Lets talk... Tech

[Scootersp]

loafer123 said:

No, not to my knowledge.

Every loan requires a certain amount of capital and the rest has to come from depositors, inter bank lending or other sources of liquidity.

They can’t just say abracadabra and create money or the BoE would get jealous.

Well they need to be cautious as they need to get it back so that should keep them in some sort of check no?

If they aren't able to create how has the system expanded so much as from what you are saying my interpretation would be that everything is backed and balanced?

However if this is true from day one then all the depositor money around would already be the other side of an existing loan wouldn't it? Or at the very least we'd have reached a point at some time where all the "depositors, inter bank lending or other sources of liquidity" was used against the loans to date and there was no more, we had to stop lending, but we have never got there have we? if anything we've massively accelerated overall lending?

We need more debt to keep things expanding, more debt means more money (can this be contested?), so where does it get loaned into existence from, it has to be the banks (it's symantics to me if central or commercial and it always reaches people and businesses via commerical banks) Someone somewhere is expanding the supply of debt and money?

[Gecko1978]

loafer123 said:

Scootersp said:

Is it correct to say they have the ability to create money via loans so the money goes to others, but they can't do a one sided accounting entry and lend to themselves?

There was a bit in his video about loans where he said the banks say "you'll find the money in your account" not we've transferred it into your account, because it hasn't been transferred in from anywhere, is that true?

No, not to my knowledge.

Every loan requires a certain amount of capital and the rest has to come from depositors, inter bank lending or other sources of liquidity.

They can’t just say abracadabra and create money or the BoE would get jealous.

Capital v the asset is a fraction so simple using a std formula for an SME (as retail customers don't have external ratings).

Let's say Bob Smith Ltd has a BBB rating from memory this would be 100% Risk weight so BSltd wants to borrow 100k we assume plain vanilla loan so no undrawn amount therfore CCf does not matter.

So we have a loan of 100k

Risk weighted at 100% = 100k x 1 = 100k

So we now need between 10 and 13.5% capital. (Under basel 2 which I used to report under when I had a line role was 8% so we can use that).

So to lend 100k I need 8k in capital. Your account will be credited with 100k and a loan account will be set up with an outstanding amount which you pay down.

The bank only had 8k but you can spend 100k that is they have created 92k more than they had.

The capital is supposed to offset the risk of default hence banks assests are "Risk weighted" which is a bit different to a simple company asset

Edited by Gecko1978 on Sunday 12th March 18:19

[loafer123]

Gecko1978 said:

Not infinite as has been explained to you. Its a function of capital v RWA. Your capital requirement.is based on rules in place today (Basel 3) and any add ons specified by your local regulator I.e. PRA, Fed, ECB etc. So get more capital lend more but again there are rules on size of balance sheet etc. Many of us try an explain this but jts a little more complex than I can type out on my phone. Also Finance, Risk departments (I work in the latter) look at it differently. So it's not a t shirt sized explanation sorry to say.

I understand all of that, as my posts explain, and they are necessarily in everyday language because this isn’t a banking forum.

Are you of the view that your bank can create money (and I am specifically referring to the non bank capital element of each loan) without taking it from another source, whether that be deposits or external liquidity sources?

My experience is that is not the case, which is why loans are floating rate to match the bank’s cost of borrowing liquidity.

[loafer123]

Gecko1978 said:

Capital v the asset is a fraction so simple using a std formula for and SME (as retail customers don't have external ratings).

Let's say Bob Smith Ltd has a BBB rating from memory this would be 100% Risk weight so BSltd wants to borrow 100k we assume plain vanilla loan so no undrained amount therfore CCf does not matter.

So we have a loan of 100k

Risk weighted at 100% = 100k x 1 = 100k

So we now need between 10 and 13.5% capital. (Under basel 2 which I used to report under when I had a line Jon was 8% so we can use that).

So to lend 100k I need 8k in capital. Your account will be credited with 100k and a loan account will be set up with an outstanding amount which you pay down.

The bank only had 8k but you can spend 100k that is they have created 92k more than they had.

The capital is supposed to offset the risk of default

You might want to tell your Treasury department that…they’ll be able to leave at lunchtime. /s

Under your scenario the banks balance sheet has an additional asset to the value of the loan and no addition liability.

That isn’t what happens.

[Gecko1978]

loafer123 said:

Gecko1978 said:

Capital v the asset is a fraction so simple using a std formula for and SME (as retail customers don't have external ratings).

Let's say Bob Smith Ltd has a BBB rating from memory this would be 100% Risk weight so BSltd wants to borrow 100k we assume plain vanilla loan so no undrained amount therfore CCf does not matter.

So we have a loan of 100k

Risk weighted at 100% = 100k x 1 = 100k

So we now need between 10 and 13.5% capital. (Under basel 2 which I used to report under when I had a line Jon was 8% so we can use that).

