Talk:Fractional-reserve banking/Archive 10

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"financial intermediaries" - main page contradicts itself

The main page includes the following quote from the Federal Reserve Bank of Chicago:

"Of course, they [commercial banks] do not really make loans out of the money they receive as deposits. If they did this, they would be acting just like financial intermediaries and no additional money would be created."

This quote implies that banks do not act as financial intermediaries. And yet in two other locations on the main page it states that banks do act as financial intermediaries. Can we clear this up? Reissgo (talk) 09:08, 30 May 2015 (UTC)

No, what it implies is that banks do more. They are not just financial intermediaries. LK (talk) 03:59, 5 June 2015 (UTC)

As an aside, that whole section Fractional-reserve_banking#Creation_of_deposit_liabilities_through_the_lending_process should be cleaned up or removed, It's just a bunch of quotes strung together. LK (talk) 03:59, 5 June 2015 (UTC)

The sources themselves apparently contradict one another on the use of the term "financial intermediary" -- but that may or may not be an actual contradiction. It might just be that different sources are using the same term in different senses. I'm not sure yet whether we as editors can -- or should -- "clear this up." So, I don't currently have a specific answer to Reissgo's question.

On the section on deposit liabilities, I probably added that section a while back, in response to repeated controversy among editors on how the basic process works. If we remove that material, there is the danger that eventually that whole controversy will pop up again, forcing us to re-insert the same (or similar) material in the article. Thoughts, anyone? Famspear (talk) 12:49, 5 June 2015 (UTC)

I don't believe there was any controversy here. Consensus has long been clear. I think that the deposit liabilities section is not encyclopedic exposition and should be removed. It is undue and it relates to the subject of the article only by means of a WP:SYNTH association with the topic. Furthermore, we must be guided by WP policy and we certainly should not feel obliged to sustain bad content in the article or that we might be forced to reinsert such content after it's been exhaustively discussed and rejected on Talk. The section should be removed. It can be copied here to the talk page in case future editors wish to make use of the material in a policy-appropriate way to improve the article. SPECIFICO talk 16:22, 5 June 2015 (UTC)

With regard there being a controversy or not: the senior research advisor in the Bank’s new research hub has just produced a working paper called Banks are not intermediaries of loanable funds — and why this matters. In the paper he says, "financing through money creation (FMC) description of the role of banks can be found in many publications of the world’s leading central banks." Reissgo (talk) 17:13, 5 June 2015 (UTC)

The issue is whether there is controversy among the editors here. There is not. As to whether there is controversy in the relevant RS literature, you would need to find a source that states there is controversy, not merely tag it as such based on your opinion. At any rate, there is consensus here -- your dissent nothwithstanding -- that the section should be removed. SPECIFICO talk 19:30, 5 June 2015 (UTC)

Dear Specifico: I was referring to the section called "Creation of deposit liabilities through the lending process". That material is precisely on topic, and the material is correct. I would argue that it is "encyclopedic." I don't also don't follow what you mean by "undue." It is certainly not a synthesis of source A with source B to arrive at conclusion C that is not found in source A or B.

Can you clarify what material you are referring to? Famspear (talk) 01:35, 6 June 2015 (UTC)

I also have to disagree with Lawrencekhoo on this matter -- which is weird, because I don't recall ever disagreeing with him before, and we've both been editing the banking-related articles for a long time. If the objection -- that the material is "a bunch of quotes strung together" -- is valid, then maybe we can summarize the material. Personally, I don't see any reason to change it. Famspear (talk) 01:42, 6 June 2015 (UTC)

PS: Maybe I'm remembering wrong, but I thought that there was a big controversy a while back as to how to explain how banks create money (in the form of non-currency money, or "deposit liabilities") and how banks make loans. I was thinking that the material was added to clear that up by providing the article with some relatively simple, plain English explanations from eminently reliable (and authoritative) sources. You can't get much more authoritative than the former head of research at the Federal Deposit Insurance Corporation, for example.

