federal reserve notes, whatever) to actually secure all the money which has been created in the act of lending. In other words, they hold a lot of Harris-notes and Joe-Blow notes and so on from all kinds of people, and have so many, that they'd be in all kinds of hell if all these people suddenly dropped dead tomorrow. Well, yes. That's because part of money-creation (credit-money, here, obviously) involves IOU's, which involve promises to work tomorrow if you only will give me gold or silver today. There are a lot of people out there who've mortaged large parts of their future lives and time, and the banks have allowed them to do this without any security at ALL (all that credit card debt, for example). There needs to be a system to allow this, and to spread the risk around, so that the various IOU Joe-notes and Harris-notes, etc, are fungable and usable as actual money right now, by Joes and Harrises who need a lot of money for a big expense (like buying a house or starting a business). That's essentially what banks DO for a living. Fractional reserves are the CONSEQUENCE of that. If they didn't exist, the urge for people to write IOU's on their future labor and have a place to exchange them, would CREATE fractional-reserve banks. S B H arris 23:53, 7 December 2007 (UTC)

Why devalue the dollar to subsidise debt?

Somebody has to. Anytime anybody loans a dollar against somebody's future work (extends credit), the dollar has been devalued to the extent that there is risk the future work will not occur. Do you want to stop extending credit to people? And if you do, what units of value are you going to do it WITH? It's credit in terms of SOMETHING valuable, or else it's not credit. If you loan somebody gold that you have on deposit for somebody else, you thereby somewhat devalue gold. That's the whole point of interest-- do you think the gold just mysteriously should grow it, by sitting down there in the dark like mushrooms? There's nothing special about paper money, as somebody above explained. It's just a standin for anything of value, from gold to somebody's promise to pay gold, to somebody's promise to pay gold in the future, to somebody's promise to do work in the future. S B H arris 01:36, 9 December 2007 (UTC)

My position is that a full-reserve system would be preferable. It would have to be a fiat currency because it is too late to go back to a gold standard (the government don't have enough gold for that). Under a full-reserve system you would still be able to extend credit and you would be able to charge interest. The problem with the fractional-reserve system is that the currency is devalued every time a loan is made (permanently if the loan defaults). I'm not sure I agree with your statement that "If you loan somebody gold that you have on deposit for somebody else, you thereby somewhat devalue gold" surely you devalue the gold receipts not the gold?

Well, yes and no. Suppose I have 100 oz of gold in the vault and 100 certificates which we all agree stand for it (are redeemable for it anytime). Now, I also have a gold mine, and observe that I expect to have 200 oz of gold by next month, and propose to issue 200 certificates, with the proviso for the second 100 that you can't redeem them until next month. However, to sweeten the deal, I'll give you 100 of them for 90 oz worth of your goods and services-- thus in effect making you my creditor. Even though I'm the bank, you understand. And have the gold. And let's say it all works out and you (or somebody else you gave them to) comes in, in a month, and gives me the extra 100 certificates and get your 100 oz of freshly mined gold, and we're both happy. Now, in the meantime, while those extra "gold bond" or "gold-money-market" certificates were circulating, have I devalued the gold I hold? Or have you? We both understood we were issuing "money" against goods and services that didn't exist yet, because we hadn't done the work. So was this fraud? Because it is pretty much fractional reserve banking. Everybody knows what's going on. In fact, suppose I don't even put a withdrawal restriction on the gold you can redeem, but just say you can get it anytime-- and if everybody comes in to get their gold at once, I have deal with the government that if there's a run on my gold reserves, I can borrow 100 oz from THEM for a month, until I can replace it from my goldmine. How, now? S B H arris 01:29, 10 December 2007 (UTC)

When I come to redeem my gold bond am I entitled to ask for actual gold or are more gold certificates legal tender for all debts, public and private?

I accept the argument is a fair one, the situation you describe with the bank being something like a gold mine does reflect the reality of banking. The difference (apart from substituting "work" with gold) is that the bank is in debt not the customer. But it makes a difference if the customer can demand actual gold. Otherwise we have no choice but to take the bank's credit.

Yes, or the central bank's credit, which is the credit of the country, if it's a "legal tender" note. As you may know, there are some countries like Scotland that don't even have any fiat money (legal tender). They function entirely on banknote credit money. In the US the situation is interesting. For just about a century, from the early civil war to 1963 when the US went off the silver standard, two types of notes circulated side by side. Before the Federal Reserve existed, a bunch of federal government-backed banks issued notes backed by US bonds (ie, by the US government's promise to pay, basically like a T-bill). These US banknotes were the first "greenbacks" and were declared legal tender in 1862 or so. They were unsecured by specie, so were not representative money. Alongside them, however, circulated the gold certificates and then the silver certificates that were that type of money, and that finally disappeared and were entirely replaced by the federal reserve notes after 1964. However, during that century, if you had one kind of note you could always find somebody willling to trade you for the other kind, so a century of side-by-side circulation failed in having "bad money drive out good". Or else the US legal tender notes were seen to be just as good, even if not specie-backed. A big government's power and promise to tax and pay is, in a sense, even more reliable than a bank's promise to give you gold out of their vault. The bank can be robbed or go out of buisiness. Less likely so a powerful country like the US. US federal reserve notes are actually, if you think about it, backed not by gold, but by plutonium. I'm only half kidding. The Commies are right that we're plutocrats. But not in the way they think. S B H arris 22:38, 24 December 2007 (UTC)

Merge

Should Debt-based monetary system be merged here? -- Kendrick7^talk 03:39, 3 January 2008 (UTC)

There's a lot of the same conspiracy stuff in both. For example, the entire article above calls credit money (i.e., bank notes that aren't representative money) by the nonstandard and unlinked term "debt money". Sort of like pessimists insisting a thing be called "half-empty". S B H arris 17:35, 5 January 2008 (UTC)

How would a bank loan money to consumers and businesses if it had to keep everything in reserve?

I think the article is ruined beyond salvation, so I will not even attempt to clean it up. I got a question for the conspiracy theorists, Ron Paul fans and proponents of full-reserve banking: How would a bank loan money to consumers and businesses if it had to keep everything in reserve? As for the article, it would probably be better off being blank or linking to a Google search on the topic. Ekonomics geek (talk) 20:19, 5 January 2008 (UTC)

If the bank is unable to make the loan itself, it would ask depositors if they wished to lend money to the business. Orangedolphin (talk) 19:42, 8 January 2008 (UTC)

The banks in a "full-reserve" system back all loans up by "hard" assets such as gold. The reserves for "full-reserve" banking are different than the reserves for "fractional-reserve" banking. I think the proponents of fractional-reserve banking wish to return to the Gold Standard, which would be financial suicide. --EGeek (talk) 20:22, 5 January 2008 (UTC)

I think you are confused about both of these. Fractional-reserve banking: you give the bank $10 for safe-keeping, it loans $9 to someone else at interest. Full-reserve banking: you give the bank $10, it's required to hold all of it. Gold standard is a somewhat orthogonal issue, but modern banking systems are fractional-reserve and not on gold standard. Ekonomics geek (talk) 23:24, 5 January 2008 (UTC)

The first sentence in the Full-reserve banking article does a little better explaining this, but the source is not an easy read to most people. I'll try to find something a little better. --EGeek (talk) 03:18, 6 January 2008 (UTC)

Ekonomicsgeek - don't give on wikipedia just yet. I've been trying to learn how this stuff works and I believe I can contribute to this article in an objective way that also includes sources to explain things. Wikipedia is still relatively young and I think many things throughout wikipedia will improve as time passes. Analoguni (talk) 01:01, 6 January 2008 (UTC)

Banks are supposed to earn revenues through service fees and investment returns. Once these revenues are the bank's priopriety, it can lend it at whoever it wishes. --Childhood's End (talk) 19:43, 11 January 2008 (UTC)

Graph Showing Expansion of Money Supply

Zenwhat, why do you want to keep the graph that shows an expansion of the M1 money supply? The data that supports the graph was deleted due to WP:NOR violation. If we keep it, I suggest moving it to the "A bank can lend the money immediately" section. --EGeek (talk) 20:36, 5 January 2008 (UTC)

the table isn't original work. I gave the source for it. It's from the New York regional reserve bank of the US Federal Reserve System. See http://en.wikipedia.org/wiki/Talk:Fractional-reserve_banking#here_is_the_source_for_the_table

"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity." This is from http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html Analoguni (talk) 00:56, 6 January 2008 (UTC)

Can we move it to that section then? It is out of place at the top of the page. --EGeek (talk) 02:46, 6 January 2008 (UTC)

Sure. Zenwhat (talk) 03:56, 7 January 2008 (UTC)

Actually, wait. I was wrong. The chart isn't using the same numbers. But yes, as I said, it reflects mainstream economics. It's called the "money multiplier." See Money_creation#Money_Multiplier. Zenwhat (talk) 03:58, 7 January 2008 (UTC)

Then a link to Money_creation#Money_Multiplier might be more efficient for the article. --EGeek (talk) 04:26, 7 January 2008 (UTC)

I have noticed that the "How it Works" section is evolving into a duplicate of the money creation article. Does anyone reject to updating the money creation article with this information, since its well sourced and more detailed, and provide a link to money creation? --EGeek (talk) 20:25, 9 January 2008 (UTC)

"Lending more than you have is fraud"

Is there some way to put a stop to this nonsense? A bank does not lend more than it "has." It receives deposits, the deposit is lent out, and this in no way constitutes fraud. This is absurd. I think someone would have noticed if it somehow constituted fraud.--Gregalton (talk) 19:20, 26 December 2007 (UTC)

First, that is a common misconception, that banks lend out money from there deposits. This simply not the case; their deposits do not go anywhere. Banks do not lend money, they "create" it out of the borrowers promise to repay, then charge interest to the borrower on the "money" they just "created" a nanosecond ago. The process has been called the mandrake method. It is essentially "accrual accounting" where future revenue is credited as payed, even before the loan is repaid.

Second, banks are permitted to create "check book" money usually at a 9:1 ratio of deposits.

Third, the debt created can be converted to Federal Reserve Notes. Basically swapping one IOU for a Government debt IOU.

Fourth, because banks are able to re-lend out the interest and due to the multiplier effect, a loan at 12% interest actually takes in 120% of the principle.

Lastly, what banks do is literally government sanctioned counterfeiting; the ultimate result is that the inflated currency ALWAYS becomes worthless.

N0 D1C4 (talk) 02:36, 27 December 2007 (UTC)

Your last sentence makes the point nicely, thanks: both points are just opinions w/o references, as was the fraud allegation. Neither have a place in the article (and thank you for removing it).--Gregalton (talk) 05:45, 27 December 2007 (UTC)

OK, what are we agreeing or disagreeing on here? There is one fact that I'd like to know, and if this entire article was replaced by this sole fact, then the article would be better for it: How much can a bank lend out as a proportion of its savings deposits? Answer accompanied by a reputable online reference showing what this ratio is in a major western nation (USA, UK, etc...), please. Gantlord (talk) 19:04, 3 January 2008 (UTC)

Maybe this is what I'm looking for... http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html Gantlord (talk) 19:24, 3 January 2008 (UTC)

Yes, that is what you're looking for. However, I have heard claims that banks are allowed to immediately lend out at a 1:9 ratio and I've been looking for a source but haven't found one yet. People say that a bank can do this immediately because it is theoretically possible for one person to make a $100 deposit, then get a loan for $90, then deposit that $90 into the bank, then get another loan for $81. Since it is theoretically possible for a person to do that, some people claim that the bank can just start off with the 1:9 ratio immediately and skip all those steps in between. Like I said, I've been looking for a source to confirm this but haven't found one yet. Analoguni (talk) 01:09, 6 January 2008 (UTC)

I suppose a bank could do that to create 10 times their money but why would they do it? At that point they would have exhausted their ability to loan. They would only have 10% in reserves and could no longer loan more money. The bank absolutely can't just loan 10 times the assets they have. If they did your little trick, they would have to have a willing borrower who took the loans but also deposited those back in the bank. Why would the borrower do that? In the end neither party has an advantage. I can loan myself $100 and deposit that back into my fictitious bank and do it again and again. I could claim to have a billion + 100 dollars in deposits and a billion dollars in liabilities. What would I gain from it? I couldn't turn around and loan a billion to a third party167.1.150.177 (talk) 15:27, 24 January 2008 (UTC)

 —Preceding unsigned comment added by 167.1.150.177 (talk) 15:23, 24 January 2008 (UTC)

N0 D1C4, the claim that "banks lend money from their deposits" is mainstream economics. Please, do not violate WP:FRINGE amd WP:NOR, even if you believe such fringe theories are correct. Zenwhat (talk) 04:49, 5 January 2008 (UTC)

Given "bank credit" can be exchanged for physical currency at any bank, why would it matter if the issuing bank has deposits (the recipient can always go to another bank)? Orangedolphin (talk) 19:40, 8 January 2008 (UTC)

Deposits (unlike reserves) are irrelevant to a bank's ability to make loans because deposits are not a loan to the bank. Orangedolphin (talk) 18:08, 11 January 2008 (UTC)

So all those banks that spend advertising dollars to persuade people to deposit money with them are just burning money then? That money has to come from somewhere. It mostly comes from deposits because they are the cheapest. Money from other banks (including the central bank) are more expensive. --EGeek (talk) 18:46, 11 January 2008 (UTC)

Fractional-reserve banking enables banks to increase the money supply. Orangedolphin (talk) 19:14, 11 January 2008 (UTC)

Fractional-reserve banking enables money creation through loans. The bank can not create more money unless it has money to loan. It must use money from deposits or loans from other banks (commerical bank or central bank). The bank must pay interest on loans from other banks; therefore, banks prefer deposits because they are the cheaper. --EGeek (talk) 01:46, 12 January 2008 (UTC)

The point about fractional-reserve banking is that the bank can lend more than it has borrowed. Otherwise it would be full-reserve banking. Orangedolphin (talk) 16:55, 12 January 2008 (UTC)

That is incorrect. A bank can only lend what it has; however, it can and does lend more than it holds in reserves. The only requirement of full-reserve banking is that it hold 100% reserves. Depending only banking regulations, the bank can manage deposits and loans to hold more than 100% reserves; thus, enabling the bank to lend money out. I thought this was pretty clear in both the fractional-reserve banking and full-reserve banking articles. Please let me know if this is not the case. --EGeek (talk) 18:28, 12 January 2008 (UTC)

I'm having trouble understanding the distinction you make between deposits and reserves. When I take money out of the bank is it deposits or reserves? Orangedolphin (talk) 18:49, 12 January 2008 (UTC)

When you make a withdraw from a bank, you are withdrawing your deposits. Since the liability of the bank to pay those deposits also decrease in the amount you withdraw, the required reserves will decrease by the current reserve ratio (i.e. 10%). --EGeek (talk) 19:33, 12 January 2008 (UTC)

Let's say a bank has a reserve ratio of 10% and the required ratio is 0%. If the bank makes a new loan, it must first borrow the money to do so. So, given that the bank has simultaneously loaned and borrowed the same amount is the reserve ratio affected? Orangedolphin (talk) 21:35, 12 January 2008 (UTC)

At that point in time, the capital inflow (money coming in) equals the capital outflow (money going out); thus, the reserve ratio is unaffected. Due to the risks of performing this financial maneuver , a higher than normal interest rate will be demanded from the borrower; therefore, due to competitive forces, banks desire the use of deposits instead of bank loans.