So to lend 100k I need 8k in capital. Your account will be credited with 100k and a loan account will be set up with an outstanding amount which you pay down.

The bank only had 8k but you can spend 100k that is they have created 92k more than they had.

The capital is supposed to offset the risk of default

You might want to tell your Treasury department that…they’ll be able to leave at lunchtime. /s

Under your scenario the banks balance sheet has an additional asset to the value of the loan and no addition liability.

That isn’t what happens.

If as you state all loans were funded from existing deposit base there would be no balance sheet growth at all less the gap between funding and lending rates.

So as I keep saying assets are Risk weighted and capital funds thoes assets as a fraction of them. Even where RW is 100% the capital to fund that is still less.

Or look at it another way if you borrow 500k to buy a house your scenario requires there to be deposits of that....for every mortgage....if there were no one would need a mortgage if they had 500k spare.

Big deposits balances tend to be corporate balances and they move about constantly usally in terms of hedging FX or commodity risk they don't leave 1bn there so the ba m can lend it out over 25 years

Edit to add: I think building societies do work like that I.e. lending from deposit base but I have never worked in reg in that area.

Edited by Gecko1978 on Sunday 12th March 18:39

[Scootersp]

Gecko, thanks for the examples, this was my current understanding of how things work and expand.

So the important part of this is the risk ratings and potential default effects, as well as the fact that with a significant loan book no bank has the ability to survive a full on bank run.

[Gecko1978]

Scootersp said:

Gecko, thanks for the examples, this was my current understanding of how things work and expand.

So the important part of this is the risk ratings and potential default effects, as well as the fact that with a significant loan book no bank has the ability to survive a full on bank run.

In the end it does come back to basics if all your customers pull put you No longer have a bank.

[Zed Ed]

Although being heavily exposed to clients in the same sector is a risk , and some of the issues in play here, like interest rate variations, would be core to scenarios considered when managing financial risk.

[loafer123]

Gecko1978 said:

If as you state all loans were funded from existing deposit base there would be no balance sheet growth at all less the gap between funding and lending rates.

So as I keep saying assets are Risk weighted and capital funds thoes assets as a fraction of them. Even where RW is 100% the capital to fund that is still less.

Or look at it another way if you borrow 500k to buy a house your scenario requires there to be deposits of that....for every mortgage....if there were no one would need a mortgage if they had 500k spare.

Big deposits balances tend to be corporate balances and they move about constantly usally in terms of hedging FX or commodity risk they don't leave 1bn there so the ba m can lend it out over 25 years

Edit to add: I think building societies do work like that I.e. lending from deposit base but I have never worked in reg in that area.

Edited by Gecko1978 on Sunday 12th March 18:39

I have been very careful with what I said…I didn’t say all loans are funded by deposits. Loans are funded by a mix of sources of liquidity, from deposits to overnight deposits (money market funds) to bonds, syndications of loans to investors and lots of other funding sources.

I agree that capital forms a fraction based on risk (I.E. capital on calculated based on RWAs), but the rest of the loan is not created by your Treaury department..they spend a lot of time, effort and money matching liabilities and assets, and ensuring they continue to have the right mix.

Fundamentally, SVB haven’t got the right mix - they have clients with cash deposits as liabilities and long term bonds as assets with a mark to market impairment.

If they could create money out of thin air, don’t you think they would have?

[Scootersp]

loafer123 said:

If they could create money out of thin air, don’t you think they would have?

Isn't the point Gecko makes that they create a loan and essentially extra/additional money for the receipient but not money for themselves?

He said to make the loan they only need X% to back it and so the excess was created for the borrower. (what is the point of the basel % rules if they can't do this?)

They can't print it for themselves or their mates, wives etc etc I think we can all agree that?

What you've not explained is that if the total of it is backed by other money of various forms (regardless of nomicalture they are all essentually money presumably?) then as Gecko said how does the balance sheet increase, and all banks have increased, it's not like one takes on more debt and becomes bigger and another bank gets smaller is it? They've all got bigger which can't happen with a finite amount of money?

How do you see money has been created, money supplied expanded if not the way Gecko describes?

[loafer123]

I think there is a way of reconciling the two points. See the following article for the economic principle;

https://courses.lumenlearning.com/wm-macroeconomic...

Banks do create money by owing the original deposit to their customer, whilst lending it on to others, and due to the fractional reserve system, the first deposit is then lent several times, creating money along the way.

If all these transactions were in cash, with numbered banknotes, you could follow the same cash through the system, but at the same time multiple assets and liabilities (loans and deposits) have been created along the way.

[InformationSuperHighway]

Good news at last:

https://www.cnbc.com/amp/2023/03/12/stock-market-f...