Maybe I'm mis-remembering how the material came to be in the article (???). Famspear (talk) 01:48, 6 June 2015 (UTC)

Hello, Famspear. Thanks for your reply. I'll try to be less terse. An encyclopedia article should provide a clear and reasoned exposition of relevant subject matter. The string of quotes in this section read like a series of criticisms or attempts to undermine the article's narrative as to the nature and operation of the fractional reserve banking system. Here's what I meant by SYNTH: We need explicit statements from sources, not a series of quotes from which some editors or readers will draw a personal inference that other content in the article is false. There are abundant RS secondary and tertiary references from which to source the narrative of this article. Selective quoting (aka "cherrypicking") -- even of competent individuals' views -- is not providing a balanced exposition of the mainstream consensus view of the subject. SPECIFICO talk 12:56, 6 June 2015 (UTC)

OK, you've completely lost me. How in the world does an explanation of exactly how fractional reserve banking works undermine the article narrative? How it is a criticism? How in the world would this material lead someone to think that something else in the article is false? How is this "selective cherrypicking?" How is this material not "balanced"? Famspear (talk) 13:33, 6 June 2015 (UTC)

PS: The material you are talking about removing IS the mainstream. It describes how fractional reserve banking works. This is basic stuff, and is taught in university courses on banking. (In fact, that's where the Horvitz material comes from: the college textbook for the Money and Banking course I took in college). I am a former bank auditor. You and I and Lawrencekhoo and others have been working for years on this and other banking-related articles to keep the banking articles from veering off into "crazy-ness". Right now, things are fairly quiet.

At this point, I am astounded at your comments. Famspear (talk) 13:48, 6 June 2015 (UTC)

For reference, this is the material I assume we are discussing:

[begin subject material]

The proceeds of most bank loans are not, however, in the form of currency (central bank money). In the United States, the Federal Reserve Bank of Chicago has stated:

Of course, they [commercial banks] do not really make loans out of the money they receive as deposits. If they did this, they would be acting just like financial intermediaries and no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits they make to the borrowers' deposit accounts. Loans (assets) and deposits (liabilities) both rise.... Federal Reserve Bank of Chicago, Modern Money Mechanics, pp. 3-13 (May 1961), reprinted in Money and Banking: Theory, Analysis, and Policy, p. 59, ed. by S. Mittra (Random House, New York 1970).

The American Bankers Association has also stated that most bank loans are made not by doling out paper currency and coin, but instead by creating or increasing deposit liabilities owed by the bank:

Typically, bank loans are made to existing customers, or the proceeds of a loan are used to open an account; thus, most bank loans increase total deposits. In the typical credit situation, two balance sheet items --loans and deposits -- are simultaneously increased. Eric N. Compton, Principles of Banking, p. 150, American Bankers Ass'n (1979).

From Professor Paul Horvitz:

Deposits may arise in a different way, however. Let us suppose a businessman comes into the bank and wants to borrow $1000 to cover the cost of some additional inventory he wants to purchase. The bank may approve the loan, and the businessman will tell the bank to credit the $1000 to his deposit account.

Bank Assets

debit Loans $1000

Bank Liabilities

credit Deposits $1000

The businessman now has an additional $1000 demand deposit. No one else's demand deposits have been reduced. This is clearly an increase in the money supply, and it is apparent that the bank created the $1000.

These derivative deposits are important both quantitatively and theoretically -- it is in terms of derivative deposits that banks can be thought of as creators of money. If all deposits arose from primary deposits, banks could not be said to create money. Paul M. Horvitz, Monetary Policy and the Financial System, pp. 56-57, Prentice-Hall, 3rd ed. (1974).

Allowing the issuance of loan proceeds in the form of cash (that is, in the form of paper currency and current coins) is considered to be a weakness in internal control in a bank. See, generally, Industry Audit Guide: Audits of Banks, p. 56, Banking Committee, American Institute of Certified Public Accountants (1983).

[end of subject material]

This is the very essence of the subject of this article. I don't want to hurt anyone's feelings, but if you disagree with or do not understand this material, then you probably do not have an adequate understanding of how fractional reserve banking works, and you may well not understand the article as a whole. Famspear (talk) 14:00, 6 June 2015 (UTC)

To all readers: On my talk page, Editor Specifico has expressed some concern that I am attacking him personally or engaging in an ad hominem. I want to assure Specifico and all other readers that I have worked with him for a long time on these banking-related articles, and that I respect his work. I am not intending to attack him personally or to engage in an ad hominem argument.

