AARHUS UNIVERSITET
Banks don’t lend money, they create it:
Deobfuscating monetary and banking terminology
7th Critical Finance
Studies Conference
CBS, Copenhagen,
August 20-21, 2015
Ib Ravn
Research Program
on Organization and Learning,
Department of Education,
Aarhus University, Denmark
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
1. The problems
Problems
•
What does a bank do when it lends?
•
Three theories of bank lending
(Werner, 2014). Which is true? Or when?
•
Why do terms like ‘lending’
seem like obfuscation?
My presentation
1. How banks create money (account money).
2. The three theories of bank lending fit three different monetary and banking systems.
3. Some money and banking terms that need to be deobfuscated
– and a few hypotheses as to why they haven’t been already.
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
2. When a bank lends? It creates money
•
Bank of England paper, Money Creation in the Modern Economy:
”Banks do not act simply as intermediaries, lending out deposits that savers place with
them” (McLeay et al., 2014, p. 14).
•
Hugo Frey Jensen, (Deputy) Governor, Danmarks Nationalbank: "Banks create
deposits, and thus money when providing loans” (Jensen, 2013, p. 1).
•
Example: Loan 800,000 DKK. Entered into my current account (a bank liability)
A new loan account: -800,000 DKK. My debt to the bank (a bank asset).
The bank’s balance has been extended.
No transfer of funds. No intermediation.
•
Michael Kumhof, Senior Research Advisor, Bank of England: “…whenever a bank
makes a new loan to a non-bank customer X, it creates a new loan entry in the
name of customer X on the asset side of its balance sheet, and it simultaneously
creates a new and equal-sized deposit entry, also in the name of customer X, on the
liability side of its balance sheet. The bank therefore creates its own funding,
deposits, in the act of lending.” (Jakab & Kumhof, 2015, p. 3).
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
3. Lending + clearing => money creation
•
When loan has been made, the borrower spends it = payment, a transfer to another
account. Doesn’t that require the bank to cough up the money?
•
No, because millions of payments: the national payment system (in DK: Nets). Clearing
(Norman et al., 2011). Only small net amounts are transacted. A payment system
facilitates money creation.
•
Loans increase deposits. Increases money supply = money creation
Loan repayments deduct from deposits. Decreases money supply = money destruction
•
Consequence: In good times, banks
over-lend and feed bubbles in fixed assets,
driving boom-and-bust rollercoaster.
•
Unchecked bank lending (money creation)
is the main cause of the business cycle
(Werner, 2005).
AARHUS UNIVERSITY
4. The term ‘lending’ confuses
•
Strange terminology.
What lawn mower do you
create in the act of lending it?
•
And when you return it,
does it cease to exist?
•
Why has this term persisted?
•
To justify the charging of interest?
(Savers must be compensated for the
unavailability of their funds, right?)
Ib Ravn
ravn@dpu.dk
Ib Ravn
ravn@dpu.dk
AARHUS UNIVERSITY
5. Three theories of bank lending (Werner, 2014)
1. The financial intermediation theory:
A bank gathers deposits and lends them.
2. The fractional reserve theory of banking:
A bank retains a fraction (10%) of every
deposit and lends the 90%.
3. The credit creation theory: Bank creates
new (account) money by bookkeeping
(adding digits to customer accounts).
Money. Jens Overgaard Bjerre
•
Werner (2014) finds overwhelming
evidence for no. 3.
•
I’ll argue they are suitable for three different banking systems (Weberian types)
Money. Jens Overgaard Bjerre
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
6. (1) The intermediation theory fits a warehouse bank
•
True when banks accepted gold and
valuables for safekeeping (de Soto, 2012)
•
The gold coins were lent,
with or without depositor’s knowledge.
•
This theory has survived later
developments in banking and
remains the popular theory of banks.
•
Theory 1 is true for that type of
bank (historically very rare).