Fed are backstopping

[Mrr T]

Gecko1978 said:

Capital v the asset is a fraction so simple using a std formula for an SME (as retail customers don't have external ratings).

Let's say Bob Smith Ltd has a BBB rating from memory this would be 100% Risk weight so BSltd wants to borrow 100k we assume plain vanilla loan so no undrawn amount therfore CCf does not matter.

So we have a loan of 100k

Risk weighted at 100% = 100k x 1 = 100k

So we now need between 10 and 13.5% capital. (Under basel 2 which I used to report under when I had a line role was 8% so we can use that).

So to lend 100k I need 8k in capital. Your account will be credited with 100k and a loan account will be set up with an outstanding amount which you pay down.

The bank only had 8k but you can spend 100k that is they have created 92k more than they had.

The capital is supposed to offset the risk of default hence banks assests are "Risk weighted" which is a bit different to a simple company asset

Edited by Gecko1978 on Sunday 12th March 18:19

Sorry but you are confusing to different elements of banking. Capital is regired to support assets so as to reduce risk on default. However, a bank cannot lend money it does not have so while £8 of capital may allow a bank to lend £100 it can only do so by borrowing the £92. Commercial bank cannot create money. It simple double entry bookkeeping which has been around for 500 years.

[isaldiri]

loafer123 said:

I have been very careful with what I said…I didn’t say all loans are funded by deposits. Loans are funded by a mix of sources of liquidity, from deposits to overnight deposits (money market funds) to bonds, syndications of loans to investors and lots of other funding sources.

I agree that capital forms a fraction based on risk (I.E. capital on calculated based on RWAs), but the rest of the loan is not created by your Treaury department..they spend a lot of time, effort and money matching liabilities and assets, and ensuring they continue to have the right mix.

Fundamentally, SVB haven’t got the right mix - they have clients with cash deposits as liabilities and long term bonds as assets with a mark to market impairment.

If they could create money out of thin air, don’t you think they would have?

I wonder if you and gecko aren't somewhat cross talking and the misunderstanding being simply an issue if terminology as used on a forum message board.

Commercial banks do 'create' money per se when writing a loan but their ability to do so is constrained by various things - liquidity requirements and banking regulation. As per

https://www.bankofengland.co.uk/quarterly-bulletin...

And for a less officious description of the process, I find this chap quite useful as I'm not really a balance sheet person (stongle tbh if he were around would be much better placed to comment than me)

https://fedguy.com/two-tiered-monetary-system/

[Scootersp]

loafer123 said:

If all these transactions were in cash, with numbered banknotes, you could follow the same cash through the system, but at the same time multiple assets and liabilities (loans and deposits) have been created along the way.

Are you saying in your linked example that if you started with the 10m in bank notes you could trace them through all the 9M loan and then the 8.1M loan?

Where are you saying the 10M in notes are distributed at the end if traced through? 1M Singleton, 900K First National and 8.1M second national?

When it mentions the money supply increasing at each step you don't think then that you'd need more bank notes for this?


It reads to me like after the two loans you have 10M of depositors money in Singleton, 9M for hank to spend, and 8.1M for Jack's to spend? Certainly these three entities will think they have that available? so Money supply is 27.1M?

[rodericb]

isaldiri said:

loafer123 said:

I have been very careful with what I said…I didn’t say all loans are funded by deposits. Loans are funded by a mix of sources of liquidity, from deposits to overnight deposits (money market funds) to bonds, syndications of loans to investors and lots of other funding sources.

I agree that capital forms a fraction based on risk (I.E. capital on calculated based on RWAs), but the rest of the loan is not created by your Treaury department..they spend a lot of time, effort and money matching liabilities and assets, and ensuring they continue to have the right mix.

Fundamentally, SVB haven’t got the right mix - they have clients with cash deposits as liabilities and long term bonds as assets with a mark to market impairment.

If they could create money out of thin air, don’t you think they would have?

I wonder if you and gecko aren't somewhat cross talking and the misunderstanding being simply an issue if terminology as used on a forum message board.

Commercial banks do 'create' money per se when writing a loan but their ability to do so is constrained by various things - liquidity requirements and banking regulation. As per

https://www.bankofengland.co.uk/quarterly-bulletin...

And for a less officious description of the process, I find this chap quite useful as I'm not really a balance sheet person (stongle tbh if he were around would be much better placed to comment than me)

https://fedguy.com/two-tiered-monetary-system/

Yeah - to simplify it for us up the back, the banks "create" money merely as they're part of the banking system and that system allows the banks to repeatedly lend the money they source (through deposits or borrowing). They don't determine how much money they and the system can create through that cycling - that's determined by regulation. The greater pool of money which they can use is determined by the central bank (the "money printer go brrr" meme people would have seen in the past year or two).