At the accountant's point of view, the loan coming in is both a cash asset and a liability. When the bank issues the loan, the cash asset becomes a non-cash asset in a form of "accounts receivable". The reserve assets or the deposit liability are not involved in this transaction. --EGeek (talk) 22:48, 12 January 2008 (UTC)

So when a bank makes a loan the reserve ratio is unaffected? Orangedolphin (talk) 13:49, 13 January 2008 (UTC)

If the bank uses deposits to make the loan, then no. --EGeek (talk) 19:31, 13 January 2008 (UTC)

What happens to the loan when the customer wants their deposits back? Orangedolphin (talk) 21:41, 13 January 2008 (UTC)

Nothing. Current deposits and reserves do not effect loans already issued. --EGeek (talk) 23:12, 13 January 2008 (UTC)

Where does the money come from to make the loan if the deposits have been withdrawn? Orangedolphin (talk) 15:51, 14 January 2008 (UTC)

It comes from the not-yet-withdrawn deposits or from the bank's other liquidities. The banks are not restrained to use only deposited money to make loans, but deposits are among, if not the most profitable source due to their high NIP. --Childhood's End (talk) 16:11, 14 January 2008 (UTC)

Assuming the not-yet-withdrawn deposits and the bank's other liquidities are already committed to bank loans, where does the money come from to make the loan if the relevant deposits have been withdrawn? Orangedolphin (talk) 16:44, 14 January 2008 (UTC)

I would guess that this is the kind of situation that the rules about bank reserves seek to avoid. The loaned money is already committed so it need not come from somewhere at this point. Problem would be with meeting the withdrawal demands. The banks use liquidity policies to manage their liquidites levels in order to make sure that they can always meet their short-term obligations such as deposit withdrawals, but liquidity crisis can happen and in the worst cases, the bank may need to sell assets or open lines of credit at other institutions such as the central bank. Techically, at this point, there would be intense public relations management to avoid a run on the bank, which would make the crisis worst, and regulatory agencies will be involved in an attempt to avoid deposit insurance payments and more importantly, loss of public confidence in the system. --Childhood's End (talk) 18:39, 14 January 2008 (UTC)

If customers are not able to withdraw their money because it has been used in loans, this would be a version of full-reserve banking (where deposits have been used in making loans...) not fractional-reserve banking. Orangedolphin (talk) 00:45, 21 January 2008 (UTC)

No. Deposits can be used in each. The only difference is that full-reserve banking requires that the bank hold at least 100% of the deposits, while fractional-reserve banking only requires a fractional amount such as 10%. --EGeek (talk) 05:53, 21 January 2008 (UTC)

I don't understand this. Could you explain a bit more? Orangedolphin (talk) 01:21, 23 January 2008 (UTC)

No. It would actually be the absolute opposite of full-reserve banking. In such a system, deposits are always fully secured and can always be withdrawned exactly because the bank must hold 100% reserves. The bank could only make loans with non-deposit liquidities. --Childhood's End (talk) 14:25, 21 January 2008 (UTC)

Why would depositors be unable to withdraw their funds (deposits are not a loan to the bank)? Orangedolphin (talk) 01:21, 23 January 2008 (UTC)

The bank cannot lend money it does not have; therefore, if the reserve ratio is under the required amount, then the bank can not issue another loan unless it borrows money from another bank. In the case of deposit withdraw that causes the reserve ratio to drop under the required amount, the bank would also need to borrow money from another bank. As more money is required(demanded) in the system, interest rates raise and slow down the number of loans issued. --EGeek (talk) 19:58, 14 January 2008 (UTC)

So the ability to make a withdrawal would be contingent on the bank's ability to borrow money from elsewhere? Orangedolphin (talk) 00:45, 21 January 2008 (UTC)

No. The bank holds the liability; therefore, if a depositor wants to withdraw, the bank is obligated to withdraw the deposits. The bank decides how to keep reserves on hand. --EGeek (talk) 06:02, 21 January 2008 (UTC)

But what if the bank has loaned the money to a customer? How can the bank return the money to the depositor, unless they ask for the loan back? Orangedolphin (talk) 01:21, 23 January 2008 (UTC)

So if a bank is in breach of the reserve limits it needs to borrow more money? Orangedolphin (talk) 19:58, 13 January 2008 (UTC)

It needs more money to bring their reserves up to the required ratio, so it might have to get a loan from another bank if it can not receive more from deposits. --EGeek (talk) 20:51, 13 January 2008 (UTC)

Uh, what makes you think so? Fed banks lend money to other banks at prime rate, and the money they lend is backed by nothing other than US treasury securities. Nobody has deposited ANYTHING to back it. It's backed by the power of the US government to tax you IN THE FUTURE. That's it. S B H arris 17:40, 5 January 2008 (UTC)

Deposits most emphatically are loans to (liabilities of) the bank. From its customers. See bank deposit: "the term deposit is actually used by the banking industry in financial statements to describe the liability owed by the bank to its depositor, and not the funds (whether cash or checks) themselves, which are shown an asset of the bank." (N.B. Yes, there is a distinction between a loan to the bank and a deposit, depending on the legal system, but the economic system is a loan).--Gregalton (talk) 18:19, 11 January 2008 (UTC)

If a bank lends 90% of my deposit and I withdraw my funds does the bank have to call in the loan? Orangedolphin (talk) 19:14, 11 January 2008 (UTC)

The bank will return funds equal to what you withdraw, not your funds. The ratios/limits applicable to what a bank can lend are determined upon the assumption that at this ratio x:y, the bank is normally able to refund deposits on demand since not all deposits are withdrawned at the same time. Further note : the system is not infaillible though, and up to certain amounts, most deposits are insured. Thus, when the next run on the banks happen (and they will imo ), governments (i.e. taxpayers) will cover a part of the total deposits made, while the uninsured part of the deposits will be lost. And as to the insured part, it also remains questionable wether the government would be able to meet its obligations. --Childhood's End (talk) 19:38, 11 January 2008 (UTC)

Deposit insurance is to protect against balance sheet insolvency, it has nothing to do with fractional-reserve banking. Orangedolphin (talk) 01:18, 22 January 2008 (UTC)

Deposit insurance is to protect depositors against bank failures to honor their public deposit liabilities. Failure to honor a deposit can essentially only happen in a fractional banking system since with full reserves, theorically, banks could not default on these obligations. --Childhood's End (talk) 02:09, 22 January 2008 (UTC)

Banks can still go insolvent in full-reserve banking. Orangedolphin (talk) 01:21, 23 January 2008 (UTC)

If bank deposits are a loan to the bank how does the present system differ from full-reserve banking? Orangedolphin (talk) 21:25, 11 January 2008 (UTC)

Legally, bank deposits are not loans to the bank. But banks are given the privilege to treat them as if they were and to use the money as if it was loaned to them, even if this puts your deposit at risk. In a full-reserve banking system, the bank would be under the obligation to keep 100% of the deposits which would thus be 100% safe. --Childhood's End (talk) 22:08, 11 January 2008 (UTC)

If deposits can be withdrawn on demand how are deposits relevant to a bank's ability to make loans? Orangedolphin (talk) 16:55, 12 January 2008 (UTC)

That's pretty obvious; because depositors do not all ask for full withdrawals at the very same time, so the bank is always left with large amounts of deposited money. --Childhood's End (talk) 17:44, 13 January 2008 (UTC)

Why does having large amounts of deposited money affect whether the bank can make loans? Orangedolphin (talk) 18:35, 13 January 2008 (UTC)

Because in a fractional-reserve system, the bank can lend it? --Childhood's End (talk) 18:44, 13 January 2008 (UTC)

Can the bank still lend it if the customers withdraw their deposits? Orangedolphin (talk) 19:23, 13 January 2008 (UTC)

The class resumes today. Please take the time to assimilate what you have learned so far. --Childhood's End (talk) 20:28, 13 January 2008 (UTC)

So, have you assimilated [5] ? --Childhood's End (talk) 16:14, 14 January 2008 (UTC)

See above. Orangedolphin (talk) 16:44, 14 January 2008 (UTC)

Archiving of discussion here

Could someone start the archiving process here? Perhaps an automated process?--Gregalton (talk) 18:20, 11 January 2008 (UTC)

See Help:Archiving a talk page. --Foggy Morning (talk) 06:09, 12 January 2008 (UTC)

Thanks muchly. Is there any objection to (consensus for) using an automated archiver on this page?--Gregalton (talk) 15:39, 12 January 2008 (UTC)

Sounds fine to me. Thanks for the good work. Orangedolphin (talk) 16:52, 12 January 2008 (UTC)

Trying with the Miszabot template. We'll see if it works. I've set it to 45 days so this will only clear out really old stuff (for clarity - only parts of the talk discussion that have not been touched in 45 days will be archived). We'll see how it goes. If any problems, please leave a note here. I have not put an archive box on this page yet - want to see how it goes, but if someone else puts the box up, all the better. Thanks.--Gregalton (talk) 17:20, 12 January 2008 (UTC)

I'm afraid I seem to have done the bot request okay, but screwed up the archive box. Any ideas on what I did wrong?--Gregalton (talk) 08:37, 13 January 2008 (UTC)

Think I fixed it with a cludgy hack. Hope this is acceptable (I don't think it should require any fixing).--Gregalton (talk) 19:32, 13 January 2008 (UTC)

problem in "How it works"

"Since loans are paid back with interest, there is not enough money available in the money supply to pay back all of the loans. New money must be created outside of the money listed in the table in order for all of the loans to be paid back in full plus interest. "

Now, I'm no expert, but I'm fairly sure that this is a very non-mainstream view held only by a small number of people. Others? --Jason Catlin —Preceding unsigned comment added by 72.43.26.238 (talk) 16:11, 27 January 2008 (UTC)

How would the interest be paid if there is no money in the system to pay it? Orangedolphin (talk) 00:23, 28 January 2008 (UTC)

Agree. It's nonsense.--Gregalton (talk) 17:16, 27 January 2008 (UTC)

This isn't nonsense. That sentence is just incomplete. It depends on how much interest the bank charges on a loan. There is a specific amount of interest charged on the loan that would have the system break even. In the case of the 20 percent reserve rate system, this number is 25 percent. If the banks charge less then 25 percent interest on the loans then there will be an excess amount of money available in the system to pay back all of the loans plus interest. However, the initial depositor in the system has to lose money. Ultimately, any interest charged by the banks must come from the initial depositor. If the banks charge more than 25 percent interest on the loans, then there isn't enough money available in the system. Everyone's deposits will have been completely drained and there will still be more debts to pay back. Analoguni (talk) 21:42, 27 January 2008 (UTC)

Is there any reason this article particularly merits a section of links on "the Libertarian perspective?"

I don't see why this should be split out. Any relevant points and links should be integrated into the article.--Gregalton (talk) 13:51, 18 December 2007 (UTC)

Bumping the question up a bit - anyone willing to state why a Libertarian viewpoint on banking should be of particular relevance?--Gregalton (talk) 21:55, 24 December 2007 (UTC)

The article is currently being revised by many editors independently. It will take a bit of time for the wrinkles to get ironed out. N0 D1C4 (talk)

That's not much of a reason to keep as a separate section, particularly given the borderline content of this section.--Gregalton (talk) 22:23, 24 December 2007 (UTC)

So far, no argument put as to why this merits a separate section, but willingness to revert deletion of a section that is not encyclopedic, and not justified in this article. Why is a libertarian viewpoint of particular relevance here?--Gregalton (talk) 18:12, 26 December 2007 (UTC)

As far as I know, the libertarian argument has to do with the government regulations over banks. Libertarians are generally opposed to any type of government interference, especially in economic matters. I'm not so sure if it's safe to say that libertarians tend to be opposed to fractional reserve banking, but it's pretty safe to say that libertarianism is opposed to government regulations over private banks. Milton Friedman is probably a good example. He has stated before that he would prefer that the federal reserve did not exist. By having a government regulate fractional reserve banking, people show a lack of confidence in the ability of free markets to regulate banking. Analoguni (talk) 03:44, 27 January 2008 (UTC)

"Purpose" subsection

The purpose subsection of the article should be restrained the the Federal reserve citation. I find that the upper part essentially consists of original research and has little to do with the system's purpose. Here's what I would delete :

"Fractional reserve banking provides a system that expands and contracts the money supply. In order to have an understanding of how the money supply is expanded and contracted, one needs to understand that there are two types of money in a fractional-reserve banking system^[1] :

central bank money (physical currency)
commercial bank money (money created through loans)

When a loan is supplied with central bank money, new commercial bank money is created. As a loan is paid back, the commercial bank money disappears from existence. To regulate this process governments have created central banks that control how many new loans can be created. This aspect of fractional reserve banking is what leads to criticisms of the system."

i- The first sentence is true but that's not the system's purpose. ii- The distinction between central bank money and commercial bank money can be helpful at some point but not in the purpose section. iii- And the last paragraph makes little sense if any at all; "money creation" is not contingent on whether loans are supplied with central bank money or not, and governments have not created central banks mainly to regulate this process. I will add cn tags while this discussion is carried. --Childhood's End (talk) 14:39, 22 January 2008 (UTC)

I agree that the name of the section does not match its content, but I do not see why that is a reason to delete the content. Just change the name of the section to match the content. In response to your third point, I agree that central bank money or commercial bank money can be used to create commercial bank money. In response to your third comment, most "money creation" in a fractional reserve system is from the money multiplier effect, and if the central bank's purpose does not involve regulation of the money supply, then what is its purpose?

