Monday, 6 July 2020
Banks intermediate between lenders and borrowers.
It has become fashionable recently to claim that commercial banks do not intermediate between lenders and borrowers, but rather that banks create the money they lend out from thin air. Actually banks do both: i.e. they certainly create money, but once that money is created, it then circulates between one person and another, one firm and another and between one bank and another and indeed between lenders and borrowers.
Moreover, and ironically, a paper that the above mentioned dedicated followers of fashion often quote, namely a Bank of England paper entitled “Money Creation in the Modern Economy” actually supports the above “create AND intermediate” point. At least the second sentence of the paper reads “…..banks do not act simply as intermediaries…”. I.e. the authors are saying banks DO ACT as intermediaries, but that’s not all they do. Quite right.
One way of demonstrating the way in which banks act as intermediaries is as follows.
Suppose a bank finds its deposits have risen by £X million over the last six months, plus suppose the bank thinks those deposits look like being a PERMANENT addition to the bank’s deposits. What’s the bank going to do?
Well it’s pretty much forced to lend out an extra £X million or thereabouts, because if the bank wants to expand it’s market share, or at least maintain its market share, it must pay interest to those new depositors, especially if a significant proportion of those deposits are in term accounts. And where will it get the money to pay that interest? From lending out around an extra £X million or thereabouts!
Ergo . . . roll of drums . . . . banks in effect lend on depositors’ money.