I am asking that Specifico or any other editor who is so inclined explain how this material could be thought of as "a series of criticisms or attempts to undermine the article's narrative as to the nature and operation of the fractional reserve banking system', as Specifico has said. He says: "We need explicit statements from sources, not a series of quotes from which some editors or readers will draw a personal inference that other content in the article is false." I fail to understand why he seems to be implying that this material tends to induce such an "inference."

Deposit creation, reserves, loans, the multipler effect, the reserve requirements -- all these are basic concepts in the main stream view of fractional reserve banking. Famspear (talk) 19:47, 6 June 2015 (UTC)

Editor Lawrencekhoo had also posted an objection to the subject material. His objection was to the effect that it is "just a bunch of quotes strung together." Since I believe I'm the editor who put the material in the article, I have now completely re-done the material by removing the quotes and just summarizing the material with the same citations. Thoughts anyone? Famspear (talk) 00:19, 7 June 2015 (UTC)

Your words are fine... but reading the main page again, it appears that your explanation of how FRB works appears to be competing with the contents of "Money creation process" and "Example of deposit multiplication". IMHO your explanation is better, and better sourced. So I'd zap the other two. Besides, the section "Example of deposit multiplication" has been marked as, in need of citations, for over a year. The section also includes the ridiculous sentence: "In the example, the initial deposit is lent out 10 times (of course, they do not really pay out loans from the money they receive as deposits)".

As an aside, I noticed that the section called "how it works" doesn't actually explain how it works! That section should be renamed or discarded. Reissgo (talk) 07:47, 7 June 2015 (UTC)

Dear Reissgo: I would disagree. You are talking about two different things. The explanation of "how FRB works" is simply an explanation of the process of how banks make loans by crediting the deposit liability account representing the liability owed to the customer. The contents of the "money creation process" and "deposit multiplication" sections explain the mathematical relationships of the effects of the aforementioned process.

Let's think about the process -- and effect -- of operating an automobile. The process of operating the car involves getting in the car, turning on the engine, putting the car into gear, and manipulating the steering wheel, brake pedal and accelerator pedal, and so on. That description of operating the car is analogous to the articles's explanation of "how FBR works" (how banks create money in the form of demand deposit liabilities by debiting an asset account called 'loan' and crediting a liability account called 'demand deposit').

If we now move on to describe how the application of greater and greater amounts of pressure to the accelerator pedal of the car over long periods of time results in the car traveling X number of miles over period of time Y, we are describing an effect of the operation of that car. That explanation of the effect is analogous to the article's explanation of the mathematical relationships embodied in the money multiplier effect, etc.

We are not talking about two "competing" explanations of fractional-reserve banking. We are talking about two explanations of two different aspects of fractional-reserve banking, just as the explanation of the physical operation of the accelerator pedal and the explanation of how far the car goes over a given period of time are two explanations of two different aspects of using a car.

Perhaps the article can be re-organized a bit to make that clearer. But, I don't think that you would want to delete any of the sections to which you refer. All these materials work together to describe various aspects of fractional-reserve banking. Famspear (talk) 12:19, 7 June 2015 (UTC)

I have started a minor reorganization, changing the order of the paragraphs slightly. Also, I removed this unsourced sentence: "Deposits will always be equal to loans plus a bank's reserves, since loans and reserves are created from deposits." That's a bit too much of a flat, categorical statement. A bank's reserves can be created by actions other than the creation of deposits. And "always" is far too categorical to be true. And loans are not necessarily created "from" deposits. Instead, a loan can be created through the mechanism of a corresponding creation of a deposit liability. Perhaps the material can be re-worked. Famspear (talk) 13:39, 7 June 2015 (UTC)

Flat, categorical unsourced statements

As noted earlier on the talk page, the article included this statement: "Deposits will always be equal to loans plus a bank's reserves, since loans and reserves are created from deposits." As I noted, in addition to not being sourced, that's a bit too broad of a statement to be true.

The amount of a bank's deposit liabilities would very often not be equal to the sum of the loans and reserves -- for the simple reason that a bank can dispose of loans (divest itself of loans) without affecting deposits, and without a permanent, corresponding increase in reserves. Example: Bank XYZ makes loans to customers, creating demand deposit liabilities thereby. Bank XYZ sells a portion of the loans to another bank (a very common practice), and almost immediately uses the entire proceeds of the sale to buy municipal bonds of a local school district.