In response to your recent edits, please understand that this section is not a contrast of full-reserve banking; however, I do agree that banking system elements not exclusive to fractional reserve banking should be moved to the appropriate article on banking. That entire last sentence should be moved to the criticism section or deleted.

I remember this section with much more citation with explanation within the citation. I guess it got deleted. I will look for it when I have time. --EGeek (talk) 20:02, 22 January 2008 (UTC)

I created the purpose section and put that information in it because I think it's necessary to explain why fractional reserve banking exists in the first place. The Federal Reserve explains it pretty well with the quote I put in there but I thought it was incomplete without a little information on just what the creation of money involves. Fractional reserve banking creates a second type of money and I thought it would be a good idea to put in a quick summary of what this second type of money is right there in the purpose section, then show how it is created in the 'how it works' section. I've since created a subsection that shows the two types of money. I also changed 'purpose' to 'purpose and function' which I think is a little better. As far as the information about government regulations goes, I thought it would be necessary to point out because unregulated banks can still use fractional reserve lending. See free banking. And for the sentence about criticism, I thought it should be included because it's true that some people don't believe in government regulations over businesses and banking is a private business. Also, since I noticed a lot of discussion about what the criticisms are and since this seems to be a controversial topic, I figured a quick summary of the criticisms would help things out. The information I added about the 3 functions that fractional reserve banking provides helps to clarify things and I think it's better to keep it there for simplicity and clarity. My goal was to be both as brief and as thorough as possible and I think this is apparent since a lot of information is summarized in that small section. Analoguni (talk) 23:17, 26 January 2008 (UTC)

Should Reserve requirement merge into this article?

Sorry if I am entering really late, but the two articles deserve separate spaces, beacause:

One is a system with a structure and the other is a property. Treatment has to be different and it'll be hard to frame an article to accomodate both (I believe the above topics spring from this difficulty).
Both have their own history and complexities.
Both are different at different places (in the world).

One again, sorry if I am entering this discussion too late, and what I mentioned has already been gone over. Nshuks7 (talk) 19:33, 26 January 2008 (UTC)

Two articles sounds like a good idea to me. What do others think? Orangedolphin (talk) 00:56, 27 January 2008 (UTC)

what 2 articles are you referring to? What is the system with structure and what is the property? Analoguni (talk) 03:30, 27 January 2008 (UTC)

I love riddles! Okay, one is a "system" and the other is a "property", and both are treated differently. Both have separate histories. Both are different in different areas of the world. I want to say fractional reserve banking and money supply, but both of those already have articles. What are the two articles? --EGeek (talk) 05:35, 27 January 2008 (UTC)

Proposal for merger of Fractional-reserve banking and Reserve requirement redirects here, to this talk page. In that context. Nshuks7 (talk) 06:34, 27 January 2008 (UTC)

Okay, I fixed the discuss link so that it redirects to this section. I also agree on two separate articles. --EGeek (talk) 07:36, 27 January 2008 (UTC)

I actually thought you meant we should have two articles for the alternative views on FRB. One could be the "mainstream" view and the other could be the Libertarian/Rothbard interpretation. Anybody think this is a good idea? Orangedolphin (talk) 11:19, 27 January 2008 (UTC)

I would support - this would allow us to have one core article, and then another that split off all the different interpretations, that was clearly identified as non-mainstream. There have been too many POV forks under quasi-respectable names (more editors on Monetary policy of the USA would be helpful, for example).--Gregalton (talk) 14:09, 27 January 2008 (UTC)

I think that this article can be maintained as a single article with both views being covered. It simply needs a big cleanup (especially sections 3 to 8 imo) and some more info/clarifications on the core rather than on the "examples". --Childhood's End (talk) 14:49, 31 January 2008 (UTC)

Is there a template for articles of this category? We should stick to a template. If there is no template, different sections for definitions, machinations, explanations, examples and critical views should suffice to give structure to this otherwise chaotic article. Nshuks7 (talk) 11:47, 7 February 2008 (UTC)

Numismatics Template

I do not think this article should be included in Numismatics. A banking system is more about finance than it is currency and coins. Even the money creation effect of fractional reserve banking does not create currency and coins. --EGeek (talk) 01:34, 24 February 2008 (UTC)

Agreed. Take it off! S B H arris 01:50, 24 February 2008 (UTC)

I think it is related because of the description on the Numismatics article:

Numismatics is the scientific study of currency and its history in all its varied forms. While numismatists are often characterized as students or collectors of coins, the discipline also includes a much larger study of payment media used to resolve debts and the exchange of goods

Since this description includes payment media and commercial bank money is payment media, commercial bank money is a part of numismatics. This is reinforced by some of the references about commercial bank money in the frational-reserve banking article:

"At the beginning of the 20th almost the totality of retail payments were made in central bank money. Over time, this monopoly came to be shared with commercial banks, when deposits and their transfer via checks and giros became widely accepted. Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. While transaction costs in commercial bank money were shrinking, cashless payment instruments became increasingly used, at the expense of banknotes". Source: European Central Bank - Domestic payments in Euroland: commercial and central bank money: http://www.ecb.int/press/key/date/2000/html/sp001109_2.en.html

And then there's the report from the Bank for International Settlements:

"But the central bank is not the only issuer of money in an economy. The multiplicity both of issuers of money and of payment mechanisms is a common feature in all developed economies. Commercial banks are the other primary issuers, their liabilities (ie commercial bank money) representing in fact most of the stock of money. A healthy, competitive commercial banking market is seen as an essential element of an efficient and effective economy."

"Thus central bank and commercial bank money coexist in a modern economy. Confidence in commercial bank money lies in the ability of commercial banks to convert their sight liabilities into the money of another commercial bank and/or into central bank money upon demand of their clients. In turn, confidence in central bank money rests in the ability of the central bank to maintain the value of the stock of currency as a whole (ie not only of the small portion it issues directly), or its inverse, to maintain price stability." Source: Bank for International Settlements - The Role of Central Bank Money in Payment Systems. http://www.bis.org/publ/cpss55.pdf

But it would probably be better to have this debate on the "Numismatics" page instead of this page. I figured that since fractional reseve banking is so fundamental to modern economics there should be at least one template in a wikiproject that this article belongs in. Perhaps there is a better one for it or maybe it could be a part of several projects. This subject is too fundamental to economics to be left out of other projects. Analoguni (talk) 06:12, 24 February 2008 (UTC)

P.S., In case some of you didn't notice, these are also references to information that was removed from the article. It was in the description after the table that showed how fractional reserve lending works. There weren't requests for citations, it was just removed. Well, here are the sources. Analoguni (talk) 06:23, 24 February 2008 (UTC)

The Numismatics only describes physical medias of payment. Commercial bank money is not a physical form of payment. The article even refers to stocks and bonds only in their physical certificate form. I also disagree with including a numismatics template only because commercial or central bank money is mentioned in this article. This article is on a financial system, not currency. If you think this article needs a template of some sort, then use a banking or financial template. It makes more sense than the current Numismatics template.

Precisely. Save the numismatic template for the Banknote page which covers physical manifestations of commercial bank debt-money, used as currency. THIS article is about the system of banking, not the nitty-gritty mechanics of it. There's no more reason to talk about numismatics here than there is to talk about ATMs or timelock vaults. S B H arris 06:19, 25 February 2008 (UTC)

P.S. Editors do not have to ask for sources before removing unsourced material. It is best to include the citations when new material is added. See WP:V--EGeek (talk) 19:24, 24 February 2008 (UTC)

I changed it to 'finance' which is probably more appropriate. As for removing unsourced material, wikipedia policy does say that the burden is on the editor so I guess that's fair. Analoguni (talk) 21:34, 24 February 2008 (UTC)

No, it's not fair. Challenging unsourced material you don't believe, is what {{fact}} tags are for. They produce that ^{[citation needed]} note in the text and give people time to come up with a source. If you simply deleted all unsourced material in Wikipedia you'd destroy large parts of good articles, and piss off everybody. So don't do that. If it's a reasonable statement and unsourced, you have an obligation to improve, not delete. Simply deleting, as "unsourced," a statement without at least a spirited TALK defense of why you don't believe the statement and think it should go, is close to vandalism. S B H arris 06:14, 25 February 2008 (UTC)

Lead definition

I agree that the deposits in a bank do not belong to that bank. I also understand that banks can use these deposits for more than "financing borrows"; however, the phrase "to their own ends" is too vague to explain this function. The original source cited states, "to finance profitable but illiquid investments", so I will use that instead. --EGeek (talk) 20:04, 21 February 2008 (UTC)

I really disagree. The bank can use the money to whatever ends it wishes and is not restrained to finance investments. And it can use it to non-profitable projects if it wants; another problem with the sentence you propose. The bank can also invest it internally in its information systems, buy back shares, and who knows what else. "To their own ends" may be vague but is the only acceptable description, unless you can suggest something else that I cannot think of. --Childhood's End (talk) 21:55, 21 February 2008 (UTC)

The statement does not make a distinction between internal or external investments. So investment into the firm, such as investment into information systems, still works with the statement in the source. While profitable investments are normally preferred due to risk, I will agree that profitability does not matter for a general definition of fractional reserve banking. --EGeek (talk) 01:17, 22 February 2008 (UTC)

The statement focuses on a few possibilities which are not necessarily more important than others. Even financing borrowers seems to me questionable as an example in the intro since this is not necessarily the core business in times of high interest rates, but I suppose it's the best example. The more accurate way to describe the system in a short sentence is to describe it for what it is; i.e. banks can use the money to whatever ends they want. Besides, the statement in the source says no more than in FR, deposits can be used to finance illiquid investments. It does not say this is an important function. See below. --Childhood's End (talk) 02:07, 22 February 2008 (UTC)

If you disagree with the examples I gave, then we can add to or modify them; however, I do not think we should list every type of investment. Yes, the citation does not elaborate on the importance of fractional reserve banking; it only defines it. --EGeek (talk) 02:11, 23 February 2008 (UTC)

Besides, the book you point to as a reference appears to be quite interesting. But I do not find the quote in it. --Childhood's End (talk) 22:10, 21 February 2008 (UTC)

See page 20 under "Liquidity Insurance" about midway down starting with "This is the basis for the 'fractional reserve system,' in which..." -EGeek (talk) 01:17, 22 February 2008 (UTC)

Got it, thanks. But the "basis" of the system refers to what comes before this sentence (total cash reserve needed increases less than proportionnaly with N...). --Childhood's End (talk) 01:50, 22 February 2008 (UTC)

I object to the phrasing "to whatever ends they want." This sounds biased to me, as if the banks can spend it on liquor and fast cars. In most jurisdictions, there are considerable prudential regulations, and the essence of the business of banking is that they finance longer-term, less liquid assets (with higher return than shorter-term, liquid assets) while attempting to keep exactly the right amount of liquid assets for customer demand. This is not "whatever ends they want." (In other words, liquor and fast cars comes after)--Gregalton (talk) 07:14, 22 February 2008 (UTC)

What prevents a bank from buying cars or liquors is its board and its internal management. Not the fractional-banking system. Unless you want to add "to whatever ends they want as authorized by the board" (which would be adding the obvious) there is no bias in this sentence; any reader understands that a bank is not going to buy nuclear weapons with the deposited money. Dont be paranoiac... --Childhood's End (talk) 13:13, 22 February 2008 (UTC)

Besides, banks do buy liquors (for visiting clients) and cars (for their officers)... :) --Childhood's End (talk) 13:17, 22 February 2008 (UTC)

The author explains the reason why the system works (the total reserves required increases less than the total deposits), then defines the system (where banks can use a fraction of these deposits "to finance profitable but illiquid investments."). For an encyclopedia, the subject should be defined first. --EGeek (talk) 02:17, 23 February 2008 (UTC)

I prefer EGeek's formulation. As for paranoiac, I think we should be extra cautious when the topic is a favourite of conspiracy theorists. What "any reader" understands is a point belied by the outlandish claims of many internet sites, and the frequent seizing of matters that are largely considered non-issues in mainstream economics, and so I'd argue there is a need to be extra cautious in establishing neutral phrasing. A bank that spent "on whatever they wanted" - without regard to prudential, etc - would no longer be fractional reserve banking, but simply a pyramid scheme.

I could argue about the fractional reserve part; the 'fractional' depends on its license, and hence on prudential regulations. At any rate, I reiterate the point that I don't believe the phrasing you're proposing comes across as neutral as it could and should be.--Gregalton (talk) 13:28, 22 February 2008 (UTC)

I really cannot see what is not neutral in a sentence that is accurate. The bank is free to invest or spend the money wherever it deems wiser. Not only is it misleading to point to a few specific examples, but it is also misleading to not mention the fact that the bank is not restrained.

The existence of conspiracy theorists should not force us to lower the standards of this article, nor to make it inaccurate or misleading.

Prudential guidelines do not monitor want banks do with the funds in the sense of what this sentence looks for; to suggest this would be misleading or would require long explanations. Banks usually have top-notch boards and officers, and this is where the internal controls are set. If you think a mention of this should be added, fine, but I really think it amounts to stating the obvious. --Childhood's End (talk) 13:46, 22 February 2008 (UTC)

Actually they are quite restrained in terms of asset type and quality, and particularly how it affects capital adequacy ratio. In other words, they cannot invest in "whatever they want." I don't think using EGeek's more neutral language is inaccurate or misleading. And this is in no way "lowering standards" due to conspiracy theories; it's simply avoiding loaded terminology.--Gregalton (talk) 13:55, 22 February 2008 (UTC)

Hey no, no, no! Capital requirements of banks restrain them in no way in what kind of investments banks can make. It only restrain them in their portfolio distribution. Of course a bank could not invest all its funds in junk bonds, but it can invest in junk bonds, and all banks actually do so. Riskier investments provide higher yield returns, and banks would strongly oppose any regulation that would prohibit them from investing in BB-rated debt for instance. --Childhood's End (talk) 14:30, 22 February 2008 (UTC)

Of course. But that is not "to whatever ends they want." Severe restrictions in investing in equity, real estate, and a number of others, depending on jurisdiction. At any rate, I don't think we are disagreeing on substance much - I'm simply saying the phrase sounds biased and odd to me, and alternative phrasings would (IMO) be better. We wouldn't say about any other company that they can borrow funds "and invest it to their own ends." As you put it, it's stating the obvious.--Gregalton (talk) 15:01, 22 February 2008 (UTC)

What makes it not so obvious here is that we're talking about funds that are not the bank's propriety. The ability to use such funds is not common to other companies.