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
7. (2) The fractional reserve theory fits a bank with reserves
•
Theory was invented for a
gold-type banking system
•
Here, deposit slips circulate as
money (bank notes) and
depositaries write fake deposit slips,
passing them off as loans (Ravn, 2014).
•
Reserves are banks’ and nations’ safeguards against bank runs.
•
“Reserve” only makes sense here (not in warehouse bank: no new money, thus no
need for reserves).
•
In the 1700-1900’s this theory was a fair fit (if we ignore account money!)
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
8. (3) Credit creation theory fits pure account-money bank
1. Theory: A bank credits the borrower’s
account with the deposit and enters a
corresponding asset (the value of the loan)
on the other side of the ledger. No funds
transferred. Deposit is created from scratch.
2. Suitable for a banking and monetary system
where all money is account money
(no gold or cash) (Jakab & Kumhof, 2015)
3. Bookkeepers discovered they could ”lend”
by adding numbers to a borrower’s account,
without honestly subtracting the same
number from some other account.
4. When many amounts are transferred between accounts, they tend to clear.
In the clearing of matching loans lies money creation.
5. As loans are not given as cash/gold today, this theory fits current banking system.
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
9. The three theories evaluated
•
Suitable to historically different banking systems.
•
Past economists confused about bank lending?
•
“Keynes… did little to enhance clarity in this debate, as it is possible to cite him in
support of each of the three hypotheses, through which he seems to have moved
sequentially” (Werner, 2014, p. 12).
•
British banks in 1925 were a combination of warehouse banks, gold-reserve banks,
and account-money banks.
•
Theory 3 holds today (Werner, 2014; Benes & Kumhof, 2012). Our banking system is
evermore account-based. For the other banking systems: the other theories are fine.
•
When banks use theory 1 concepts today it is misleading and self-serving:
- It justifies the charging of interest (no lender forgoes the use of their money)
- It hides banks’ enormous power to create money and control the money supply
- It portrays banks as humble servants of society’s needs when pursuing own profits
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
10. Example: Theory 1 used for public communication
Finansrådets hjemmeside:
”Banker skaber kontakt mellem de, der vil
låne penge, og de, der ønsker at spare op.
Bankernes unikke rolle som ‘pengeformidlere’
skaber blandt andet værdi ved at gøre det nemmere og billigere at låne og spare op.
…[B]ankerne leder pengene i samfundet derhen, hvor de gør størst gavn….
http://www.finansraadet.dk/Tal--Fakta/Pages/bankernes-betydning-i-samfundet/bankerne-og-vaekst/uddybning-om-ind--og-udlaan.aspx
Translation: The Danish Bankers Association website:
“Banks establish contact between those who want to borrow money and those who wish
to save. The banks’ unique role as ‘money intermediators’ creates value by making it
easier and cheaper to borrow and save. …[T]he banks channel the money in society to
where it does the most good….
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
11. Theory 1 terms
that obfuscate
1. Lending, loan. Warehouse terms
conceal that banks create money
• Create money: ”I’d like you create
£200,000 for a new home for us.”
2. Loanable funds; funding. Suggest
lent money derives from ‘funds’
• Money creation. Unethical to pretend
otherwise. Truth in advertising? Illegal?
3. Make a deposit. Nothing is deposited. • Coordinate numbers. “Would you jiggle
It’s all numbers. No gold; rarely cash.
some numbers in my accounts?”
4. Repayment of a loan. No such thing. • Destruction. “Let me destroy £500 a
You don’t ‘repay’ freshly created money. month. Erase it from my account.”
5. Business cycle – as if the boom-bust
economy is normal, not preventable.
• Money bubbles – to underscore the
money-created origins of boom-bust
Ib Ravn
ravn@dpu.dk
AARHUS UNIVERSITY
12. Possible reasons why no change in terminology
1. Ignorance: When early trading houses allowed customers to go into debt and still
trade, they didn’t know they were creating money.