These bonds are not "reserves" -- and they are not loans owed by customers to the bank. (The bonds may be considered "loans" in the sense that the school district now owes the unpaid balance of a debt to the bank, but the school district is not thereby made a "customer" of the bank. This transaction creates no deposit liability owed by the bank to that school district in this fairly common scenario.) In this case, the bank's investment in the bond is a third category of asset, in addition to loans and reserves. Here, the sum of reserves and loans has now decreased, but the amount of deposits has remained unchanged as a result of this action.

A second example of why a bank's deposit liabilities would often not be equal to the sum of the loans and reserves is the fact that the bank may own the land and building on which the bank's facility is located. The land and building are a fourth category of bank assets; these assets are neither "reserves" nor "loans". How did the bank acquire the land and building? One of the ways would be for the bank to sell some of its loans, or even use some of its reserves, to buy the land and building. (Yes, government regulators might require that the bank borrow at least some of the funds used to acquire the land and building, but that's a different story.)

One bank I audited many years ago actually had over 50% of its assets in the form of U.S. Treasury bills, etc., and municipal securities. Loans accounted for only about 20% of its assets. Adding the amount of that bank's reserves and the amount of the bank's loan balances would not even have come close to being equal to the deposit liabilities.

A third reason that a bank's deposit liabilities would often not be equal to the sum of the loans and reserves is the simple fact that the bank had to be created through investments by shareholders. When the bank was created, at least some of the original investment might have been in the form of funds that qualified as reserves once the bank acquired those funds. Here, at the instant at which the bank was created, the bank could have had millions of dollars in reserves -- and yet owe zero in deposit liabilities, for the simple reason that no one had yet opened a checking account at the bank. Now, this situation obviously would not exist for very long, even if it did exist at the moment the bank was incorporated. But, hopefully, we understand the point. We need to be careful about using flat, categorical statements in the article, especially unsourced ones. Famspear (talk) 15:33, 7 June 2015 (UTC)

Hi Famspear, Just noticed the activity on this talk page resulting from my off-hand comment earlier. My objection to the series of quotes is a purely stylistic one. Articles should summarize material to present it in a unified way, and use quotes sparingly (WP:QUOTE). I think you did a good job rewriting the section. I also agree about removing the sentence: "Deposits will always be equal to loans plus a bank's reserves, since loans and reserves are created from deposits." I think what the person who wrote it had in mind is that assets equal liabilities on a bank's balance sheet. But as you noted, the assets side includes more than just reserves and loans. And on the liabilities side, there are more than just deposits – there's also shareholder capital, retained earnings, long-term debt, etc. It's good to have someone with bank auditing experience looking at this page. (As an aside, I actually worked in a bank for a short time a long while ago, but it was in the private banking section, so I'm actually not that familiar with bank accounts.) I want to thank you for your work on this page, which is excellent, as always. Best, LK (talk) 10:47, 30 June 2015 (UTC)

Thanks! Famspear (talk) 11:44, 30 June 2015 (UTC)

reference to Menger

Hello, I'm new to this. The reference to Menger (reference 5) does not appear to be appropriate. I have searched Menger's book and could not find any reference in it to the history of fractional reserve banking. Is there a better reference to use? — Preceding unsigned comment added by Andersmith (talk • contribs) 04:11, 26 August 2015 (UTC)

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Inclusion of 'Inside Money' and 'Outside Money' terminology

Article introduces the concept that '...bank deposits are usually considered money in their own right'. In monetary economic literature this is referred to as 'Inside Money'. The article also mentions 'monetary base', which is also known as 'Outside Money'.

Under the section 'Money Creation Process', Central Bank Money is defined. I suggest that the alternative name 'Outside Money' is appended. Under the section 'Money Creation Process', Commercial Bank Money is defined, and an alternative name, 'Checkbook Money' is also included. I suggest that the more formal alternative name 'Inside Money' is appended.

This terminology is consistent with the text "Modelling Monetary Economics" by B. Champ, S. Freeman, J. Haslag. ISBN13:978-0521177009 This text is a prescribed reading for 300 level Monetary Economics course, and confirmation of the alternative terminology may help those struggling with the concept of money creation.