True that in a sense, banks cannot invest in "whatever they want" but that's not what the sentence says. I wonder what you think is biaised in saying that banks can use the funds "to their own ends". I would perhaps understand a part of your concern if it said "to whatever ends" but "to their own ends" simply states the facts without being loaded, imo. If you want, we can work on adding qualifiers about the existence of internal controls and portfolio limits which are made necessary in part by regulatory guidelines and also by good business practices, accounting standards, shareholder accountabiliy and client demands, but to reach something that is accurate would probably be more complicated than anything else for the purpose of a short intro. --Childhood's End (talk) 16:08, 22 February 2008 (UTC)

I thought of something. Do you think that "to ends of their chosing" would be slightly better? --Childhood's End (talk) 16:09, 22 February 2008 (UTC)

Please give a reasonable example of what else the bank can do with deposits that differs from a bank that reserves all of its deposits. I provided a textbook source and directly quoted that source; however, you are still not satisfied. --EGeek (talk) 02:35, 23 February 2008 (UTC)

Almost all firms borrow money, and then do things with it - that borrowed money is not their property. And other companies that borrow money also use those funds to ends of their choosing.

I'll think on it;the more I look at this the more it seems to me the point is that it is a system effect, not a bank effect. So I don't have a better suggestion right now.--Gregalton (talk) 17:08, 22 February 2008 (UTC)

You're mixing apples with oranges then. The usual purpose of a loan is to allow the borrower to use it to his own ends. But the usual purpose of a deposit is safekeeping - if you deposit money in a trust, for instance, the trust may not use it as a bank is allowed to. This is really a banking privilege. --Childhood's End (talk) 18:04, 22 February 2008 (UTC)

No. Just because a "deposit" to an interest-generating account uses the same WORD as a deposit to a safe-deposit box (say) doesn't mean they are the same action. When you get paid interest on money you "deposit" into a savings account, it is understood that you're being paid for the use of that money by the bank, as loans. Deposits into a deposit box return no such interest, and are clearly just safe-keeping. S B H arris 06:46, 23 February 2008 (UTC)

Please re-read your legal books. Bank deposits or deposits in another fashion are considered "deposits" by law, not by you or me. The first obligation a bank has towards a deposit is not to invest it, it is to safekeep it. The banks have the privilege to use the money, and accounting practices allow for double-entry bookkeeping, etc., but deposits to a bank fall under the legal concept of "deposit". --Childhood's End (talk) 15:46, 23 February 2008 (UTC)

Ummm - so what? It's still a loan in economic terms; just a loan with special features. I agree with Sbharris: some people may think it's like a safe deposit, but it is a loan; and I think most people who think about it understand that distinction. (In fact, I think one could also argue that many don't trust the theoretical difference between a trust account (where it is technically off-balance sheet) and a deposit account - because they would also understand that that money also tends to get deposited with a bank, and generally a bank within the same group.)--Gregalton (talk) 15:58, 23 February 2008 (UTC)

It's like a loan in economic terms, but it's not a loan legally. This is what causes all the confusion among profanes and brings you to think deposits are "loans". They're treated as loans by banks, but that's not what they are, and banks are well aware of this. --Childhood's End (talk) 20:53, 23 February 2008 (UTC)

Not being a lawyer and hence one of the "profane", clearly my non-sacred thinking counts for little. However, my reading of at least some of the credible legal material on bank deposits would suggest a bank deposit is a special type of loan, but a loan nonetheless. See page 85: "Such solutions do not undermine the objective character of the bank deposit as a loan transaction...a special type of loan." But I'm not about to engage in Talmudic debate about this.--Gregalton (talk) 11:58, 24 February 2008 (UTC)

Sourced material vs. "accurate" material

Please do not revert sourced material to "accurate" material without backing it up with your own source. The context of your recent change does not match the source provided, so please change it back unless you can provide an appropriate source to replace it. --EGeek (talk) 02:25, 23 February 2008 (UTC)

First, your source does not say that in fractional-reserve banking, the only use banks can make of the deposits is "to finance profitable but illiquid investments" as you try to put it. It is given as an example. If, on the other hand, you can find a source that says this is the only use possible, or that banks cannot use the deposits to their own ends, I'll bow to your position. Second, let's try not to rely to random sources to try to fashion things out a certain way. Sources are needed for challengeable content. If you can challenge that banks can use the deposits to their own ends, please do, I'm all eyes. --Childhood's End (talk) 03:58, 23 February 2008 (UTC)

This is the direct quote from the source:

"This is the basis for the 'fractional reserve system,' in which some fraction of the deposits can be used to finance profitable but illiquid investments."</block>This is the statement that you reverted from:
Fractional-reserve banking refers to a financial system where banks can use a fraction of the deposits that they accept from depositors "to finance profitable but illiquid investments."
To this:
Fractional-reserve banking refers to a financial system where banks can use a fraction of the deposits that they accept to their own ends, such as financing borrowers.
Your statement is obviously not what is stated in the source. It is your burden to prove your statement with a source, not mine. It does not matter if your statement is "accurate", but it has to be verifiable. I will change the statement to directly quote the source, now. Again. The burden of proof is on you alone because you made the change. Provide a source if you change this statement again. --EGeek (talk) 06:34, 23 February 2008 (UTC)

There's a better definition in the cited book page 194, section 7.2: Fractional reserve banking is defined as "...a system in which the bank collects the endowments of consumers (deposits), and invests a fraction of them in long-term investments while offering depositors the possibility of withdrawal on demand." Is that acceptable to all for a LEAD? S B H arris 07:00, 23 February 2008 (UTC)

This is a good book, I'm not saying it's a bad source. The problem with these quotes is that they happen to focus only on the possibility, for the banks, to invest in long-term or "illiquid" investments while it is not true that this is the sole use the banks make of the money. They can lend it short-term, they can invest in BB, B, CCC bonds, etc., it's really up to them, and the description has to reflect this. We are not bound to use a quote from a source that we know is incomplete only because "it's from a source"... --Childhood's End (talk) 15:38, 23 February 2008 (UTC)

The point of illiquidity is not that they are absolutely long-term or illiquid, but relatively long-term or illiquid - that is, compared to the (theoretical) due date of the deposit base - instantaneous.

I prefer sbharris' version, and don't believe it's incomplete or inaccurate. If we wanted to get the balance, we could specify "invests in a fraction in investments that are long-term and illiquid relative to the legal term and maturity of the deposit base."--Gregalton (talk) 15:58, 23 February 2008 (UTC)

Here's a NYT reader who understands the business [6]. And here's a source that says that banks can use the money for their internal expenses [7] (see pp. 55-56). We should not use a partially complete quote from a random source to push some incomplete idea; we have to focus on accuracy. Again, if you can challenge that banks can use the money "to their own ends", do so now by showing your argument. But stop trying to obscure things for some obscure reason, this is getting time-wasting and most annoying now. I agree that the most commonly understood use that banks make of the money is lending it, and that's why I gave it as a specific example. But to suggest that this is the only use banks make of it is misleading. --Childhood's End (talk) 16:03, 23 February 2008 (UTC)

What's annoying is misusing sources: the second says "banks use the money deposited with them to lend to borrowers. They charge interest, and use this money to pay their expenses." The second sentence is clearly talking about using the interest, not the deposits, to pay expenses. Your first source is speaking about insured deposits; not all deposits are insured. If you're going to be strident and accusatory, at least have the courtesy to not misrepresent your own sources when blathering on about accuracy.

Perhaps you could explain why this obscure point of yours is so important to include in the lead?--Gregalton (talk) 16:15, 23 February 2008 (UTC)

True about this source, apologies. I read it fast as I am tired of spending time here to explain things again and again. As to insured deposits, most are, and those who are not are not really the point of this debate.

Sorry about my tone, but right now I feel there is some fringe revolution going on here, and I cant see the rationale behind it and why we should suggest that banks are restrained to use the money to "finance profitable but illiquid investments". This is clearly incorrect. I have no obscure point to make; I have explained more than one time why I think the lead is inappropriate right now. Banks are not restrained to use them for what the lead suggests according to EGeek's version. This is unchallengeable and does not come from some cherry-picked quote from a cherry-picked source. --Childhood's End (talk) 16:57, 23 February 2008 (UTC)

Okay the major use for deposits is in investments which are "relatively illiquid" and "relatively long term" with regard what the depositor's "sees", which is an account from which he/she can get any or all of his money any time, on demand (all banks have maximal rate withdrawal restrictions for large sums, much larger at the teller-window than ATM maz rates, but still legally in place. However, banks waive these except in temporary emergencies). So anything more illiquid than "have it available pronto for demand payment," counts as "illiquid." And yes, banks can use the interest from the deposit (since they are legally required to eventually return the base value of the deposit, more or less on demand) in any way they like. Example: some checking accounts pay interest, but most do not. However, the money in them is a deposit to the bank in every way, and generates interest for the bank, since the bank uses (a fraction of) that money for investment, also. What does it do with that interest money (and with the principal, also until you ask for it by writing a check against it which somebody presents)? It uses it to pay for the services associated with "free checking", for one thing. And for a bunch of other bank operating expenses. It's bank income, and can be directed anywhere. Which is why all educated adults know that they're losing out if they keep more than a few thousand dollars in a checking account, vs. doing something with the money which has a better return rate. But are all these qualifications necessary in the LEAD? Use of interest at the bank's pleasure is TRUE, but fails to communicate that most of the bank's pleasure, and need, is to move as much of the the money as it can, to uses where it generates interest for the bank's profit (obviously tricky, since the interest-returns to the bank vary with directly the illiquidity of the investment, which is why timed-deposit/money market accounts exist). How the bank divies up that provit into interest paid to the depositor, vs. operation of the bank, will vary according to the bank. It's something to be disussed later on. However, are we really in disagreement with the basic facts?

Look, we all know why it takes checks days to "clear" and the money to show up in accounts, even checks from other banks. And yet your credit available on your credit card decreases within seconds after you make a purchase (log in and see). Nobody's fooling anybody. It doesn't take a bank that long to electronically "see" if a check from another bank is good. But it wants to hang on to the money a few days more, since it profits from every second it hangs onto it, and during which it's not available to YOU. There's a delay in getting cash out of a bank at every step which the bank can think of putting one in. S B H arris 19:44, 23 February 2008 (UTC)

Where exactly are you going with this? I remember reading some similar stuff during college in my banking law classes, and thanks for showing that you know some very basics of banking services, but this is a non sequitur. Banks are not only allowed to use the interests; they'are allowed to use the deposits as well in other venues than 'illiquid investments', and that's where the current lead is misleading. --Childhood's End (talk) 20:25, 23 February 2008 (UTC)

I have no problem with your argument over long-term vs. short-term, liquidity, or even profitability. I do have a problem with your argument over investment. You have yet to provide an example of where the bank uses deposits to finance something other than an investment. Your statements "to their own ends" and "to ends of their choosing" are too vague and not informative. I do not see a reason to replace "investment" with your vague, uninformative statement until an appropriate example is presented that shows that "investment" is not correct. --EGeek (talk) 01:56, 24 February 2008 (UTC)

I believe that the word everyone is looking for is "stuff":

Fractional-reserve banking refers to a financial system in which some fraction of the deposits can be used to finance stuff. :P Analoguni (talk) 21:15, 23 February 2008 (UTC)

It's actually more accurate. Only unencyclopedic... --Childhood's End (talk) 21:18, 23 February 2008 (UTC)

I don't see what it is you want. A bank can do indeed do anything legally with the deposits, including buy the president a Lambourghini and a gold toilet seat. But if they're smart, they don't. All this has been complicated by insurance, which tends to encourage fools. Banks are required by law to keep a fraction of the deposits in reserve against immediate demand; I have the feeling that this is less to protect depositors nowadays than to protect the FDIC and various lenders of last resort. Since otherwise the banks would lend it all out to buy crazy immediately-high-paying schemes like "AAA-bonds" backed by subprime mortgages, and then scream about liquiditity and need for lower Fed rates, when the pyramid-schemes quit running.

