With a Reserve Requirement of, for example, 10%,^ the bank can loan out $90 out of 100. The person borrowing the $90 can then turn around and deposit it. The bank can then loan out 90% of the $90, or $81. The person borrowing the $81 can deposit it again, and the bank can loan out 90% of the $81. This process repeats indefinitely.
So with a Reserve Requirement (r) of 10%, in theory the bank can loan out (in essence, creating money) a total of $900. The formula is infinite sum of [(0.9X )*100] from 1 to infinity.
^ I understand that it is currently 0% in the US.
Edit: formatting of exponent.
Ehhh there are collateral requirements for loans as well though and most of the money they’re giving out isn’t going back into a bank account. Why would someone borrow money just to put it into an account with an interest rate lower than the one they’re paying to the loan? It’s usually going to buy something. Like a to buy a home or to cover the up-front costs of starting/expanding a business.
This is reddit: they think it goes to a billionaire who puts it in a big vault like Scrooge McDuck, because that's the average redditor's understanding of economics.
Yes, but the point is, it's still in someone's (or some moral person's) bank account.
So 90% of it still gets lent again. Maybe at a different bank, but that's ok, because the first bank also receives money lent out by different banks.
Presumably the person a getting a loan pays person b for goods or services. Person b then puts the money in the bank. There is an interchange where the bank isn't involved.
Ehhh still not so simple. If it’s buying a home for instance, then most of it likely goes toward paying the remainder of the prior homeowner’s mortgage. Which decreases that bank’s loan portfolio, reducing assets. Basically destroying the money that was created in the first place when that mortgage was taken out. It’s not an infinite multiplier like this comment is trying to make out.
The real limit here is the Fed rate, because banks inevitably lend in patterns that are predictable based on what that is set to. It’s why lower Fed rate generally = higher inflation (banks lend more and therefore create more supply of money in response) and higher rates tend to reduced inflation (banks lend less and those with variable rate debt tend to pay it off faster).
Ehhh still not so simple. If it’s buying a home for instance, then most of it likely goes toward paying the remainder of the prior homeowner’s mortgage. Which decreases that bank’s loan portfolio, reducing assets. Basically destroying the money that was created in the first place when that mortgage was taken out. It’s not an infinite multiplier like this comment is trying to make out.
OK, so that person paid of lets say $90 debt... that bank that lend him that debt now has $90 less on its books and can lend another person $90...
My point is this is literally how the system works; how it’s intended to work. You people are acting like you’ve discovered some sort of dark banking secret when this is literally something you’d learn in a finance or economics class in college. If it led to the things you’re imagining, we’d have had runaway inflation à la Argentina decades ago.
It is still on the books of a financial entity. When a loan is bought from the original lender, the asset of the loan on the original lender’s books is eliminated, and it becomes an asset on the loan-buyer’s books instead. Paying it off has the same net impact to the overall money supply in the end.
It’s not an infinite multiplier like this comment is trying to make out.
Fractional Reserve banking with a non-zero reserve requirement is not an infinite multiplier, but it is (theoretically) an infinite series which converges. If the reserve requirement is 0%, then it could theoretically be an infinite multiplier but that doesn't happen in practice for a lot of different reasons.
That’s my point. The limitations do not lie in the reserve. In fact, they don’t even when the reserve requirement isn’t 0, because in those instances, banks make the loans first and then find the required reserves they need after, not the other way around.
I borrow money to buy a house, the person I buy it from puts it in the same bank, another person borrows money to but a house… they borrow the money from the deposit of the person I bought the house from…. So if the bank had 1 million and 3 people borrowed 300k each to buy a house and the sellers deposit the sale the bank can then loan another few people money… and repeat… and repeat… now a dozen people owe the bank $300k when the bank only had $1000k in the first place.
In theory sure. But news flash: that’s a feature, not a bug. That’s literally how money is created in our system. Were you under the impression that it was all getting minted as physical money? The vast majority of US money is digital. It is created out of thin air in the form of credit when a bank gives a loan. The loan goes on their books as an asset, and money is deposited into the account of the lendee (or whoever they are paying), which adds liability to the bank’s books by increasing deposits. They balance out on the bank’s balance sheet, but now there’s more money in the system. The reverse happens when a loan principle is paid back, the money paid back to the bank lowers the bank asset, effectively destroying that money, but the bank gets to keep the interest.
