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Do banks create money from nothing?

by Ollie Barron 01 February 2010 |

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I've come across some info online that describes how banks create money, essentially conjuring it from nothing. This info contradicts what I thought about money creation, with images of the Royal Mint printing vast sheets of notes. Rather, when you ask for a loan from a bank, they don't actually have the money but create the credit on your account in their "system." They then ask for all of this money back with extra in the form of interest - money that they didn't have in the first place! When you deposit money into an account, the bank is able to create money upto ten times the amount you deposited - money from nothing! Can anyone confirm or refute this please?

If it's the case that it cost the bank nothing to create the credit, then I think there's an argument for not paying it back.

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manzanilla posted
This is called fractional reserve banking. It has been universal in all modern western socities for several hundred years.
It does cost the bank to create your credit, because banking rules and regulations limit the amount that they can create. You may have heard recently of banks such as Lloyds having rights issues - this is because they need more capital in relation to the size of their lending.
The reasons why you should pay back the money that you have borrowed are:
a) you agreed to do this when you borrowed the money.
b) your credit rating will be wrecked if you don't, and you could lose your house , car or have bailiffs round.
c) you take advantage of the modern banking system by having your salary and benefits being paid into an account and being able to withdraw it when you want. The banking system is not some elaborate con - stop reading the sorts of loony websites which say that it is.
manzanilla
Posted on 01 February 2010 | Love 3 loves Report
216

SoftwareBear posted
Hi Ollie,
As with anything ... you need to read between the lines.
The banks have been accused of making money by selling on portfolios of mortgages that included more risky loans than the buyer was aware of.
Just as you can buy something and be disappointed in the quality. However you've spent the money already ... real money.
They haven't 'printed their own money' so to speak ... or invented money ... they hyped something up and someone else parted with the money.
The Royal Mint is often just replacing notes and coins that already existed.
However with the quantitative easing ... effectively the BoE is inventing some money ... which is effectively de-valuing the pound against all the other currencies out there ... but it's also loosing some assets whilst doing so.
There is only so much money in existence ... but it depends what the units are and how they compare to other units.
When the bank gives you a loan ... you pull the money out of the cash machine ... which isn't actually the same money they gave you in the loan ... it's in another system ... but the systems will sync up at the end of the day (or instantly) ... and your account will be debited and you have the cash in your hand.
How much more real can it be ?
Posted on 01 February 2010 | Love 1 love Report
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Swarbs posted
Ollie
I think the online info has taken a very selective view of fractional reserve banking! The bank cannot just lend you money that it doesn't have, as you obviously have the right to take that money out in cash. What happens is that banks take in money from various sources, including deposits, loans from other banks, loans from the Bank of England etc. They can then lend up to around 92% of this money to other customers, and have to keep around 8% of it themselves, effectively 'in their vault'. This is where the ten times figure comes from - the bank can lend out ten times the amount of money that it has in its vault, but only because the other 90% has been provided from other sources - deposits, loans made to the bank, securities sold by the bank etc. This is a very simplified view of the whole system, but I think it demonstrates the basic principle.
So the bank doesn't make money from nothing, it makes money from moving money around. There is a cost to create the credit - the cost is the interest paid on the deposits and loans that the bank has taken out, as well as the admin cost of paying the bank employees. If you take out a loan and don't pay it back, the bank makes a loss on that loan. If enough people don't pay their loans back, the bank can't afford to pay back the depositors and loans it has made, and hence goes bankrupt, or has to be bailed out. This causes knock on problems, as the bank has borrowed money from other banks, and sold them securities, causing these other banks to go bankrupt. As the credit crunch showed, banks can be connected all over the world so if enough banks fail in one country, the problem spreads to all countries. As you can probably see, there are lots of potential problems with this system, but it is founded on principles, albeit tenuous ones.
Does that answer your question?
Posted on 01 February 2010 | Love 1 love Report
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MikeGG1 posted
Basically, the Bank is only lending money that it has borrowed. It has to pay interest on that borrowing and repay the capital. In just the same way you have to pay them interest on what you have borrowed and repay the capital, so that they can do it.
That is the work that they do. You expect to get paid for work that you do. So do they. You have costs like food, clothing and travel. They have staff costs, maintenance of buildings and the cost of that 10% capital and the borrowings.
Mike
Posted on 01 February 2010 | Love 0 loves Report
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Ollie Barron posted
Thanks chaps, some interesting points. I don't fully understand some of the things you've mentioned but I'll look into them. You've certainly provided me with an alternative POV which I always like to find when learning about things. The question that started this all off for me was, "if capitalism requires infinite growth, is this possible in a finite world?" I don't much care for communism though... I'm just looking into alternatives to the current method. If you dislike that in any way, I just ask that you keep an open mind, and remember that there's a positive correlation between resistance to change and Alzeimer's! Peace out.
Posted on 02 February 2010 | Love 0 loves Report

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