Oh, wait-- they did that. Well, at least without SOME fractional reserve requirement, it would have been even worse. S B H arris 01:09, 24 February 2008 (UTC)

You're actually beginning to get the point. Now, just imagine for one second that banks can also buy CCC bonds. Oh wait, they can and they do every day. --Childhood's End (talk) 14:42, 25 February 2008 (UTC)

Actually, there are limits on using deposits for liquor and lap dances - namely, if the bank doesn't have assets sufficient to cover deposits, it would run into major regulatory issues in very short order. So it can effectively pay for expenses only out of earnings and other components of owners' equity (capital). The problem is the old chestnut that "money is fungible" - no way to distinguish which money is being used for what.--Gregalton (talk) 12:03, 24 February 2008 (UTC)

Regulations are nation-specific and stray away from the concept of fractional-reserve banking. Analoguni (talk) 01:09, 25 February 2008 (UTC)

I cannot spend more time on this so I'll let you have the article as you like it instead of as it should be, because it would be "vague" (as if this was wrong). Fractional-reserve banking is, before anything else, a legal issue - it doesnt exist without its legal framework. EGeek's has no legal source whatsoever to support that banks are restrained to use the money "to finance profitable but illiquid investments" as the lead now suggests (as if the bank can know for certain in advance whether an indvestment will be profitable...). That is because the law actually allows banks to use the money in non-profitable investments, or in non-investment venues, and it is how it should be. According to all rating agencies, bonds rated BB or lower are non-investment grade; thanks to reality rather than EGeek's excellent book, banks can buy them nonetheless. Banks lose money every day in various undertakings. They make profits on the overall result of their different portfolios (consumer loans, commercial lending, treasury, etc.) and lines of business. I dont understand what the problem is in acknowleding that. --Childhood's End (talk) 14:42, 25 February 2008 (UTC)

Include the worldwide importance of fractional-reserve banking

Since fractional-reserve banking is the basis for financial systems worldwide, I think it would be necessary to include information about this in the intro. Analoguni (talk) 00:29, 25 February 2008 (UTC)

I do not consider worldwide use of fractional-reserve banking synonymous with its worldwide importance. There is also evidence on the Full-reserve banking and Islamic banking articles that not all banking systems in the world use fractional-reserve banking. --EGeek (talk) 01:18, 25 February 2008 (UTC)

At least include something of it's significance. For example, the Federal Reserve was founded as a direct result of fractional-reserve banking. Central banks around the world were founded because of fractional-reserve banking. I think some info on the significance of it would be appropriate and necessary. The euro and the dollar are the major world currencies and are affected by this system. This is a fundamental aspect of global finance so not mentioning this significance would make this article incomplete. Analoguni (talk) 01:35, 25 February 2008 (UTC)

The lead should not add anything more to the article. It should be a summary of the article. A short explanation of the fractional-reserve system's link to bank runs and the money multiplier as well as the criticism that the subject enjoys would work well. --EGeek (talk) 04:48, 25 February 2008 (UTC)

While I don't think it's necessary to have it in the lead, the evidence on full-reserve banking and Islamic banking is weak - most reviews I've seen have said that they are "in principle" full-reserve, but rarely in practice - just like Islamic banking is not supposed to have interest, almost every analysis says something like "if it looks like, smells like, acts like and tastes like interest - even if it's called something else - it's interest.--Gregalton (talk) 08:18, 25 February 2008 (UTC)

Definitions from other sources

I figure that definitions other sources use should help. Here are a few.

A banking system in which only a fraction of the total deposits managed by a bank must be kept in reserve. The amount of the deposits equals the amount of the reserves times the deposit multiplier. In the U.S., this system is maintained by the Federal Reserve Board. Source: http://www.investorwords.com/5581/fractional_reserve_banking.html
Monetary policy at the basis of the modern banking system. Under FRS, banks are required to hold only a fraction (typically 12 percent) of the depositors' funds as cash reserves. The remaining 88 percent of deposited funds can be loaned out to create new deposits which in turn create new loans ... and so on, exerting a multiplier effect on the total money supply. However, in case of a bank run, this policy can cause banks to suffer huge losses and may even push them into bankruptcy. Source: http://www.businessdictionary.com/definition/fractional-reserve-system-FRS.html

Definition of credit on the same site: Purchasing power created by banks through lending based on fractional reserve system. Banks literally 'create' money with their bookkeeping entries. Source: http://www.businessdictionary.com/definition/credit.html

A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Most countries operate under this type of system. Many U.S. banks were forced to shut down during the Great Depression because so many people attempted to withdraw assets at the same time. Today there are many safeguards in place to prevent such an instance from occurring again, but the fractional-reserve banking system remains in place. Source: http://www.investopedia.com/terms/f/fractionalreservebanking.asp
In a fractional-reserve banking system, banks hold a fraction of the money deposited as reserves and lend out the rest. Reserves are deposits that banks have received but have not loaned out. Source: http://www.whcbridge.com/ec7290.html
The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income. Some reserves support savings accounts and time deposits (deposits which earn interest but don’t allow you to write cheques on). Banking evolved so as to also permit a fractional reserve for “checkable deposits”. The majority of world banking systems today follow this model of fractional banking. Source: http://www.bankintroductions.com/definition.html

There is also a definition of full-reserve banking:

a full reserve bank is a bank that backs up all its loans and deposits with 100% of the funds promised to others, also called bank reserves. On the face of the definition, this would appear to be the same thing as today’s banking system, but it isn’t. Today’s banking system is called a fractional reserve banking system. The difference between a fractional reserve and a full reserve is huge. In the simplest terms, a fractional reserve bank is allowed to promise the same money to two people at the same time. Source: http://www.fullreservebanking.com/what-is-full-reserve-banking/definition-of-full-reserve-banking/

Analoguni (talk) 21:36, 5 March 2008 (UTC)

Good work, plenty of better material than what's currently in the lead. My choice would be "The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income." --Childhood's End (talk) 00:55, 6 March 2008 (UTC)

The lead is too small.

Single sentences are inappropriate and it uses technical terms which aren't appropriately explained.

I expanded it. For any gold bugs here or for Karmaisking's sockpuppets which have yet to be caught, this:

In other words, fractional-reserve banking is a form of banking where banks are only required to hold a fraction of customers' deposits in reserve, as opposed to full-reserve banking, where banks must hold 100% of all customers' deposits, or free banking, where there is no legal requirement for banks to hold any reserves at all.

is just a non-technical reiteration of the first sentence and doesn't need to be sourced.

This is common knowledge:

Virtually every modern banking institution in the world today uses fractional-reserve banking.

And thus doesn't need to be sourced either. Thanks. ☯ Zenwhat (talk) 22:11, 7 March 2008 (UTC)

This last sentence needs to be sourced. It's usually true in Western economies, but Wikipedia must hold a worldwide perspective. --Childhood's End (talk) 13:21, 13 March 2008 (UTC)

Okay, just... stop it

Banks are required to keep 10% of deposits "On reserve" in case of a run. They are allowed to lend out ten times this 10%, or 100%. This is not 1,000%, and it never was. See: http://www.fdic.gov/regulations/index.html Sim 05:51, 1 February 2007 (UTC)

The can loan out 1000% of their reserve, which is 100% of their deposits. The 1000% number is correct, it just needs to be clear what number they are referring to. Paladinwannabe2 14:29, 26 June 2007 (UTC)

"If a bank has $100 in reserves, with a 10% reserve ratio, it can lend out $90. That $90 is then paid into another bank, which can similarly lend out 10% ($81) on that $90 deposit. That $81 dollars also winds up in a bank, and the bank can then lend out 90% of that, and so on. The banks are lending based on money that has itself already been lent, many times over, in a series of decreasing amounts, until the amount becomes to small to practically lend. By that time, a total of $900 has been lent in total. Including the original deposit, $1000 now exists where there was once just $100.

It may be that this process happens within just one bank (because they cannot recognise the money as originating with them), or it may happen within many. The system continues to operate on a large scale as long as money continues to flow in and out of banks."

Can I please suggest using the above example of the way money is created through FRB to be put at the beginning of the article? It is simple and gives the layman a solid background. As it stands, this article is very difficult to penetrate and appears to contradict itself.

202.130.159.184 10:14, 21 September 2007 (UTC)

it is a reserve RATIO not percentage. i believe it is 1:9 in the us currently.

thus you deposit ten dollars, they may use this as a reserve and lend 90.

10:90

reserve:check book money —Preceding unsigned comment added by 91.110.58.90 (talk) 16:17, 15 December 2007 (UTC)

The bank does not lend from its reserves; it lends from its deposits (or other sources). The reserves are a fraction of the bank's deposits that it is required to keep as a risk management policy. Thus, it is wrong to suggest that "If a bank has $100 in reserves, with a 10% reserve ratio, it can lend out $90". It would rather be "if a bank has 100$ in deposits, with a 10% reserve ratio, it can lend out 90$". Then what happens to this 90$ really depends on what the borrower does with it. If he deposits it (makes little sense because he loses on the interest margin), then yes, the next bank must keep 10% reserve (9$) and can lend the other 90% (81$), a process that "created" virtual money (171$ lent out of a 100$ initial deposit). But if he, for instance, invests it or lends it, the forthcoming events are quite different. --Childhood's End (talk) 16:11, 21 January 2008 (UTC)

If banks needed deposits to make loans it would be like full-reserve banking. Deposits are not a loan to the bank and are not required for lending. Why doesn't the Federal Reserve Act mention that a bank needs to use deposits to make loans? Orangedolphin (talk) 20:34, 15 March 2008 (UTC)

What happens with the money that has been invested or lend? Does it not go into a bank again?--Rougieux (talk) 17:52, 14 February 2008 (UTC)

It might if it's invested in bank shares, but that would not be a deposit and would instead add to the bank's capital. If it's invested in another company's shares, it will add to this company's capital. If it's lent to entity X, then who knows what entity X will do with it, and so forth. --Childhood's End (talk) 19:36, 14 February 2008 (UTC)

I think the answer is that the money will be either placed in a bank account or spent. It may be spent on a house, a car, groceries, shares, foreign currency, gold, a work of art... or anything, including any investment. (There is no reason to distinguish between investing and spending: investing is simply buying something you expect to increase in value.) The seller will then either bank the money or spend it in turn. Unless a seller keeps the money in banknotes under the bed, it will eventually return to a bank, and if the payment was not in cash it will never leave the banking system. So, if we consider the entire banking system to be one big bank, the scenario where the borrower redeposits the money in the same account is an accurate, if simplified, model of the bigger picture.

In the example of bank shares, the money would only be added to the bank's capital if the shares were bought directly from the bank at their first issue. Most cases would be a simple purchase from a seller and would not affect the bank's capital in any way.89.243.99.97 (talk) 14:34, 28 March 2008 (UTC)

Lead: text suggestion

I find the current lead a bit weak. I have found this in the Bank Credit Analysis Handbook by Jonathan Golin (Wiley and Sons):

"The customary form of banking system prevalent worldwide in which banks need only keep a fraction of their deposits in reserve and may lend out the remainder."

Is this better?--Gregalton (talk) 12:12, 13 March 2008 (UTC)

Imo, the most accurate description so far that could be used for a lead has been suggested above : "The practice of holding (only) a portion of overall assets in cash or cash equivalents (required reserves) in order to meet short-term obligations immediately upon demand. Money which is not held in reserve is invested, usually loaned out so as to generate interest income" http://www.bankintroductions.com/definition.html --Childhood's End (talk) 13:24, 13 March 2008 (UTC)

Let's use that then.--Gregalton (talk) 14:09, 13 March 2008 (UTC)

Alright. --Childhood's End (talk) 14:21, 13 March 2008 (UTC)

I do not a problem with using this context, but is the source reliable? --EGeek (talk) 19:33, 13 March 2008 (UTC)

If we agree that the text is fine, there's no need for a source actually (except perhaps for copyright issues). Why? --Childhood's End (talk) 19:45, 13 March 2008 (UTC)

The problem is that this text is likely to be challenged; thus, the text must have a citation due to policy. Also, as you stated, there will be a copyright issue with this text even if we paraphrase. --EGeek (talk) 23:56, 13 March 2008 (UTC)

For the purposes of a lead, we can combine the two and cite. For example,

"The practice of keeping only a fraction of deposits in reserve (in cash or cash equivalents) in order to meet short-term obligations (withdrawals), while investing the remainder in loans and other assets so as to generate interest income. Fractional reserve banking is the customary form of banking system prevalent worldwide."

comments?--Gregalton (talk) 07:52, 14 March 2008 (UTC)

I like the first one by Jonathan Golin. It's simple and covers what I think are the main points. If there aren't copyright issues I would say to use that one. If that one doesn't work I think the last one above can be an alternative, but it may need a little fine-tuning. Analoguni (talk) 07:07, 19 March 2008 (UTC)

Please archive this page and restrict discusion

Wikipedia is not an appropriate venue for extended debate between "experts" nor for attempts to educate uninformed editors. Please archive this talk page and avoid extended discussion that is not constructive to this encyclopedia. Thank you. 64.181.90.43 (talk) 03:06, 29 March 2008 (UTC)

What? It's a talk page. where else do you want discussions between editors and authors to go? Protonk (talk) 07:40, 17 April 2008 (UTC)

Clarification

If the net redemption demands are unusually large, the bank will run low on reserves and will be forced to raise new funds from additional borrowings (e.g. by borrowing from the money market or using lines of credit held with other banks),

is "borrowing from the money market or using lines of credit held with other banks" different from borrowing from the central bank? Chendy (talk) 22:07, 9 April 2008 (UTC)

In my understanding, borrowing from the central bank is last recourse, although there may be other cases. Note that, except if the bank's liquidity crisis is due to bad management, it is likely that other banks face pressure on their liquidities when one does. It might then be difficult to borrow from the market. --Childhood's End (talk) 13:59, 10 April 2008 (UTC)

This is correct to the best of my understanding as well. I'd link you to an explanation from the fed's website but they are hopelessly pedantic.Protonk (talk) 07:27, 18 April 2008 (UTC)

Austrian soapboxing

What is this silliness?

The business cycle theory was recognized by the Royal Swedish Academy of Sciences, which awards the Nobel Prize in Economics [8], but is not universally accepted; at least one mainstream economist, Paul Krugman, considered it unworthy of serious study.

Austrian economics is not just "universally accepted." It's marginalized, because it's heterodox. The passage above treats it like mainstream economic theory, worthy of the Nobel Prize. The ABCT and the mainstream business cycle theory are literally contradictory to one another, because the former assumes a classic relationship between saving and borrowing, while the latter assumes Keynesian theories on interest that are so old and well-accepted (about 75 years now) that they're standard economics and taught in Econ 101.

There is no citation to support this, but there won't be. Just as you won't find a citation for the non-existence of unicorns in Biology. The reason (similar to the unicorns example) is that there is no dialogue between Austrian economists and mainstream economists, because the former reject the the modern scientific method in favor of ancient Greek philosophizing to the point that they're shunned.