Jarryd Johnson (talk) 23:49, 1 November 2015 (UTC)

3RR Noticeboard

See [1]

SPECIFICO talk 16:50, 14 November 2015 (UTC)

Fringe assertions

This page has been under constant attack over the last few years from people holding the fringe idea that banks, on receiving a deposit, immediately issue credit that are a multiple (1/rr) of the deposits received. The rallying cry of these fringe activists is 'banks do not lend out deposits'. As far as I can tell, there are no reliable sources banking up the assertion that banks immediately issue credit equal to a multiple of newly deposited funds. Standard texts back the idea that banks loan out only a fraction of newly deposited funds -- since banks have prudential standards, and funds lent out by a bank are usually withdrawn from the bank. I would like to test consensus for the standard 'multiple steps' story of deposit multiplication, shown by the graph in the section Example of deposit multiplication. Are we all (or mostly) of like mind on this issue? Yours in fringe frustration, LK (talk) 13:44, 15 November 2015 (UTC)

I agree that the idea you described those people as holding -- that when a bank receives a customer deposit, the bank somehow immediately issues credits in amounts equal to a multiple of the amount of the deposit -- would be a fringe view, and would be frivolous.

As an aside, or general comment: Of course, in one narrow, technical sense, banks do not lend "deposits" (when we use the word "deposit" to mean the liability owed by the bank). You can't "lend" an obligation that you owe.

And, even when we use the word "deposit" to mean the paper currency or coin deposited by a customer (or the customer's act of making that deposit), the bank only rarely "lends" those items to someone else. Instead, most bank loan proceeds are in the form of bank checks, credits to a customer deposit account, etc., etc. Certainly, some actual paper currency and coin is disbursed by the bank each day, but borrowers generally do not receive loan proceeds by walking out of the bank lobby with bags of currency.

Usually, when currency is being disbursed by the bank, the currency is being disbursed to a customer, to reduce the amount of his deposit account balance, and not as loan proceeds. Famspear (talk) 16:52, 17 November 2015 (UTC)

I wouldn't say that 'banks lend out deposits', but I would say that if a bank is short of funding, when funds are deposited by customers, the bank will be able to lend out more (but less than the amount of funds deposited). LK (talk) 02:05, 18 November 2015 (UTC)

Consensus on money creation

Over the past several years, there has been a slow but constant influx of what I would call 'cranks' (pardon my french) who argue that this page gets money creation all wrong (WouNur being just the last in line). I think people here are clear about how money creation works in the real world. I just want to establish consensus about how money creation works, so that we can refer to this consensus for future debates, and to help guide us in the editing of this page.

Money creation in short:

• The central bank has a target interest rate that it pursues to control inflation. It freely buys and sells government bonds in the financial markets (and thus expands or contracts reserve money) to keep market interest rates at the target rate.
• The money supply may change if the central bank raises (or lowers) the target rate, thus raising (lowering) the inter-bank market interest rate. This encourages banks to contract (expand) lending, which contracts (expands) the money supply.
• The money supply may also change if the business environment changes, causing banks to banks to expand or contract lending, thus expanding or contracting the money supply.
• Thus, there can be both 'supply shocks' as well as 'demand shocks' affecting the monetary system.

I believe this is the standard textbook version, but am open to critiques and changes. Comments anyone? LK (talk) 03:29, 26 November 2015 (UTC)

That is sort of a holistic view of money creation. I think the more reductionist view of money creation is that it basically done in one of two ways, either through an increase in the money base or through the money multiplier. The one which I think is most relevant the topic of fractional reserve banking, and the one primarily covered in this article, is money creation through the money multiplier. You can of course have a long discussion of how the money multiplier can be affected in all sorts of ways by regulators, the central bank and market forces, but I am not sure such a holistic view of the matter is really needed here. I am fine with the more specific view presented in the article.TheFreeloader (talk) 18:42, 26 November 2015 (UTC)

There are two issues with the more mechanical money multiplier view. First, given that the central bank does OMO to keep to an interest rate target, an improvement in business sentiment (and thus more bank lending) can 'pull' reserves into the system. And second, the money multiplier doesn't hold when interest rates are near zero (liquidity trap) as bank just accumulate excess reserves. However, I see your point. These complication shouldn't be discussed in length in this article. Instead, they should be elaborated upon in the money creation article. How about this, we point cranks who argue that we get money creation all wrong to the money creation article and ask them to improve that instead? LK (talk) 01:25, 27 November 2015 (UTC)