2. Gradual awareness of deception: E.g., goldsmiths writing fake deposit slips.
3. Deliberate silence for gain. Why call attention to a fraud by naming it so?
4. ‘Bankers’ responsibility’ to guard the public’s ‘trust’ (Nielsen, 1930, s. 59)
5. Scholars unaware. Money and banks virtually
absent from economics. Neutral veil; can be ignored.
Highly convenient for bankers. Shared interests?
Major failing:
•
Bankers practical – use extant concepts
•
But finance scholars and economists
should have updated theory (from no. 1 to 3)
and reconceptualized ages ago.
www.tinyurl.com/keen-krug
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
13. Conclusions
1. Lending and other terminology hidden behind a veil.
Not veil of neutrality, but a veil of deception (Häring, 2013)
2. Three banking systems overlap, as do three models of lending.
3. (1) The warehouse theory legitimizes the charging interest and glorifies bank’s role
(2) Banks seen as having gold reserves: fractional reserve banking
(3) Best fit today: banks add to the money supply when lending = money creation
4. Responsibility of academics in (critical) finance: This really matters. Business cycles
concentrate wealth at the top and deprive millions of their just share.
5. If we don’t understand this causal factor, bubbles will return. The nature of bank
lending needs to be clear: banks’ money creation feeds bubbles and crises.
6. Help design a more equitable monetary system – which controls bank credit creation
(Werner, 2005) or strips banks of their power to create money (Wolf, 2014; Jackson &
Dyson, 2012; Sigurjónsson, 2015)
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
14. References (a)
Benes, J., & Kumhof, M. (2012). The Chicago Plan revisited. IMF Working Paper
WP/12/202.
De Soto, Jesús Huartes (2012). Money, bank credit, and economic cycles. 3rd edn.
Auburn, AL: Ludwig van Mises Institute.
Häring, Norbert (2013). The veil of deception over money: How central bankers and textbooks distort the nature of banking and central banking. Real-world economics review, 62: 2-18 (25 March).
Jackson, Andrew, & Dyson, Ben (2012). Modernising money. London: Positive Money.
Jakab, Zoltan, & Kumhof, Michael (2015). Banks are not intermediaries of loanable funds –
and why this matters. Working paper No. 529, Bank of England, May.
Jensen, Hugo Frey (2014): Money at the bank is also good money. Danmarks
Nationalbank, Press Release, Sept. 23, www.tinyurl.com/hugo-money
McLeay, Michael, Radia, Amar, & Thomas, Ryland (2014b). Money creation in the modern
economy. Bank of England Quarterly Bulletin, Q1, 14-27.
Nielsen, Axel (1930). Bankpolitik. Bd 2: Læren. København: Hagerups Forlag.
AARHUS UNIVERSITY
Ib Ravn
ravn@dpu.dk
15. References (b)
Norman, B., Shaw, R., & Speight, G. (2011). The history of interbank settlement
arrangements: exploring central banks’ role in the payment system. Working Paper
No. 412, Bank of England, June.
Ravn, Ib (2014). Private bankers pengeskabelse – belyst ud fra en episode i 1600-tallet
med Londons guldsmede. Samfundsøkonomen, nr. 2, april, 4-10. [Money creation by
commercial banks, explained through an episode in the 1600’s with the goldsmiths of
London]
Sigurjónsson, Frosti (2015). Monetary reform: a better monetary system for Iceland. A
report commisioned by the prime minister of Iceland.
Werner, Richard A. (2005). New paradigm in macroeconomics: Solving the riddle of Japnese macroeconomic performance. Houndmills, UK: Palgrave Macmillan.
Werner, Richard A. (2014). Can banks individually create money out of nothing? — The
theories and the empirical evidence. International Review of Financial Analysis, 36, 119. A blogger’s fine summary here: www.kortlink.dk/frkv
Wolf, Martin (2014): Wolf, M. (2014). Strip private banks of their power to create money.
Financial Times, 24. April.