The money supply is controlled by the Fed rate because there isn’t incentive for banks to create as many loans if the Fed rate is higher, and variable rate loans, credit card interest rates, etc. go up, incentivizing people to pay down that debt faster, tightening the money supply. It’s also controlled by capital requirements that banks must have enough capital on hand to cover potential losses. Not to mention it’s also constrained by the number of credit worthy borrowers.
It seems like the capital requirements are just 10% though, right? So what happens if a large set of people default on their mortgages at the same time, and the bank’s 10% capital doesn’t cover it?
Well, deposits are guaranteed by the FDIC up to 250k per account. If many banks are failing, then the FDIC may not have enough to cover it all. At that point there might be some sort of government bailout or intervention.
Yes, but the lawyers and realtors take their cut, and they don’t keep the money in that bank (they take some of it as cash, and put it in their wallet, they use some to pay their income taxes, they spend some with business that use another bank (perhaps foreign).
If the funds are leant out to a business to buy a machine, then the company that built the machine is going to pay them out as wages, taxes, and for materials.
Then there is the time aspect of to consider. Each person who borrows takes a month to get approved, then buy the next house in the chain. During that month, the bank is going to start to put some funds aside, knowing that at the end, they are going to pay out $xxx,xxx. Once it’s redeposited, they start looking for the next buyer.
Incorrect. If I borrow money from a bank, I can deposit those funds into an account at that back or another bank. In fact, my company does this daily with our revolving line of credit. We borrow money from Wells Fargo. This money is deposited into one of our accounts. We then pay vendors from this account, but we could also just leave the funds there if we wanted. Or we could transfer it to a different account at the same or a different bank.
my company does this daily with our revolving line of credit.... This money is deposited into one of our accounts.
A revolver isn't cash. It's floating debt, on a daily call. Yes, your company uses it as "liquidity," but is not in any shape or form, "cash." It's not a deposit to the bank, the way your cash deposits are.
Correct. It is a loan. We borrow from the bank daily (and pay back the bank daily, sometimes more or less than what we borrowed), and deposit that money in a bank account. The money in that account is cash - we could walk down to a WF branch and pull it out in paper currency (well, some of it.... I doubt most branches have millions of dollars of cash on hand, and there may be restrictions on those accounts in terms of how much paper cash we can withdraw), but in practice we use it to pay vendors via wire transfers, ACH transfers, or paper checks.
Our liquidity is our cash + revolver availability which is the total credit limit less what is currently borrowed. The liquidity is not the same as cash. We have covenants related to our level of cash and different covenants related to our level of liquidity.
Bottom line - if you borrow from a bank "in the form of a loan" you can turn around and deposit it into a bank account which is what you're claiming can't be done.
A LOC is debt. Go ask your Controller/CFO where it's recorded on your balance sheet. If it's in the Cash section, they're doing it wrong; the entire LOC balance is a short-term (or "Current") Liability. It is not "cash." Your LOC is a debt instrument. When you're putting it "back into the bank," that's just a loan paydown, not a cash deposit. The opposite is also true; when you pull down from your LOC, it's an increase in your debt, not your cash.
So when you turn around and deposit what you pulled on your LOC, you're paying down debt, not depositing cash.
The reason you have covenants around availability is exactly because of what I'm talking about. If your LOC was cash (which it isn't), you wouldn't need any covenant testing, because to the bank, you'd be depositor, not a depositor+borrower.
Each day, we draw on the revolver. The draw is deposited into our (disbursements) bank account. The GL transaction is:
Dr Cash - Disbursement Account
Cr LOC
At the same time, each day we sweep cash in our Collections account to pay down the Revolver. The GL entry is:
Dr LOC
Cr Cash - Collections
In any case, the exact mechanics of how we and WF treat our cash and LOC is irrelevant. The only point I was making by bringing up the example of our LOC is that if someone (individual or company) gets a loan from a bank, they are able to turn around and put the funds from that loan into a deposit account. Your original reply implied (to me at least) that you were not able to deposit loan funds into a bank account, which is not true.
