Monday, April 2, 2012

Musings on banking

By Helge Nome

The big question is whether bank deposits are re-lent to borrowers, or invested in financial instruments, as the case may be, or are simply parked in limbo while new money is created in the form of loans to bank customers.

I think the problem is embedded in the language we use to describe transactions where "money" is seen as some kind of entity moving around from here to there. Except for currency, this is patently not the case. Deposits and withdrawals are simply accounting
entries following accepted rules and conventions. So, in reality, there is no great pile of deposits that are moved to other places to become deposits there, at the expense of a diminishing pile at source. There are simply diminishing numbers at source balance sheets as compared to increasing numbers on destination balance sheets.

The sneaky part about bank balance sheet numbers is this: New loans appear as assets to the bank in the asset column and as deposits in the liabilities column. These deposit entries in the liabilities column are not distinguished from deposits from sources external to the bank. So when you read the bank's consolidated balance sheet it appears as if something like 90% of deposits have been issued as loans.
The assumption made by an outsider is that the bank has re-lent about 90% of its deposits (hanging on to 10% in case someone comes back for their money). The reality is, of course, that a substantial number of those deposits were made out of thin air by way of internal accounting entries.

All that said, people use banks to park their money in a safe place and expect some interest return on their money. So if banks accept the stuff (which normal banks have to do) they have to find some way of generating money to cover this interest plus some profit for themselves. Ergo, rules are created which enable them to do so because they fill a very real need in society. However, in order to appease public sentiments, it is important to generate the illusion that banks re-lend money placed in their vaults at a marginal increase in interest rate.

I tried my hand as an illusionist (magician) in my young days. The crafts of magic and banking have many traits in common.

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