Anyone here who disagrees, please cite any modern econ 101 textbook (I have my own I could cite) and just tell me: What, in the glossary, mentions Austrian economics? You won't find it. ☯ Zenwhat (talk) 22:21, 7 March 2008 (UTC)

Zenwhat's strange obsession with deleting Austrian economics from the face of planet earth continues...--Lagrandebanquesucre (talk) 06:42, 8 May 2008 (UTC)

His actions and motivations have been clearly explained: there seems to be an obsession in spamming Austrian points of view out of all proportion to their prevalence in academic studies.--Gregalton (talk) 07:06, 8 May 2008 (UTC)

M0

Correct me if I'm wrong, but doesn't most central bank money exist only as a digital record, rather than as actual paper and coins? <eleland/talkedits> 01:19, 10 May 2008 (UTC)

This section of the article is actually quite bad ("the cumulative effect" bit needs to be looked at, and the M1 definition does not look right). That said, both M0 and M1 are wikilinked and you can check in their main articles.--Gregalton (talk) 01:40, 10 May 2008 (UTC)

I think the "M" stuff would be covered better in a later section. The "how it works" section explains the theory and philosophy about how it works. Putting in the M0 and M1 stuff is useful, but I think it makes more sense to explain the general theory first then show later how it's applied to the money supply. Also, "central bank money" and "commercial bank money" are terms that are used by the Bank for International Settlements and the European Central Bank. Both of these sourced terms were removed and this section is turning into one that is about the money supply, which it partially is, but this is about fractional reserve banking first and it's under a section titled "how it works". Even though M0 is central bank money and M1 tends to be loans created with central bank money, this system of "M's" doesn't have to exist and it's not universal. Fractional reserve banking can exist without this "M" category system so I think it might be better to bring up the "M" stuff a little later and just stick to "central bank money" and "commercial bank money". It keeps it simpler and is easier to understand. Analoguni (talk) 00:41, 16 May 2008 (UTC)

Also, Gregaltron, I disagree with your assessment that this section is "quite bad". I can agree that it can use some more improvements but it is sourced and gets to the heart of what fractional reserve banking is all about. Saying that it is "quite bad" gives me the impression that it needs undergo a significant overhaul, which I don't think it does since it is sourced by the Federal Reseve, the Bank for International Settlements, and the European Central Bank. Analoguni (talk) 00:49, 16 May 2008 (UTC)

I do agree with Gregalton that "the cumulative effect" could be expanded upon. both the images [1] and [2] show currency increasing at something greater than linear. This is an artifact of Fractional-reserve banking and lending money at interest. --Zven (talk) 22:48, 16 May 2008 (UTC)

Unnecessary riddles!

The main article is full of riddles and deliberately confusing, even quoting a fractional reserve of 20%, when in fact it is 10% (even easier to calculate and far more profitable!); the "bank balance sheets" require even less (as currently being printed in financial newspapers 5% - 8%). This article is continuing making a very simple (scandalous) system into an unnecessary enigma (which is what the financial system does best). 10% fractional reserve is very easily to explain: £100 is leant by the central bank (BOE, Federal Reserve etc.), to commercial banks, who can then create £900 in loans (on the strength of the £100 they borrow!). They can then CHARGE INTEREST ON the full £900 (created out of thin air) not the initial £100 (go figure!). So, in fact, a person borrowing £900 for a year, who pays back the capital and interest at 5% will be paying £45 interest on the £100 (initial) central bank loan NOT THE £900 sum. The initial "£100" central bank loan was money (created out of thin air) borrowed by the government to pay for services not covered by taxation (usually a bond of some description - which pays interest to the buyer). The interest people are paying for money borrowed from banks (mortgages etc.) is just a hidden form of tax, with bankers taking a nice fat slice, colluding in the action. This example is simplified, but explains how money is created from thin air, but how it is controlled (from the top). Fiat currency (money backed by nothing but good will)is only good while it is trusted. We are now seeing 100 years of usury coming unraved, it is a flawed system for the majority. The result, when it finally collapses, will be mass starvation or the death and destruction due to (probably a global) war. While it lasts; enjoy the ride! —Preceding unsigned comment added by 79.121.186.28 (talk) 09:14, 17 July 2008 (UTC)

You're right. When editors continuously come to this page and think that fractional-reserve banking means that banks can make a £900 loan off of only £100, then the article is not communicating the principles of fractional-reserve banking very well. Before getting into the mathematical meat, fractional-reserve banking needs to be fully defined, because the readers are not getting it. --EGeek (talk) 20:29, 17 July 2008 (UTC)

Money Facts from U.S. subcommittee

I think Martycarbone was trying to add the entire section taken out of a subcommittee paper from 1964. [I was not trying to put up a Google book. Off hand I forget where I got the material I have on my site -- but I could probably dig it up again. Martycarbone (talk) 01:07, 7 August 2008 (UTC)] Considering its source, it seems reliable as a historical recollection. But considering content about goldsmiths are already included, [I do not understand where the blurb on Goldsmaiths is included Martycarbone (talk) 01:07, 7 August 2008 (UTC)]it might be better to only add it as a source to the existing content.[what existing content? I had no idea I was anywhere a "goldsmith" article Martycarbone (talk) 01:07, 7 August 2008 (UTC)] -- EGeek (talk) 04:56, 29 July 2008 (UTC)

[If you go to << http://www.howto-ville.com/abcmoneysupply.html >> You can read and copy the entire "MONEY FACTS / 169 Questions and Answers on Money -- A Supplement to A Primer on Money" at no charge.

" I could not tell because of the code? near the word "reliable" -- but did you write "it seems reliable"? In my opinion it is reliable. It and its companion documents are in my opinion the absolute best description of the Money System -- including Fractional Reserve Banking and Goldsmiths Martycarbone (talk) 01:07, 7 August 2008 (UTC)].

Question about fractional banking

I've read through the whole article, most of the talk page and a lot of the sources found here and from google and I still don't understand a simple basic aspect: Forgetting the "fractional reserve", is the bank allowed to lend more than it has(it's own money + money it has burrowed)? If the bank lend only currency, it physically couldn't - But most money can travel as "bank notes" or simply electronic.

If you keep the idea in your head that your checking account or a bank-issued bank-note, it is merely a receipt for some money held in safe-keeping by the bank. A fee would be charged for this service. This is properly known as deposit banking. The bank does not own that money, nor is it a loan to the bank. The commercial banks, however, muddy the waters by paying a very nominal amount of interest on that money so it looks like a loan. It cannot be a loan, however, as there is no defined term. Additionally, banks may charge various fees that exceed the interest paid. This is a demand-deposit, for safe-keeping only, hence the money deposited must be returned immediately on presentation of the bank-note or a cheque/check.

Banks (legally) can abuse their stewardship position, as a collection of depositors will not all withdraw their deposits at once. Thus, the banks do make use the deposits for their lending activities. Not only that, but if those who they lend to keep some or all the loaned-money within the same bank, or spend some their loaned-money with other bank clients who keep deposits at the same bank, then at least part the loan value returns to the bank as additional demand-deposits. This is where money is created. The original deposit-money is loaned, re-deposited, loaned, re-deposited, twice, thrice, etc. As you can see, in a bank-run, the bank cannot recall it's loans fast enough in order to return the deposits to the deposit holders.

The proper (and moral) way to offer loans (properly known as loan banking), is to offer interest to investors who willingly loan money to the bank for pre-defined terms. The bank then re-loans this loaned money at a greater interest rate. The banks then make money on the difference between the interest rate offered to the investor and the interest rate charged to the debtor. In this case, there cannot so easily be a bank-run, as the bank has some control of the repayment cycle to their investors. If the terms offered to investors are shorter than that offered to borrowers, it can still go pear-shaped if the bank cannot solicit new investor funds in a timely fashion. Of course in this system, money cannot so easily be created, since additional loans can only be made if additional investors funds are found. Commercial banks usually conduct business using a mix of these models, so the boundarys between the two systems can seem to become blurred. —Preceding unsigned comment added by Jonathan Rabbitt (talk • contribs) 00:30, 12 August 2008 (UTC)

So if I'm a bank and ALL I have is 100$ can I, considering the 10% reserve, lend somebody 1000$ by writing him a "bank note"?

Another example. I'm a bank and ALL I have at first is 0$. I then get a deposit from somebody, say John, of 100$ and I write John a "bank note" for it saying "100$". I than put the 100$ in my reserve and counting on it and considering the fact that I already have 100$ promised (to John) I can lend somebody else another fictional 900$ on a "bank note". Is this right?

I'm asking this because all the processes and tables in the article and in the talk above don't look like money "creation" because for the bank (or bank system) to get to "stage 2" (and lend 64$) it has to have the initial money (80$) it has lend come back to it as a deposit. So no extra money (currency or whatever) exists outside of the bank at any one time. The "free" money is actually less and less at every step as the bank reserves more.

When replying please keep things simple. Don't get into complicated explanations involving the Fed and other details. Leaving all details aside, is the answer to the above questions "yes"?

As a side note, somebody was arguing above that this discussion page shouldn't be about educating uninformed editors. I disagree. I think uninformed editors - like me - should stay away from the main article but should use the talk page as much as possible as this is the way the article can be steered by the folks who know this stuff towards it's intended audience: non-experts. On the other hand it would be great if non-experts would abstain from making positive, determined affirmations about things that they don't know enough about. A "maybe" put in front of a phrase can do wonders in figuring out what is certain and what is not. --Cosmin 20:48, 29 May 2008 (UTC)

I think in theory a commercial bank can only lend out a fraction of its deposit balance so in your example if the fractional reserve is 10% and $100 is deposited in the bank then it can only lend out $90. At this point you need to think of money recursively, you started in the closed world example with $100 in the system, now for every lender there is a borrower, money is spent in the system, and ultimately ends up in other banks where they can re-lend it to someone else. The sum of the recursive re-lending of money in theory is 1 over the factional reserve a 10 times multiplier on the money in the system creating $1000 (but in practice inefficiencies mean the real multiplier is less than that, somewhere around 8 times). This is the creation of money in the form of credit. Added to this issue is that interest is charged on all the money in the system each year. The act of lending money creates money, money disappears when someone pays back a debt. When times of credit expansion there is creation of wealth, in times of credit contraction there is destruction of wealth. --Zven (talk) 07:37, 29 May 2008 (UTC)

Let's keep this simple guys, so everyone can understand the basic idea of frb.

This is a common confusion and people get so puzzled by the creation of money out of thin air or from "nothing". It is incorrect that banks lend more than they have on deposit. People get confused because they focus on the numbers and don't realise it's the "speed" and "timing" of the flow of money that creates more money. Let me explain.

Forget about amounts and $$$$s and think about time and commodities and trust. I am a banker. I have been given 100 gold sovereigns for safekeeping by an old grandma, because I am the only one in the village with a gun, so she entrusts me with her precious money. I give her a solemn promise that whenever she calls back, I'll have her money sitting here, just like I promised. Any. Time. She. Wants. That's called an "at call" deposit account, immediately redeemable for cash (in this case, gold sovereigns). Got it?

She then gets a little piece of paper saying "redeemable for 100 gold sovereigns". The little piece of paper "represents" 100 gold sovereigns. She tucks the piece of paper carefully under her pillow and occasionally kisses it, thinking to herself "What a lot of money I've got in safekeeping with that reputable young banking gentlemen in the nice suit with the nice car."

I then keep 10 gold sovereigns "on tap" just in case she calls to ask for some money back. If she asks for 10, I proudly give them to her, saying "here you are darling, here's your money back, just like I promised." However, I then lend out her 90 gold sovereigns in the local village to earn myself interest (praying to God that she doesn't call back for all her money. If she does, I'll feel like declaring a bank holiday immediately).

I don't lend out more than I have in deposits, but I keep for immediate payment (for all "at call" depositors) a fraction of their savings/deposits in cash, even though I have the legal and moral obligation to pay these depositors back immediately if they walk through the door and ask.

Doing this over and over "accelerates" the money supply exponentially - until there's a run on the bank with all the grandma's coming into my store at once. Then the game is up - I don't have the 100 sovereigns like I promised and I go out of business. In the banking game, you say "I've sunk like a Rock".

To use another simple analogy to get the point across. Assume I'm a sharebroker/custodian for your shares. They are mixed with other shares in the same company. You can't tell the difference between one share and another share. I estimate that there's a very small chance all shareholders will ask for the shares back at one time. Although I have the obligation to supply the shares immediately you ask for them, I play the sharemarket in my spare time, whilst you're not looking, "shorting" these shares. I sell your shares on the stockmarket and hope to God I can buy them back cheaper, before you notice. That's just like frb, and it does happen in financial markets today. It's very, very simple. In a standard commodity market it's normally called embezzlement, but for historical reasons (the British govt made a deal in 1694 to legalize the practice and support it through the introduction of the Bank of England), it's legal in the financial world because you can't tell one dollar from another and you can't tell one share from another (if they were diamonds it would be different). And this little game is the foundation of modern Western finance and, by extension, Western Imperialism.

This ends the lesson for today.--Socppt15 (talk) 07:42, 29 May 2008 (UTC)

Sorry to still bug you but I think this is a very important point. Scoppt15, you say "It is incorrect that banks lend more than they have on deposit.". Is it incorrect in the sense "not important" or in the sense "they do not do this, they are not allowed"? —Preceding unsigned comment added by 79.114.13.250 (talk) 11:12, 29 May 2008 (UTC)

Not allowed (literally) - in the initial round of fun and games. Recall that I mentioned you need to think of money in terms of flow. In the first round, you embezzle 90 sovereigns of Grandma No. 1's life savings, by lending that 90 to Speculator 1, who then spends it on Landowner 1 who (inevitably) deposits it right back in your bank. Whoopee! You can then take 9/10ths of this deposit and lend to Speculator 2 (also at interest). Think of a boomerang. You throw it, it looks as though you're letting it go - but magically it does a full circle and comes right back. Magic! You then throw 9/10ths of it out into the market and you can be (reasonably) sure it will come back. And so on. On each throw you're only throwing 9/10ths of existing deposits, but by throwing this stuff out into the market you are creating money because all of the deposits being created are on deposit "at call" (none of them are term deposits) and these deposits (created by the issuance of debt to Speculator 1 and 2) can be used as money and can be withdrawn at any time on demand.

In the initial throw, you can, as Mr Legit Banker, say you are not lending more than you have on deposit: "I had 100 sovereigns of Grandma's dough. I only lent out 90. What's the problem???" Well, problem number 1 is that several Grandmas may come into the store at any time and ask for it all back. Problem number 2 is that Speculator 1 or 2 may go bust or run away with the gold sovereigns. Problem number 3 is that you have to pay off the cops if Grandma starts screaming you stole her money when she finds out what you've done. Lesson 1: Only take the savings off Grandmas without guns. Lesson 2: Lend your money to people who will pay you back (hard-nosed alpha male business-types with a predominant recessive greed gene work best here). Lesson 3: Always have your luggage packed and a flight booked to a tax haven. After all, you're on borrowed time (literally).