AIUI - and this is a simplified version of events - SVB got a massive amount of deposits a couple of years ago and had to do something with them so they bought a heap of US government bonds. As US bonds are an ultra-safe, low coupon rate (interest rate) investment, when interest rates are going up they lose their lustre as a good parking spot for money, especially the long terms bonds which SVB owned, as you're losing money on paper. So, like many other holders of bonds currently, they were sitting on a chunky unrealized loss on the bonds and some finance media commentator started spruiking this "fact". This triggered a run on the bank (businesses and individuals rushing to take their deposits out) to which the bank had to sell their bonds, at a loss, to satisfy the need for cash to return to the depositors. This whole palaver made shareholders in SVB start dumping stock like crazy.

[Gecko1978]

https://positivemoney.org/how-money-%20works/how-b...

Link above takes you to an article where a stament from the bank of England clarifys this.

So big tech what do we think are the threats opportunities

Me lack of funding curtials innovation which prevents energy outcomes we actually want being achieved.

Also online world's making youth desire to live in them greater than desire to live in real world I.e. Web 3.0 and giant mmorpg making people spend thier lives thier an stop engaging in the actual world.

[turbobloke]

£1 sorts it.

[loafer123]

rodericb said:

Yeah - to simplify it for us up the back, the banks "create" money merely as they're part of the banking system and that system allows the banks to repeatedly lend the money they source (through deposits or borrowing). They don't determine how much money they and the system can create through that cycling - that's determined by regulation. The greater pool of money which they can use is determined by the central bank (the "money printer go brrr" meme people would have seen in the past year or two).

Good summary, and as as Isaldri says above, I suspect Gecko and I are talking at cross purposes.

The chart of the SVB balance sheet is informative. It shows the small amount of equity as a proportion of the balance sheet, but also that every asset, whether bond or loan, has a matching liability, whether deposit or bank debt;

[Mrr T]

Lots of views so here is a detailed summary of how money works in the modern banking system.

I will use a simple example. I will also introduce you to the concept of Central Bank Money (CBM) the core of a low risk settlement system.

Let start with a simple example. A, who banks with Barclay borrows 100 from HSBC. I will ignore capital for simplicity but remember capital is just another liability.

So how might that transact be carried out by a payment system. The obvious solution would create the following BS entries.

HSBC

Liability	Asset
Loan from Barclay 100	Loan to A 100

Barclays

Liability	Asset
Loan from A 100	Loan HSBC 100

While that works it not the process used for two reasons complexity and risk.

I have just shown one transaction but there are millions of payments between companies in the UK. Retail payment are generally small but large companies make very large payment as do investment funds. If the above system was used at any one time one bank could have a very large exposure to another. If that bank fails then it could bring down others. This is systemic risk. The CB worst nightmare.

It would also require every bank to operate and manage an account for every bank it deals with. The system could be make safer by requiring exposures to be collaterlised. But in the UK collateral is transfer of title. Trying to manage collateral with so many account would be a nightmare.

So it does not work like that.

So now let's discuss CBM. CBM is at the core of the 2 UK payment systems for banks, CHAPS and BACS. The system means that every payment between banks is settled not directly but via accounts the banks hold with the BOE. If we take our simple example above the balance sheets after the loan settles would be.

HSBC

Liability	Asset
Loan from BOE 100	Loan to A 100

Barclays

Liability	Asset
Loan from A 100	Loan to BOE 100

BOE

Liability	Asset
Loan from Barclay 100	Loan to HSBC 100

Only banks can have a CBM account with the BOE, and while foreign banks can have an account the account owner has to be a properly capitalised UK sub.

It makes the system much easier since the banks interaction with the rest of the market is via one BOE account. The BOE requires any risk it has on a bank to be collaterlised. But the system means just one collateral account with the BOE. It less complex and a lot less risky.

Since I have already mentioned investment funds it worth also mentioning Central Securities Depository. The CSD records the legal ownership of all gilts and UK listed equity and bonds. In the UK the CSD is Euroclear UK using a system called CREST. To settle purchases and sales safely all transactions are on a Delivery V Payment basis. And the payment system used is CHAPS. In that way all these transactions settle via CBM.

Now to go back to our example HSBC can fund the loan by borrowing from the BOE but that's expensive. The loan form the BOE requires collateral which the HSBC I would need to borrow to buy which has a cost and the rate on BOE accounts is high. So the HSBC will actually borrow from someone else. Let's say in this case Tesco, last time I looked Tesco had lots of cash on its balance sheet.

Without going through the details Tesco will lend HSBC 100 which CHAPS will settle via HSBC BOE account. The balance on the HSBC BOE account is now zero and the HSBC balance sheet is now.

HSBC

Liability	Asset
Loan from Tesco 100	Loan to A 100

I have read this a couple of time and hope there are no errors but will correct if any are pointed out. Also any questions or disagreement please ask.