I think this is one of those "technically true" things, but it works out very similarly.
You deposit $1 with the bank. The bank now has a liability to you of $1, and deposits the $1 with the bank's bank (often the central bank).
hand waving
Separately, the bank is able to negotiate for loans from the central bank. This is on the basis of its demonstrated capital controls, liabilities, deposits (with the central bank, including your $1), business plan, etc.
When the bank receives a loan from the central bank, there isn't necessarily any cash moving around. It's literally just numbers in a ledger, and a system of governance where eventually guys with guns will liquidate the bank's property if they don't handle things properly.
The central bank wants a cut of the action in terms of the prime rate. Whether the local bank can lend directly from deposits depends on how much control the central bank wants to exert, since this is an end-run around the monetary policy and oversight.
> You deposit $1 with the bank. The bank now has a liability to you of $1, and deposits the $1 with the bank's bank (often the central bank)
This is not how it works. You deposit $1 with the bank and create a liability. The same day, another branch makes a loan and creates new deposits from thin air. At the end of the day, the bank figures out its reserve position. If it is short, it borrows reserves from other banks.
I mean generally. This is a pervasively common myth (the Talk section of the wiki article alludes to this). Read about the money multiplier myth, or, a direct source from a central bank about how loans are created by creating new deposits at the point of loan creation: https://www.bankofengland.co.uk/explainers/how-is-money-crea...
There is a concept of reserve in the system. That is: banks must keep a reserve with the central bank relative to the amount of new money they are creating through loans. At the moment though, that reserve ratio is 0 (zero) for the UK and the US, rendering it meaningless.
I guess I still don’t understand your original point in the context of your reply.
Say the banks are creating new money through these loans. And then enough of the original depositors plus some of the people that have been lent money want their money out that the bank can’t give it to all of them. From a layperson’s perspective (like mine) this seems like the bank has loaned out their deposits — it seems like a distinction without a difference to me.
There's a lot to unpick, and it's a massively confusing system that I'm still trying to understand myself, but I'll do my best.
When you deposit money into a bank a few things happen:
- The money is no longer yours, it's the banks, you have no ownership of it anymore
- The bank creates an IOU (a deposit) in your account to say that you may request money equalling this value at any time. You can spend this IOU in various places, it is widely accepted as money. This "bank money" is confusingly referred to as dollars (or whatever your currency is), just like actual cash is.
- Completely separated from handling deposits, another arm of the bank creates loans, which also creates IOU's (deposits) in their respective account.
- Someone given a loan may request to withdraw cash (or a transfer), which may force the bank to reach into it's reserves, which is partly made up of customer cash deposits. These reserves are owned by the bank, not depositors. Banks are not holding onto depositors money in a strict sense, it's the banks money until an IOU is called in.
I think the last bit might be where the question about the "distinction without a difference" might be coming from? when the borrower requests cash, they are not "withdrawing" their loan, they are cashing in their deposit of "bank money". Because the percentage of reserves is always vastly smaller than all deposits they hold, bank runs are always destructive on the system. The whole system is a massive plate spinning act that works fine if the plates keep spinning.
Their whole business is lending other people's deposits. For the most part they have no money of their own. They use your money lend and speculate with.
When a bank makes a loan, they create a loan and a deposit from nothing, they don't need deposits to create loans.
Banks are subject to capital requirements, and are concerned about profitability and loan losses, so they don't make an unlimited number of loans.
This might seem like semantics but someone who believes reserve requirements and deposits are the limits on lending would find it tough to explain why banks aren't lending huge amounts after the reserve requirement in the US was cut to zero.
What's taught in undergrad economics courses is incorrect. Fractional reserve banking doesn't really exist anymore. Banks don't lend out the deposits they recieve, they create new ones 'out of thin air'.
Arguably the most important constraint on a bank's ability to create new loans (and hence new deposits) is its core tier one capital ratio: that is, its total liabilities divided by its shareholders' equity.