Note that no one (not even Murray Rothbard) has a problem with banks "investing" money they have been given on term deposit. Let's say you have $15 billion lying around and want to leave it with the bank for 5 years and have them pay interest. If they then lend it out for the same 5 years and have the borrower pay interest - no problem. Everyone knows that the term of the deposit matches the maturity of the loan. It's a potentially fatal gamble when the maturities do not match. And that's what frb is: a dangerous gamble. As a banker you're playing with fire and hoping your depositors don't "test" your integrity. If they do, you're immediately insolvent because you have borrowed the money "short" but lent "long". You haven't got the money on hand you have promised all your depositors. It's as simple as that.

There's some controversy over this video, but I find it helpful in explaining these concepts. It may also help your understanding. Warning: some consider the video "controversial" in nature, so please don't watch it with the kiddies around. It's strictly adults only. Perhaps have a whiskey in one hand and the mouse in the other (to pause it if it gets too much for you).--Socppt15 (talk) 12:35, 29 May 2008 (UTC)

All hyperbole aside, the original question was "can a bank lend more than it has on deposit?" as a way of getting to "can banks create money?". It also said "no extra money (currency or whatever)". The distinction is crucial: regular banks cannot make money in the sense of currency. Their actions do lead to the creation of money substitutes - in this sense, meaning something that is (can be, may be, will be) accepted in payment of debt (see money supply). (In fact, non-banks can do this too, but most people won't accept notes from "Bob's Rigamarole and Fishing Shoppe.")

A bank can lend "Tom", say, $900, if Tom will accept promissory notes instead of cash. Tom might do this if everyone else also accepts the bank's promissory notes in payment of debt. It is not currency, but may be convertible into currency relatively easily. This is not all that different from (for example) the bank selling bonds, promissory notes, or whatever for cash, and then lending Tom the money directly. The costs will be different (interest, discounts, liquidity/convertibility, etc).

Most of the discussion about banks lending the money it does not have (the deposit/cash movements) is about technicalities of how it happens, but glosses over this point: that bank deposits are NOT money, they are money substitutes. (Or, if you prefer, a different type of money).--Gregalton (talk) 14:22, 29 May 2008 (UTC)

This point above arguing that (some say that) banks should always match pretty much misses the point of financial intermediation. Taking almost any random bank's financial statements, the auditors will usually have a statement to this effect: "The matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to management of the Bank. It is unusual for banks ever to be completely matched since business transacted is often of an uncertain term and of different types. An unmatched position potentially enhances profitability, but can also increase the risk of losses. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature, are important factors in assessing the liquidity of the Bank and its exposure to changes in interest and exchange rates." (My emphasis)

In other words, bleating that banks should always be matched is silly: term transformation - i.e. controlled mismatching -(amongst other things) is a key part of what banks DO. If banks did not do this, there would be less medium/long term funding available in the market; if they were restricted from doing so, it would introduce serious difficulties with transaction costs (bank can't give you your five-year loan until they have exactly that five year funding, and they would certainly not raise that five year funding in advance. It also misses the point that the ALM/interest rate and other mismatches are not fixed from day to day, but change due to prepayments, convexity/concavity and a bunch of greek letters. Exact matching is really not feasible for any dynamic portfolio (although the dimensions of the problem can be significantly reduced - which is what banks are actually doing most days). And what all those various regulations do (Basel etc) is to attempt - imperfectly - to ensure that the mismatching does not get out of hand.--Gregalton (talk) 15:17, 29 May 2008 (UTC)

Socppt15, "Not allowed (literally)". If so, this should be included in the article - do you have a of law reference on it?

Gregalton, if Tom can burrow 900$ (as a promissory note, not currency) than it means that Socppt15 is wrong regarding the "not allowed" above and that a bank can lend more than it has ever been entrusted with. As I understand, this is also the point of your second "matching" post.

I think it's very important to distinct between just being required to have 10% in currency on all promissory notes the bank has issued on one hand (1) and also not being allowed to write more lend promissory notes than the currency it has received through deposit promissory notes on the other hand(2). So is a bank only required to abide (1) or both (1) and (2)? This is what I'm trying to figure out and I think it also needs to be cleared in the article. --Cosmin 16:33, 29 May 2008 (UTC)

I think the first sentence captures frb beautifully. I couldn't improve on it. This is all that's needed. If the article stated blandly "Banks can't lend more than they have on deposit" you'd be missing the flow of money creation, which Analoguni has explained (superbly) with the graphs. Someone needs to simplify the concepts for non-financial types on the talk page. The video mentioned above is OK. Take a look and see what you think. Murray Rothbard is also good at explaining it in simple terms (although non-Austrian economists find him distastefully blunt). Google "fractional reserve banking deposits lending" and you'll get loads of stuff on this. I think the article itself is OK as it is.

Oh, and Gregalton, I agree that borrowing short and lending long is what banking is all about, and what Basel II tries to address. However, the question is whether it's adequately addressed. Some say Basel II is a joke. Others are Keynesians.--Socppt15 (talk) 23:23, 29 May 2008 (UTC)

In an effort to answer the original question and follow the K.I.S.S. principle, instead of diving directly into the mathematics of the multiplier effect, the article should first show an example of fractional-reserve banking in action. For example:

Joe deposits $1,000,000 in People's Bank. People's Bank now has $1,000,000 in cash and $1,000,000 in accounts it is liable to pay on demand. People's Bank loans Bob $900,000 to build a house. Bob pays the builders $900,000, who deposit it in People's Bank. People's Bank now has $1,000,000 in cash and $1,900,000 in demand liability. People's Bank loans Sarah $810,000 to start her own business. She pays the employees and suppliers $810,000 in cash, who deposit it in People's Bank. People's Bank now has $1,000,000 in cash and $2,710,000 in accounts it is liable to pay to its depositors...

Although it may not be considered encyclopedic, this story shows that the total amount of currency never changes and the new money created is the liability of the bank to give cash back to its depositors when they demand to withdraw it. The bank does not, nor does it need to, issue new currency unless the government gives them the right to do so (e.g. a central bank, National Banking Act) otherwise it would be counterfeiting, which is considered illegal in most countries. --EGeek (talk) 05:08, 30 May 2008 (UTC)

"Illegal in most countries"?!? Name those where it's legal - I want to emigrate. Perhaps you mean it's legal in those countries where the central bank is spineless and panics and "saves" stupid banks by swapping Treasury bonds and $$$ for bad debt when the big banks go bust? Is that the subtle point you're trying to make? —Preceding unsigned comment added by 165.228.179.155 (talk) 06:20, 5 June 2008 (UTC)

Perhaps one way to present this, would be to fold the complexity of the "banking system", into an example that represents it as a single bank (as in the People's Bank eg. above.), rather than the large collective that in practice exists. I'm not sure if references to currency necessarily help much, the reality today is that most money is actually electronic, and real live currency is a small fraction of the total. Whilst it's true Banks can't issue physical currency, something appears to have multiplied the electronic supply rather considerably of late. Mischling (talk) 08:38, 9 July 2008 (UTC)

The single bank method is currently being used in one of the examples. Whether physical or electronic, money is money and both follow the same rules. The difference with "electronic" money is its transactional speed. The reasoning for the rapid increase in money is more related to monetary theory (i.e. low interest rates) than the makeup of the money itself. --EGeek (talk) 21:06, 17 July 2008 (UTC)

please make sense of this first

Here is some stuff that was put into the article. I took it out and am pasting it here. Please make sense of this information:(I will try Martycarbone (talk) 14:20, 26 August 2008 (UTC))

(The main article seems to claim that the fractional reserve is 10%. That is incorrect. The material that follows tells (a) what the Fractional reserve is and (b) how that reserve is established by law. What specifically does not make sense? Martycarbone (talk) 14:20, 26 August 2008 (UTC))( please answer by email << martycarbone@yahoo.com>> Martycarbone (talk) 14:20, 26 August 2008 (UTC))
The following reserve requirement ratios are prescribed for FDIC regulated banks. The numbers come from § 204.9 of << http://www.fdic.gov/regulations/laws/rules/7500-500.html#7500204.2 >>, a federal law.
"Net Transaction Accounts" is basically the dollar value of all customer's deposits and accounts receivable on the bank's books. The precise definition of "transaction account" comes from § "202 Definitions" of the URL immediately above: the precise definition is reproduced below.
§ 202 (e) "Transaction account means a deposit or account from which the depositor or account holder is permitted to make transfers or withdrawals by negotiable or transferable instrument, payment order of withdrawal, telephone transfer, or other similar device for the purpose of making payments or transfers to third persons or others or from which the depositor may make third party payments at an automated teller machine (“ATM”) or a remote service unit, or other electronic device, including by debit card ... "
§ 204.9 Reserve requirement ratios
The following reserve requirement ratios are prescribed for all depository institutions, banking edge and agreement corporations, and United States branches and agencies of foreign banks:
For a net "Transaction Amount" (TA), the "Reserve Requirement" (RR) is in accordance with the following text.
For a TA of $0 to $9.3 million, the RR is 0% of TA For a TA of $9.3 to $43.9 million, the RR is 3% of TA For a TA over $43.9 million, the RR is $1,038,000 + 10% of amount over $43.9 million
In other words, if a bank has a total of $50 million of (a) customer's deposits and (b) loans to borrowers on its books, it must have $1,099,000 of its own money as a reserve [$ 1,038,000 + $61,000 (10% of $6,100,000)].
That $1,038,000 is just under 4% of the $50 million. That means such a bank can lend about 25 times as much money as it has in "net transaction amounts".
Note that the bank needs zero reserves if it has up to $9 million dollars in loans out to customers. In other words, if a bank has none of its own money in the bank — it can still lend out up to $9 million.

I think somebody just added the entry level requirement for a US Bank, and from the look of things it's set low for small banks. I agree, i don't think it's relevant here. This should be an article just about Fractional Reserve Banking, and the many national variants in its implementation need to be dealt with elsewhere (imho). Maybe a disclaimer should be added to that effect? Mischling (talk) 11:33, 11 August 2008 (UTC)

Analoguni (talk) 02:35, 8 August 2008 (UTC)

promotion of personal website (Is mentioning a personal website in violation of wikilaw? Martycarbone (talk) 14:31, 26 August 2008 (UTC) )

This user wants to promote his website (I do not want to "promote" my site. I want to offer the information on that site for consideration Martycarbone (talk) 14:31, 26 August 2008 (UTC))(I think "promote" has negative connotations that are not appropriate here Martycarbone (talk) 14:31, 26 August 2008 (UTC)) I moved the text from the top and put it into this section. Analoguni (talk) 02:38, 8 August 2008 (UTC)

(I think I was just at the discussion tab of Talk:Fractional-reserve banking. I clicked on "edit" and find myself here.
I hope this message gets to people who can advise me
I would like to discuss the basic Fractional Reserve Banking page and the "restructure proposed" page with the goal of offering changes to the entire subject. Please look at the following URL's where I discuss this subject and related money-related subjects. http://www.howto-ville.com/commonomics.html http://www.howto-ville.com/money%20copy/moneysupply.html
The information on those pages is basically based on authoritative sources that I cite at the top of those pages.
There is some original thoughts and opinions on those pages -- but I think they are easily recognized as such.
I think it might be best if I simply do a new wikipedia (unpublished) page on "Money" in the United States that would be based on the sources I cite. Otherwise, I would have to more-or-less stay within the (partially unsatisfactory) format presently being used for this subject matter.
Once I put up that page -- you experienced "wikipedians" -- can do whatever you want with it -- ignore it completely, or use whatever parts you think are worthwhile. I would be happy to discuss any of the information with any of you.
All of the material on my website is available for the complete free use by anyone.
Please respond to me by email (martycarbone@yahoo.com) -- since I am presently unfamiliar with the wikipedia protocol, that would be easiest for me Martycarbone (talk) 00:35, 7 August 2008 (UTC)
I will also offer Signed off-the-top-of-my-head comments interspersed in the material below with the understanding that you can easily remove what I write before it confuses anyone.Martycarbone (talk) 00:35, 7 August 2008 (UTC))

Martycarbone, please post new comments at the end of sections or right after the signature of other editors. It may not seem like there is a problem at this time, but after a while the discussion will be confusing to other readers. -- EGeek (talk) 18:54, 26 August 2008 (UTC)

This article does not state the reserve ratio requirements for banks. It only explains the money creation/multiplier concept due to fractional reserve banking and shows examples the concept using different ratios. Reserve requirements differ between countries around the world; therefore, resources that state specific details of reserve requirements of one country does not represent a world view for a general topic such as fractional reserve banking. The information you provided is better presented on the Federal Reserve System article. -- EGeek (talk) 18:54, 26 August 2008 (UTC)

Also, Analoguni's comment is correct. Personal websites are not deemed a reliable source of information. This is due Wikipedia policy that the article's content must be verifiable. -- EGeek (talk) 18:54, 26 August 2008 (UTC)

So, what happens if the Bank sells the loan?

This is somewhat tangential to the discussion, but nobody i've asked has been able to answer. Given the way the capital reserve acts to regulate the eventual expansion of the monetary supply by the banks, doesn't selling the loan outside of the regulated banking system (say as a Mortgage Backed Security) completely circumvent that control? Mischling (talk) —Preceding undated comment was added at 12:26, 24 August 2008 (UTC)

In part, yes, depending on whom the bank sells it to, and whether that is an entity that uses leverage. If it sells it for cash (to an investor using it for income that is not leveraged), it should have no effect.

Hmm. My thought was that when that occurred, it would effectively create the positive feedback loop in the money supply the credit reserve limit was created to stop? Since the credit reserve limit is a property of the bank, rather than the loan - then this would basically make the limit on monetary expansion (or money equivalent) by the banks at any rate, the amount of loans that the larger economy is able to support. Mischling (talk)

If it sells it to another bank, or a hedge fund, it will depend on whether that entity is subject to leverage restrictions and how they apply. One way to look at it is to assume that the other purchaser is a bank (or that it will be used through the banking system somehow, i.e. that the purchaser is funding itself through a bank by doing repos): if the capital requirement for the purchaser will effectively be subject to the same capital requirement (because it's also a bank), then there should be no effect.

