Sunday, 10 January 2016

What % of money for loans comes from intermediation?

Commercial banks which want to lend are forced to obtain some of the relevant money from savers, else those banks run out of reserves. At the same time, banks create a certain amount of money from thin air every year. So how much “loan money” comes from each of those two sources?

It could be argued that since the money supply expands at 5 to 10% pa, that the ratio is about 90% intermediation 10% origination. But is ONE YEAR the appropriate period? Probably not. I suspect the appropriate period is the duration of the average loan: say roughly 10 years, during which time the money supply would double roughly speaking (in nominal rather than real terms). So in that case we’re talking about an intermediation / origination ratio of about 50:50. But that’s very much a back of the envelope calculation.

It can be argued that when a loan is repaid, money vanishes, and when a new loan is granted, ALL OF the relevant money is created from thin air. That’s not a totally invalid way of looking at it. But it’s a bit of a silly way of looking at it, and for the reason given above, namely that a bank HAS TO attract some money from savers (including those who repay loans) else it runs out of reserves.

Thus the conventional view of banks adopted by those who have never opened an  economics text book, namely that they are piggy banks which cannot lend until they receive savings, is not totally invalid.

The moral is that if you think philosophy is abstract, you ain’t seen nothing: try working out what banks are and what they do.


  1. "Commercial banks which want to lend are forced to obtain some of the relevant money from savers".

    This only applies to individual banks which are not creditworthy enough to be able to borrow from other domestic or international financial institutions.
    Credit worthy banks always have the option of borrowing from the central bank, the lender of last resort.

    1. I intended the word "saver" in a broad sense: i.e. to include those who fund "other domestic or international financial institutions". Perhaps I should have made that clear.

  2. I've never a bank tell me that they couldn't give me my money because they had lent it to someone else.

    1. That’s because taxpayers stand behind the absurd / fraudulent promise made by private banks, namely that loaned on money is totally safe. Had you had money in Northern Rock, and had the taxpayer not stood behind Northern Rock then NR would have told you: “Sorry you can’t have all your money back”.

  3. Ralph> What % of money for loans comes from intermediation?

    Exactly (1-RReff)x100 with RReff being the effective reserve ratio, RReff=R/M with R reserves and M bank loans.
    I.e. at most (1-RRmin)x100 with RRmin being the minimum reserve ratio, where legally imposed (e.g. for USD).

    Or also (1-1/m)x100 with m being the money multiplier, m=1/RR. On macroeconomic scale, the money multiplier can be estimated from monetary aggregates as monitored and published by central banks, as the ratio of broad money (M2) over base money (M0 or MB).


    Numerically: with e.g. reserve ratio RR=0.1 (10%, minimum requirement for USA banks) or equivalently money multiplier m=10, 10% of loans is base money and 90% of loans is bank money.

    1. Strikes me your (1-reserves) percentage is the percentage of all money that is privately issued. I’m concerned with a different percentage, i.e. the percentage of money for loans comes from privately issued money which was created long ago (that’s the intermediation proportion) as compared to the proportion that is created on the spot and out of thin air for those wanting loans.

    2. I'm trying to read your underlying intentions with this topic ;-)

      Presumably (as a full-reserve advocate) you're trying to separate intermediation and creation, in the hope of finding a way to restrain the private sector to intermediation-only activities, while money creation would remain monopoly of the sovereign.

      So here's a paper that might be interesting:
      "Intermediation, Money Creation, and Keynesian Macrodynamics in Multi-agent Systems", Gibson and Setterfield, 2015

      Abstract> Keynesian economists refer to capitalism as a monetary production economy, in which the theory of money and the theory of production are inseparable (Skidelsky, 1992). One important aspect of this, brought to light by Robertson following the publication of The General Theory, is that in a Keynesian economy, endogenous money creation is logically necessary if the economy is to expand. A Keynesian economy cannot operate with an exogenously given supply of money as in verticalism. One way to ensure that money is endogenous is to simply assume that the supply of money is infinitely elastic, known in the literature as horizontalism. In this view, prior savings cannot be a constraint on current investment and it follows that the level of economic activity is determined by effective demand. Using a multi-agent systems model, this paper shows that real economies, especially those subject to recurrent financial crises, can be neither horizontalist or verticalist. Horizontalism overlooks microeconomic factors that might block flows from savers to investors, while verticalism ignores an irreducible ability of the system to generate endogenous money, even when the monetary authority does everything in its power to limit credit creation.