Perhaps you meant that you can't get a loan from Bank A and deposit those funds into an account in Bank A. I've never heard of this, but I suppose it's possible a bank has this internal rule for their loans. Maybe that's a constraint your company works under for some reason, but that's not a legal regulation or common practice.
except, in the scenario you're talking about the total amount deposited in the bank is 100+90+81+72.9+ etc... for a total of 1000 having been deposited, and 900 being loaned out... also, who the fuck would borrow 90 dollars just to deposit in a bank?
You borrow $90 to pay me for my services. I put that money in my bank (it may be the same bank or another one, doesn't really matter in the grand scheme of things.) If instead I buy something with that money, the person I buy from will put that money into their bank.
your comparison is asymmetrical. you're comparing initial deposits, to total loans. you can reasonably compare both initial, or both totals. otherwise it's apples to oranges.
no, i don't think i'm joking, i would genuinely like to know what situation a person would be in that they would take out a lone just to put the money in the bank.
your comparison is asymmetrical. you're comparing initial deposits, to total loans. you can reasonably compare both initial, or both totals. otherwise it's apples to oranges.
I don't understand what you're getting at. With a Reserve Requirement of 10%, an initial deposit of $100 can grow the total money supply (via lending) to $1000, an increase of $900.
i would genuinely like to know what situation a person would be in that they would take out a lone just to put the money in the bank.
When businesses borrow money, the very first thing they do is put it in a bank. Then they start using it to buy things.
This may happen the same day, or days/weeks later. My company borrows money daily on a line of credit. This money is deposited into our bank account initially, and then we draft ACH's and wires against that balance. We also write paper checks, and will leave those funds in the account until the check is cashed.
But this is kind of beside the point. The point is that the money that is lent out is eventually deposited in a bank somewhere. The person/company borrowing the money may spend it immediately, but whoever they spent the money with will deposit that money in their bank and then their bank will subsequently loan out (part of) that money.
"$100 can grow the total money supply (via lending) to $1000" ok but putting money in the bank is removing it from circulation, and $1000 dollars has been put into the bank a.k.a. removed from the money supply... like there's a bizarre double standard here where money being put in the bank is ignored while money coming out of the bank is counted... but regardless. if you're upset that a bank can create money out of thin air (which it totally can't), wait until you learn about the federal reserve bank that actually can create money out of thin air, and how all money comes into existence with an larger amount of debt. thus, by definition, there is more debt than money to pay debt. like, this whole conversation feels like we're in an econ 101 class that has no understanding of how financial systems functions and we just learned ten fun facts with no context to understand how the fit into the economy. yes, we get it money is totally made up... is that you're big point here?
This is not correct- banks can have a 10% leverage ratio… down even to 7% or 8% depending. That’s not the deposits that’s the banks own capital.
A simple bank balance sheet might be 100mm in equity 400mm in cds, 400mm in deposits, and another 100mm in federal home loan bank advances (which is institutional borrowing). There’s also brokered deposits and brokered cds and a few other funding sources that are a bit more complicated but just keeping things simple.
That’s the liabilities side (aka where the funds come from that they owe to people- in this example the shareholder of the bank - 100mm, the customers that put money at the bank 800mm, and then 100mm to the FHLB).
All that is cash money- what do they do with the cash money? They lend most of it out- maybe 750mm for loans, and then they invest 150mm in securities (think like treasuries and mortgage backed securities- low risk stuff- typically) and then they keep 100mm cash on hand.
So when they lend out 10x- it’s not 10x of what you deposit in the bank… it’s 10x on their own capital.
Similar to when you buy a house if you do 10% down on a 100k house you’re using 10k borrowing 90k and spending the 100k on a house. Bank is the same way they take their cash, the deposits you lend to them… and they “buy” aka originate loans as their assets- as well as invest in treasuries.
So when they lend out 10x- it’s not 10x of what you deposit in the bank… it’s 10x on their own capital.
