Richard Murphy claims banks do not need deposits before lending.

 
 

 

That’s in an article of his entitled “Banks do not need any deposits to make loans.”

I’ve actually run through this question as how reliant banks are on deposits before on this blog. But no harm in briefly running thru it again.

The problem with Murphy’s article is not that it is totally wrong, but that there are important ifs and buts which he ignores, and as follows.

First, he is not clear on whether he is referring to INDIVIDUAL banks or commercial banks as a whole. There’s a big difference. But I’ll start by assuming he means individual banks.

It is perfectly true that a bank under the existing “fractional reserve” system can make a LIMITED NUMBER of loans without getting money in from depositors (or for that matter, bond holders or shareholders). But a bank that does that on any significant scale will run short of reserves (i.e. base money) and thus has to borrow reserves from the central bank or other commercial banks.

It runs out of reserves because when the home made money which the bank gives to borrowers is spent, most of it is deposited at other banks, which in turn will want reserves off the original bank. That’s OK as long as those other banks have confidence in the original bank’s ability to settle its debts. But if they don’t, then the original bank is in a Northern Rock position, i.e. up shit creek without a paddle.
 
Another big question mark over the claim that a bank can grant loans without money coming in from depositors (and bond holders and shareholders) is this: why have banks over the decades dished out billions by way of interest and dividends to the latter three type of funder if banks don’t need their money?

In contrast to INDIVIDUAL banks, there is the commercial bank sector as a whole. That sector has greater freedom to expand its lending than an individual bank does because assuming all banks expand their lending by about the same amount, money created and loaned out by one bank ends up as a deposit at another. Thus no individual bank runs short of reserves. But there a still SOME constraints even on the bank sector as a whole: e.g. banks have to abide by capital ratio and reserve ratio rules, so to that extent they have to get money in from shareholders. (Those “ratio” rules vary from one jurisdiction to another of course.)

Murphy is also wrong to say in his article that according to this Bank of England article “Loans are quite emphatically not the recycling of depositors' money: all loans are made from newly created money.” Actually that BoE article says in its second sentence that commercial banks do two things: first create money (as Murphy says) and second, intermediate between lenders and borrowers, i.e. in effect, lend out depositors’ money.

 

Positive Money.

It is also relevant to note that Murphy gives pride of place on this issue to the Bank of England when in fact Positive Money was making a song and dance about the fact that commercial banks create money several years before the BoE article. In fact a bunch of Positive Money supporters in the North East of England (of which I’m a member) had a special celebration in a pub where we consumed a bottle of champagne when the BoE article was published.  That was to celebrate the BoE tumbling to what we’d been saying for some time.

But that’s not to say that the better economics text books long before Positive Money was founded were unaware that commercial banks create money: they certainly were aware of that fact. Some of those text books are on my bookshelves.

As to why Murphy did not give credit to Positive Money, that’s no doubt because he is no friend of PM: see his article entitled “Why Positive Money is wrong.”

And finally, and on the plus side, it’s good to see Richard Murphy putting a lot of effort into spreading MMT ideas.