      In more mundane language: the authors argue that real economies can't expand when the sovereign tries to impose a monopoly on money creation.
      Note that endogenous money is bank-created money, exogenous money is sovereign money, also see

    3. Given the huge number of different things that have served as money thru history, I'm baffled as to why economic growth isn't possible in an "exogenous money only" economy. Items that have been used as money include cattle, sea shells, rare metals, base metals, paper, wood (as in tally sticks) - the list is endless.

    4. Ralph> Given the huge number of different things that have served as money thru history, I'm baffled as to why economic growth isn't possible in an "exogenous money only" economy.

      There is plenty of anthropological evidence that "exogenous-money-only" economies have never existed; prehistoric and historic economies have always used credit-debt accounting in one form or another (in people's memories, on clay tablets, as tallies etc) according to the needs of the real economy. That is endogenous money. The exogenous monies available in limited quantities (such as coins, precious metals...) were often used only for transactions with the state (soldier salary payment, tax payment), for transactions between strangers, or for "clearance" (netting out accumulated mutual credit-debts among economic agents at more or less regular intervals). Cfr for instance "5,000 years of debt" by David Graeber (full text available on the web).

      Further to the original question, there is a detailed and very instructive case study in section 3.2 "A Live Empirical Test" (p. 13 ff) in the paper
      "Can banks individually create money out of nothing? — The theories and the empirical evidence" (R. Werner, 2014)

      The findings are compatible with the "credit creation" hypothesis and incompatible with the "financial intermediation" and "fractional reserve" hypotheses. (p. 15)
      Actually the case study confirms how commercial loans are booked in practice, by the creation of two matching records (with opposite signs) on the customer's account, and corresponding records on the balance sheet, one at the asset side (as a loan under rubric "claims on customers") and one at the liabilities side (as a customer deposit under rubric "claims by customers").

      Ultimately, and contrary to what many monetarists may believe, banks don't lend money (or not) just because the money happens to be there (or not). Instead, banks provide new credit (against corresponding new debt) according to actual demand for credit from microeconomic agents (large, medium-sized and small firms; self-employed; households).

    5. If it is in fact true that exo money only economies “have never existed”, that doesn’t prove that such an economy wouldn’t work. In fact we’ve made a significant move in the direction of an exo money only economy in the last three years or so in that the proportion of the money supply issued by central banks (thanks to QE) has soared.

      Re your 3rd para, I fully accept that private banks create money out of nothing. The best economics text books have made that point for a long time. It’s precisely the latter practice that advocates of full reserve like me want to abolish. One reason is that it is precisely the fact of issuing money that makes banks vulnerable and causes bank crises: and it’s not just advocates of full reserve who make that “vulnerable” point. Messers Diamond and Rajan make the point in the abstract of this paper of theirs:

    6. Diamond & Rajan make a valid point. The question is whether avoiding this particular risk warrants the drastic remedy of severely crippling commercial bank operations by imposing full-reserve regulation. That would surely have negative effects on the smooth operation of today's economies, the "cure" might be much more damaging than the "disease". I think "mild" review (somewhat less leverage, in line with e.g. Admati) would be effective enough.