It seems you are arguing against yourself. Your "two issues" serve to show that the vanilla money multiplier idea is simply junk. So why promote it? There are many ultra senior central bankers that say we shouldn't. Reissgo (talk) 10:50, 27 November 2015 (UTC)

Ressigo, would it satisfy you if we keep the exact mechanism by which a central bank expands money supply vague (but not incorrect) on this page, and point to the money creation page with more detail there? I know that you dislike the presentation of the money multiplier table, but such a table is in all the textbooks when they explain the broad money implications of fractional reserve banking, and so it should be here. We can add a short note somewhere in this article that explains that central banks do not generally 'inject money into the system', rather they lower their interest rate targets, which causes them to purchase government bonds, which injects money into the system. LK (talk) 15:18, 2 December 2015 (UTC)

I agree, that sounds like a good plan. This article's section on money creation should just be a summary of the technical parts which pertain to fractional-reserve banking of the money creation article. The broader view of the matter is only really relevant to the money creation article.TheFreeloader (talk) 17:36, 27 November 2015 (UTC)

I don't support this idea. Firstly, the money creation page is dreadful. Secondly, the money multiplier table has no relevance to the real world. Reissgo (talk) 11:34, 3 December 2015 (UTC)

LK, I suggest you ignore the fringe views and make whatever edits you feel would clarify the presentation of the mainstream view. You are the editor who is perhaps most familiar with current presentations of this subject matter in textbooks and other widely acknowledged RS. SPECIFICO talk 14:18, 3 December 2015 (UTC)

According to Google Schollar, the Bank of England paper Money creation in the modern economy has had 114 citations already. Can you really call it fringe? Reissgo (talk) 17:57, 3 December 2015 (UTC)

Affirmatory. Please familiarize yourself with WP policy in this matter. SPECIFICO talk 18:07, 3 December 2015 (UTC)

Please enlighten me with some example sources, on the monetary system, that you consider more authoritative/reliable than the Bank of England Quarterly Bulletin. Reissgo (talk) 14:21, 5 December 2015 (UTC)

Full reserve banking initiative in the Netherlands

Recently an initiative for full reserve banking in the Netherlands (depositobank.nl) failed because it would have had to take part in the national deposit insurance scheme. The Dutch national bank refused to grant an exemption because it said existing legislation did not allow for it. This led to parliamentary questions. If we can find good English language sources, this might be useful to work into the article. Martijn Meijering (talk) 22:07, 26 December 2015 (UTC)

How long can a section be left with citations needed flag?

I noticed that the section "example of deposit multiplication" had a flag saying "This section needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. (May 2014)". Wikipedia is supposed to contain verifiable information - so I thought it was about time the section was deleted. SPECIFICO then restored the section.

What should happen here? For how long can an inadequately cited section remain on wikipedia?

For the record, I think the section is misleading, and the BoE amongst many others has said as much. Reissgo (talk) 15:04, 30 March 2016 (UTC)

I just did a search of the article as currently written, and the phrase "example of deposit multiplication" does not appear in the article. What is the exact wording of the heading for the specific section you are referring to? Famspear (talk) 17:33, 31 March 2016 (UTC)

PS: Also, I just did another search, and I found no flag anywhere saying "This section needs additional citations for verification..." etc. Famspear (talk) 17:34, 31 March 2016 (UTC)

PS: There is a section on the money multiplier concept, but the text in that section says (in part):

A mechanism used to calculate the maximum size of the money supply from any given quantity of base money and a given reserve ratio, is known as the "money multiplier". Rather than directly limiting the money supply however......

That is a description of a mathematical concept, not a description of an actual physical process of creating deposits by making loans, etc. But, I'm not sure if that's the text you're referring to, anyway. Famspear (talk) 17:40, 31 March 2016 (UTC)

Famspear, your efforts here are appreciated but in this case WP:DENY is best. Recent edits should be reverted to the last stable version. SPECIFICO talk 18:33, 31 March 2016 (UTC)

Famspear, your search did not find anything because I had removed the section again with an edit at 09:27, March 31, 2016 - see history. Reissgo (talk) 18:48, 31 March 2016 (UTC)