BUT, sometimes the repackaging of e.g. mortgages into various instruments like CDOs, SIVs, conduits, etc, results in more leverage by definition. And sometimes the packaging into a security (securitization, unleveraged) results in relatively more of the pool being considered triple-A, meaning a bank could hold it with less capital (regulatory arbitrage, in a sense). See this article for a discussion of some of these points (and there is a lot more out there).

A lot of this is based on the fact (opinion?) that there are more leveraged investors (like hedge funds), and that many of them borrow from the banks (or are run by, or owned by, banks).

I try not to think too much about the way the recent spate of financial jiggerypokery seems to have ended up using loans as collateral for further loans. But on the other hand, if you have a localised mechanism somewhere in the economy creating additional money/credit - it has to go somewhere, and i think it's possible the Hedge funds are actually a symptom rather than as some think a cause.

So in a sense, you're right. Others might disagree and say that it's not a function of the banking system selling the loan, but the fact that other de facto financial institutions are unregulated. But it's a good question.--Gregalton (talk) 15:10, 24 August 2008 (UTC)

Yes, if you made the credit reserve a property of the loan, that might be one way to resolve the problem. Although that in turn creates a huge monitoring headache.

Sorry, one additional thought: there are different issues here. Some refer to fractional-reserve banking as the source of money creation (and it is undoubtedly a source of creation of a good money substitute). You've hit on one part, that ANY entity that issues "money substitutes" is creating money. If paper like securitizations are considered a good money substitute, and they are being used outside the banking system, they are creating money. The problem is that the "substitutability" of each type of money may not be consistent: hence the various Ms. ABS is not money, but for a while was arguably being accepted as a decent substitute (M6? 7? I don't know). Then - it stopped being accepted as a decent substitute. This has unclear and problematic implications, to say the least.--Gregalton (talk) 15:20, 24 August 2008 (UTC)

Seriously. However, i don't think it's necessary even that ABS are 'money' - although i appreciate the distinction you're making. I think that it's enough that as a fraction of loans 'escape' the credit reserve, then a positive feedback loop gets created operating on the money supply, within the credit portion of the economy. And we can see the results around us.Mischling (talk)

Isn't there lots of stuff that's outside the credit reserve? Isn't every corporate and municipal bond and corporate paper outside the reserve as well? Wasn't that true before?--Gregalton (talk) 18:02, 24 August 2008 (UTC)

Erm - good question. But corporate loans are tied to a particular entity, which is (supposedly) going to pay them back from expected future income, aren't they? And presumably, one of the due diligences of buying such things is a quick check on the quantity outstanding, etc. The Banks on the other hand are statistically multiplexing their deposits. So Corporate Entity Alice sells a bond saying that it will repay it with interest in X years. That can move around the economy however it wants, but ultimately Alice is going to have to cough up at some point, or declare bankruptcy, at which point bond holders are higher up the food chain than share holders for the remaining assets, iirc. Banking entity Goldfinger on the other hand, lends money to Bob, sells that loan to some pension fund, and can keep on lending money, to Christine, Daniel, Emelia, et al. until it runs out of purchasers for the loans. So it would seem to create an infinite debt generating machine, and by extension, do equally nasty things to the bank generated part of the money supply. Or? Mischling (talk) 18:47, 24 August 2008 (UTC)

It's the (supposedly) that concerns me. Some would say that there is no guarantee the bond market is doing as much checking than the banks. Some might say it doesn't make a lot of difference whether it is through the banks or some other mechanism, if the sources of funds and the borrowers are all the same.--Gregalton (talk) 19:20, 24 August 2008 (UTC)

Thinking about it some more, i don't see how the corporate loan directly affects the Money Supply, the way the bank loan does. It's just a monetary transfer - I believe that's the difference. (leaving aside second order problems of the origin of the money paid for the corporate loan). Mischling (talk) 07:38, 25 August 2008 (UTC)

So, what if a bank buys the corporate bond? Or the non-bank owners hold it at a bank and agree to let the bank lend it to others? And what if the corporate bond is rated triple-A, and counts as a form of money? What if the corporate gets the cash, and deposits it in the banking system? Or with some other quasi-bank (by holding, for example, SIV-sponsored short-term paper)?

My point is, in principle any form of loan is arguably a type of money/money creation, or leads to it. Some (like bank money creation) are more obviously so, and may be high-powered or have a different money multiplier, but I'm not convinced the effect is necessarily different. (I reserve the right to be wrong, however).--Gregalton (talk) 09:44, 25 August 2008 (UTC)

I suspect this has to be separated into second order and first order effects. I put a Bank buying a loan as a second order effect. As EGeek says below, there are different kinds of loan. Two i think. One is a direct transfer - i give you a $10 bill and you promise to pay me back at some point. I no longer have a $10 bill. No money supply impact. The other is the statistical multiplexing that the Banks do, i give the Bank the $10 bill to store for me, and they lend out a part of it, because they know that not all $10 bills that they have will be demanded at once. That increases the money supply, but the credit reserve places a limit on how much. So going down your list,

Bank buys a corporate loan - depends what they buy it with, and how it gets treated by their accounting. Potentially dangerous if it can be treated as part of the reserve, and it goes poof.
Non-bankers holding it at a bank - transfer.
Loan can be counted as money. That's the dangerous one i think. Allowing loans to be used as collateral for other loans, obviously creates a positive feedback loop. Another one.
Corporate gets cash and deposits in banking system. Still a transfer. Ditto quasi Bank. (equally reserving the right to be wrong about all this)Mischling (talk) 21:38, 26 August 2008 (UTC)

Not all loans create money. Money is created out of fractional-reserve banking due to the deposit liabilities of banks -- essentially the money supply minus the currency. This is similar to a central bank note representing the liability of the central bank that issued it. The exchange of securities and mortgages only affect the makeup of assets and does nothing to the bank's deposit liability. However, these securities may increase value and result in increased demand for more money to meet liquidity expectations. While related, an increase in money demand is different than an increase in money supply; although, they do not always follow each other. -- EGeek (talk) 19:27, 26 August 2008 (UTC)

I think i understand what you're saying here, but let me check. Basically the amount a bank can lend is a fixed amount determined as a multiple of the amount the central bank allows it to hold there. However, i don't think it stops the mechanism i'm talking about operating. I believe the problem is, the limit on the amount the Bank can lend belongs to the Bank. If loans are sold, that limit doesn't go with them, it stays with the bank, which is now free to just keep creating loans/money. It's fine if the loan stays inside the banking system - but of course, ABS's are designed not to. Mischling (talk) 21:38, 26 August 2008 (UTC)

It is important to understand cash flows when thinking through this process. Non-cash Assets, which have value, can not directly provide liquidity to pay bills or debts. These assets much be sold for money, first. When a bank sells a bond or loan, it may receive cash for that asset. This additional cash came from the entity that bought the asset; therefore, no money was created in this exchange. Assuming the bank met the required reserve ratio prior to the exchange, the bank now has free reserves to offer a new loan. If the bank makes a loan, no new money is created because the money originated from the assets exchange and the bank has no additional liabilities on that money. -- EGeek (talk) 19:25, 27 August 2008 (UTC)

I think you may be right if the bank just transferred the cash from the loan sale to somebody else as another loan. However i believe the money from the sale of the loan is actually treated as income, ie. profit. (minus expenses etc.) So it in fact gets paid out as bonuses, shareholder dividends etc. which are then deposited back into the banking system. Which creates the positive feedback loop.

With reference to the table on the main page, this is the simplest example i can think of:

individual bank	amount deposited	amount lent out	reserves	sale of loan (cash)
A	100	80	20	0
B	80	0	0	0
A has lent out 80, and this has been deposited at B. This is the first step of the FRB process. Now bank A sells the loan - to whoever has the deposit at bank B.
A	100	0	0	80
B	0	0	0	0
The money from the sale of the loan is pure profit, the bank pays it out to its shareholders, which get deposited in bank C.
C	80	0	0	0
Assuming Bank A can find somebody to lend money to, it is free to lend out again. And that money gets once again deposited in Bank B.
A	100	80	20	0
B	80	0	0	0
Bank A once again sells the loan to the depositor at bank B, disperses the resulting 'profit' to its shareholders, this ends up at Bank C
A	100	0	0	80
A	100	0	0	0
B	0	0	0	0
C	160	0	0	0

Since the credit reserve limiter has been effectively disabled, this process can continue until bank A runs out of people to lend money to. Mischling (talk) 22:41, 3 September 2008 (UTC)

There are two problems in the scenario you presented:

When the proceeds from the sale of the loan were given to the shareholders, you created money. The Dividends would have be paid with the money that the bank received from the sale of the loan. Therefore, after paying the dividends, the bank would only have its reserves and nothing left to lend out. On the other hand, bank C could lend out money from its new deposits. -- EGeek (talk) 23:52, 4 September 2008 (UTC)

No, the bank still has the original deposit. If it could lend money from that before, then it can lend money again, once the loan has been sold. The fractional reserve system created the money. (as it's allowed to) Mischling (talk) 01:52, 7 September 2008 (UTC)

Reserves should remain the same until the amount deposited in the bank changes. Selling a loan does not rid the bank of its deposit liabilities. -- EGeek (talk) 23:52, 4 September 2008 (UTC)

Indeed. However it does rid the bank of its credit reserve liability for the loan it has sold Mischling (talk) 01:52, 7 September 2008 (UTC)

Income and cashflow are two different things. Even if the sale of a loan for 80 that originally cost 80 were a profit, the dividends still come from money that the company has on hand. A firm can record a gain of income, but lose money; and, a firm can record a loss of income, but gain money. -- EGeek (talk) 23:52, 4 September 2008 (UTC)

True - but with all due respect, irrelevant to the problem of shall we say, inadvertent money creation. I used the shareholder example to make things as simple as possible. The bank can set up a property investment subsidiary which goes on a florida land buying spree with the money, and ends up with severe losses; the entire process, granted over a period of some years, has still created money outside of the original intent of the credit reserve limit. Mischling (talk) 01:52, 7 September 2008 (UTC)

Here is my version of the same scenario:

Individual Bank	Amount Deposited	Amount Lent Out (Debt Value)	Reserves	"Free" Reserves (cash)	Sale of Loan (cash)
A	100	80	20	0	0
B	80	0	16	64	0
Bank A has lent out 80, and this has been deposited at B. Bank A has no more free reserves to loan.
A	100	0	20	80	80
B	0	0	0	0	0
Bank A has sold its loan to the depositor at bank B. Bank A now has free reserves and can loan money out again.
A	100	0	20	0	0
B	0	0	0	0	0
C	80	0	16	64	0
Bank A decides to give all of the proceeds to its shareholders. Those shareholders deposit the money in Bank C. Bank A now has no free reserves to lend out. Bank C has free reserves for which to lend.

A sum of reserves and deposits show that no money has been created or destroyed except for the initial loan amount Bank A made. A sum of all reserves reveal the initial amount of money in the economy before any loans were made. -- EGeek (talk) 23:52, 4 September 2008 (UTC)

Again, please don't respond inside my responses. It will confuse other readers. Instead, please point to what you are responding. For example use "In response to #2, ...", or whatever phase works best for you.

In response to using the original deposit to validate a loan when the bank has no free reserves, the deposit represents the liability of the bank to give cash on demand to its depositors. The deposit does not allow a bank to make a loan with non-existant money. The original loan came from the money from its depositors that it did not have to leave in reserve, or "free" reserves. This money was returned from the sale of the original loan, but it was given away to the shareholders; therefore, the bank did not have any money to loan.

In response to "credit reserve liability", the bank is still liable for the deposits it holds. The amount of loans it makes, nor the value of loans on its books does not change this - only the amount of deposits.

In response to the relevance of understanding the difference between income and cashflow. My initial discussion in this section began with the explanation of the difference between money of value of assets. I'm also interested in how a bank can create money by feeding a dying subsidiary. -- EGeek (talk) 03:58, 7 September 2008 (UTC)

^ Bank for International Settlements - The Role of Central Bank Money in Payment Systems. See page 9, titled, "The coexistence of central and commercial bank monies: multiple issuers, one currency": http://www.bis.org/publ/cpss55.pdf A quick quote in reference to the 2 different types of money is listed on page 3. It is the first sentence of the document:
"Contemporary monetary systems are based on the mutually reinforcing roles of central bank money and commercial bank monies."

[bis-1] Bank for International Settlements - The Role of Central Bank Money in Payment Systems. See page 9, titled, "The coexistence of central and commercial bank monies: multiple issuers, one currency": http://www.bis.org/publ/cpss55.pdf A quick quote in reference to the 2 different types of money is listed on page 3. It is the first sentence of the document:
"Contemporary monetary systems are based on the mutually reinforcing roles of central bank money and commercial bank monies."

[1]

early discussions

History

Do U. S. citizens understand that commercial banks have only fractional reserves?

Sorting out and identifying points of view

How is this different from saying "we're no longer on the gold standard?"

Deleted text

From the village pump

worthless without explaining Bank for International Settlements

Tags added

Disputed

Some clarifications that might help / and on Inflation

Page re-write

Just a general comment

Videos-Documentries

Supposed loaning of demand deposits and national banks reserve accounts with the Fed

Rothbard on Fractional Reserves

All bank notes are redeemable in lawful money on demand

Fractional lending is a powerful tool

Two 'views' of fractional reserve banking are not equivalent

Disputed

Vandalism and Mindless Trivial Edits

Define "Reserves"! (or "banking" for that matter)

Merge

How would a bank loan money to consumers and businesses if it had to keep everything in reserve?

Graph Showing Expansion of Money Supply

"Lending more than you have is fraud"

Archiving of discussion here

problem in "How it works"

Is there any reason this article particularly merits a section of links on "the Libertarian perspective?"

"Purpose" subsection

Should Reserve requirement merge into this article?

Numismatics Template

Lead definition

Sourced material vs. "accurate" material

Include the worldwide importance of fractional-reserve banking

Definitions from other sources

The lead is too small.

Okay, just... stop it

Lead: text suggestion

Please archive this page and restrict discusion

Clarification

Austrian soapboxing

M0

Unnecessary riddles!

Money Facts from U.S. subcommittee

Question about fractional banking

More questions about fractional banking

please make sense of this first

promotion of personal website (Is mentioning a personal website in violation of wikilaw? Martycarbone (talk) 14:31, 26 August 2008 (UTC) )

So, what happens if the Bank sells the loan?