      IMHO there are much bigger and more dangerous risks in today's finance markets, such as (1) intrinsic dynamic instabilities (studied a.o. by Minsky and Keen), (2) off-balance operations escaping regulatory and prudential control, (3) algorithmic high-speed trade. It's my personal intuition (FWIW) that the recent crises have been caused primarily by these latter risks, not by commercial bank credit-debt creation. But anyway, you're raising interesting questions with your posts... fun to think about ;-)

    7. I think it’s going a bit far to say full reserve would “cripple” commercial banks. All full reserve does is to require money lending corporations (i.e. banks) to be funded the same way as other corporations: i.e. mainly via a mixture of shares and bonds. Both of the latter type of stakeholder are likely to get hair cuts when things go wrong, and clearly that increases the return they demand. But the return they demand isn't excessive: for example Google is funded 90% by shares. Google isn't exactly a failure.

      Re off balance sheet stuff, that’s just ridiculous. It should be banned whether we convert to full reserve or not. It’s pretty much banned in Spain as I understand it.

      Re high frequency trading, strikes me there’s no question but that our existing bank system poses bigger risks than high frequency trading. It’s undeniable that banks were the main cause of the 2007/8 crisis and the seven or so subsequent years of excess unemployment. In contrast, while high frequency trading has obvious risks, it hasn’t so far done anywhere remotely near the same damage as banks. If the FTSE index drops 50% in one hour because of the twits who go in for high frequency trading, that would be so obviously the result of high frequency trading rather than fundamentals that I doubt a single business person in the country would pay any attention to it.

    8. Ralph> All full reserve does is to require money lending corporations (i.e. banks) to be funded the same way as other corporations: i.e. mainly via a mixture of shares and bonds.

      I've read your full-reserve book by now; it's obviously written with a lot of research and thought. However we're on a different page on quite a few issues. I'm not lobbying nor campaigning for anything, I'm only interested to think about the dynamics at work in economics and finance, in terms of what is most efficient for the common benefit (Pareto optimality). I think (FWIW) that full-reserve as you describe is way off Pareto optimal, and (in hindsight) the high pre-crisis leverages in banking weren't Pareto-optimal either.

      Ralph> It’s undeniable that banks were the main cause of the 2007/8 crisis and the seven or so subsequent years of excess unemployment.

      Citing "banks" as main cause, without being specific, is oversimplistic... it may go down well with John Doe but not with me. It also wouldn't be fair to blame all woes of years of excess unemployment just on the "banks", there surely are other badly understood dark corners and animal spirits at work (as Blanchard and Greenspan might say).

      Most commentators agree that the root cause of the 2007/8 financial crisis is to be found in the proliferation of toxic off-balance derivatives (CDS, CDO, MBS...) within the USA financial sector, initially with specialised high-tech investment banks. And then also several traditional "Main Street" banks were infected with these instruments because (1) they sought higher returns in their portfolios, (2) they lacked the insight to evaluate the risks themselves and were misled by shiny ratings, and (3) the separation between high-risk versus low-risk banking activities had been blurred by the gradual erosion and ultimate repeal of the Glass-Steagall Act shortly before the turn of the century. This cocktail was too much for some undercapitalised banks.

      Ralph> Re off balance sheet stuff, that’s just ridiculous. It should be banned whether we convert to full reserve or not.

      Banning derivatives altogether isn't a good idea, these instruments do have useful functions beneficial to the economy (in the hands of professionals and properly shielded from the unaware).

    9. I’d argue that full reserve actually is Pareto optimal, or at least more nearly so than the existing bank system. Reason is that the existing system is subsidised (because taxpayers stand behind, i.e. subsidise, the existing system).

      You could answer that by saying that there’s no subsidy if banks and depositors PAY FOR the insurance that the state offers. Problem there is that in practice, politicians over and over again fall for the temptation of NOT charging banks for the protection offered by the state. It’s true that small banks in the US seem to pay a realistic insurance premium via FDIC, on the other hand large banks don’t, and far as I know, the Fed and US government have no intention of charging large banks a commercial rate for the hundreds of billions they borrowed at sweetheart rates of interest during the recent crisis.

      I deal with further problems involved in depositor insurance here:

      Re your next point, i.e. your claim that the problem is more compled than “banks”, you list a series of “other” problems, but they’re all essentially bank problems, far as I can see (toxic derivatives etc).