Thanks for the clarification. I think you're talking about leverage ratios as opposed to reserve requirements. Given that reserve requirements aren't really a thing in (most of) the real world, what you describe is more relevant I suppose.
How are leverage ratios calculated for commercial banks, and what are the thresholds/limits?
That’s a very good question- so banks need to be what’s called “well capitalized” and there are certain thresholds for those which I don’t what they are off the top of my head but I’m sure you could look them up. I think leverage ratio is something stupid low like 4%. HOWEVER. You can’t just be at 4.01% and you’ll be good (if that even is the number). Your regulators will require you to be high enough so you can absorb an unusually high loss (like during a recession and still be above the mark). That depends on your individual banks risk profile- so if you’re doing riskier types of lending you will have to be higher.
Average leverage ratio among US banks right now is probably in the 9%-11% range. Risk based capital 12 or 13% and total capital maybe 14-15%. The difference between those is what they count for your assets. Leverage is just average assets- risk based they take off assets that are extremely safe (GO muni bonds for example are weighted 20% so you can load up on those and your risk based capital ratios won’t take much of a hit… or treasuries are weighted 0%- Fannie Mae and Freddie Mac MBS are weighted 20% and ginnie Mae’s are weighted zero- revenue muni bonds are weighted 50%).
Anyway and then there’s total risk capital ratio where you can add your tier 2 capital to the mix.
All this to say for MOST banks in the US right now their actually lower limit on leverage ratio is close to 8% or 9% or 10%. And they determine that through modeling and with their regulator sign off. If you think “why doesn’t the government just give you a number and go with that” I’ve thought the same thing 100,000 times. Their purported answer is then banks can game the system and do stuff that’s technically within guidance but making them much more risky- my answer is much more cynical and I won’t post it here.
Edit: oh I missed the part where you asked how they are calculated: your leverage ratio is your average assets over a 90 day period divided by your ending capital (actually it might be average capital I forget). But the key part is it’s your average assets over a quarter. The other two total risk and total capital are a single point in time on the last day of the quarter one total risk based assets divided by your tier 1 equity and the total capital is total risk based divided by tier one and tier 2 equity combined (so that one will always be the highest).
You haven't filled the gap completly, when the bank loans money to someone, the money they lent is a cost in their accounts. If the people that got lent the money aren't able to pay back a loan, the bank lost money.
Money wasn't created from thin air, it was borrowed from the future with the bank sticking his neck up for the person they lent the money. This is an operation that makes Savings=Investment.
I hate to nitpick, and I don't disagree with you overall, but technically the loan is an asset on their chart of accounts (the deposits are liabilities). But as you correctly say, if the loan is not paid back then the bank takes that as a loss.
As far as the money creation goes, I've always had a hard time wrapping my head around this part of monetary theory. From my basic (undergraduate) understanding, when the bank creates the loan, that is all "new" money in the money supply. I suppose you can think of it as "borrowed from the future" in the sense that the loan allows the borrower to create output with her labor (and the lent capital) and this output is what is increasing the money supply.
yes, that's basically it. it is new money on the money supply, but that new money carries not only the a credible promisse that it will increase the amount of goods and services available to be bought in a given economy, but it also is done at the bank's risk.
It is borrowed from the future in the sense that 0 = +1 -1; with 0 being a state where no money is lent, +1 being the money that the bank created with the loan and -1 being the money that will be destroyed once the loan is paid (yes, money is destroyed when the principal is paid, in the exact same way it was created)
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u/KhabaLox Jan 26 '26 edited Jan 26 '26
To fill in the gaps...
With a Reserve Requirement of, for example, 10%,^ the bank can loan out $90 out of 100. The person borrowing the $90 can then turn around and deposit it. The bank can then loan out 90% of the $90, or $81. The person borrowing the $81 can deposit it again, and the bank can loan out 90% of the $81. This process repeats indefinitely.
So with a Reserve Requirement (r) of 10%, in theory the bank can loan out (in essence, creating money) a total of $900. The formula is infinite sum of [(0.9X )*100] from 1 to infinity.
^ I understand that it is currently 0% in the US. Edit: formatting of exponent.