      Re your third point (derivatives), I’m not arguing for banning them. I’m arguing that everything should be “on balance sheet”. A balance sheet is supposed to give a “true and fair view” of the state of a corporation at some point in time. If the corporation has significant liabilities which don’t appear on the balance sheet, then the latter is not worth the paper it’s printed on.

    10. Thanks for the link to the MPRA paper, I already had read it. Again a remarkable piece of work, contributing to the ongoing reflections on bank reform.

      Abstract> If government so much as hints that it will rescue banks in trouble, that constitutes a subsidy of banks, and subsidies misallocate resources. Alternatively, if government makes it clear it will never rescue banks, then all of those who fund banks, regardless of whether they are called depositors, bondholders or shareholders, in effect become shareholders. That is shareholder as in “someone who at worst stands to lose everything”. Since subsidies misallocate resources, i.e. reduce GDP, it follows that the GDP maximising option is the latter second one, that is a system where banks are funded just by shareholders or people who are in effect shareholders. And that equals or leads inevitably to full reserve banking.

      Now, I disagree with your conclusion that full-reserve banking maximises GDP.

      In logic, conclusions can't be stronger than premises, even if the logic reasoning is fully correct. So I challenge your premise that subsidies necessarily reduce GDP.

      The premise is often stated more generally as "subsidies reduce Pareto efficiency". Yes, I know this textbook common wisdom. I know that it's proven in mathematical economics. I know that the proof is based on rather strict assumptions in a typical mathematical model. I know that economy is essentially a behavioral science, where mathematical models are often fooled by the real economy. Whenever the economy doesn't "follow" the model, then the -model- is wrong, or at least not applicable in the specific circumstances.

      Thus the textbook "subsidies reduce Pareto efficiency" wisdom may apply most of the time, but not necessarily always under any real-world circumstances. Assertions logically derived from this premise aren't convincingly conclusive, they -can- be wrong in some cases. In short, the elimination of subsidies does not necessarily make full-reserve banking Pareto optimal. (My intuition tells me it isn't, we can here agree to disagree).

      For illustration: with some internet scanning I have found several empirical real-world research cases where indeed, rather than reducing GDP according to the textbook wisdom, subsidies -expand- GDP (thus with positive effects larger than the subsidy expenses). See for instance a study of the effects of specific interest subsidies in Brazil:
      "Effects of Government Intervention via Rural Credit Subsidy on Economic Growth and Welfare of Brazilian Regions", Debora Freire Cardoso et al, 2011,

      Abstract> The objective of this paper is to evaluate the impact of the Rural Credit Interest Rates Equalization Policy (IRE) on the economic and welfare growth of five Brazilian regions. The simulations are performed using the model, database and software from the General Equilibrium Analysis Project of the Brazilian Economy (PAEG). The results suggest IRE provides economic growth greater than the cost of the policy in the Midwest, Northeast and South regions. Moreover, in the North and East regions there is a decrease in GDP. For Brazil, the policy is cost-effective and offers 34% rate of return in terms of economic growth generation. Furthermore, all regions present welfare gain. The main conclusion is that IRE promotes economic and welfare growth and contributes to reduce regional disparities.

    11. I quite agree that subsidies CAN increase GDP. A classic example is probably subsidies for kid’s education. Apart from the social benefits of everyone being able to read and write, there would obviously be big economic costs for employers if employees from poorer backgrounds could not read and write.

      So I over-stated my case when I said (your second para above) that “subsidies misallocate resources”. I should have said something like “a reasonable assumption, in the absence of evidence to the contrary, is that a subsidy misallocates resources”. I.e. I suggest that if any sort of subsidy is proposed, the onus is on those advocating the subsidy to make the case for it, rather than there being any onus on opponents of subsidies to prove the subsidy misallocates resources.

  4. I think banking is like the ocean tides.It comes in and it goes out.Hard to tell what is happening on a daily basis,but eventually you see an effect....coastal erosion or additional sand deposits.You have to wait years to see how it will pan out.


Post a comment.