Banks don

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Banks dont lend money, they create it
Deobfuscating monetary and banking terminology
7th Critical Finance Studies ConferenceCBS,
Copenhagen, August 20-21, 2015 Ib Ravn Research
Program on Organization and Learning,
Department of Education, Aarhus University,
Denmark
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1. The problems

• Problems
• What does a bank do when it lends?
• Three theories of bank lending (Werner, 2014).
  Which is true? Or when?
• Why do terms like lending seem like
  obfuscation?
• My presentation
• How banks create money (account money).
• The three theories of bank lending fit three
  different monetary and banking systems.
• Some money and banking terms that need to be
  deobfuscated and a few hypotheses as to why
  they havent been already.

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2. When a bank lends? It creates money

• Bank of England paper, Money Creation in the
  Modern Economy Banks do not act simply as
  intermediaries, lending out deposits that savers
  place with them (McLeay et al., 2014, p. 14).
• Hugo Frey Jensen, (Deputy) Governor, Danmarks
  Nationalbank "Banks create deposits, and thus
  money when providing loans (Jensen, 2013, p. 1).
• Example Loan 800,000 DKK. Entered into my
  current account (a bank liability)A new loan
  account -800,000 DKK. My debt to the bank (a
  bank asset). The banks balance has been
  extended. No transfer of funds. No
  intermediation.
• Michael Kumhof, Senior Research Advisor, Bank of
  England whenever a bank makes a new loan to a
  non-bank customer X, it creates a new loan entry
  in the name of customer X on the asset side of
  its balance sheet, and it simultaneously creates
  a new and equal-sized deposit entry, also in the
  name of customer X, on the liability side of its
  balance sheet. The bank therefore creates its own
  funding, deposits, in the act of lending. (Jakab
  Kumhof, 2015, p. 3).

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3. Lending clearing gt money creation

• When loan has been made, the borrower spends it
  payment, a transfer to another account. Doesnt
  that require the bank to cough up the money?
• No, because millions of payments the national
  payment system (in DK Nets). Clearing (Norman et
  al., 2011). Only small net amounts are
  transacted. A payment system facilitates money
  creation.
• Loans increase deposits. Increases money supply
  money creationLoan repayments deduct from
  deposits. Decreases money supply money
  destruction
• Consequence In good times, banks over-lend and
  feed bubbles in fixed assets, driving
  boom-and-bust rollercoaster.
• Unchecked bank lending (money creation) is the
  main cause of the business cycle (Werner, 2005).

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4. The term lending confuses

• Strange terminology. What lawn mower do you
  create in the act of lending it?
• And when you return it, does it cease to exist?
• Why has this term persisted?
• To justify the charging of interest? (Savers
  must be compensated for theunavailability of
  their funds, right?)

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5. Three theories of bank lending (Werner, 2014)

• The financial intermediation theory A bank
  gathers deposits and lends them.
• The fractional reserve theory of banking A bank
  retains a fraction (10) of every deposit and
  lends the 90.
• The credit creation theory Bank creates new
  (account) money by bookkeeping (adding digits to
  customer accounts).
• Werner (2014) finds overwhelming evidence for
  no. 3.
• Ill argue they are suitable for three different
  banking systems (Weberian types)

Money. Jens Overgaard Bjerre
Money. Jens Overgaard Bjerre
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6. (1) The intermediation theory fits a warehouse
bank

• True when banks accepted gold and valuables for
  safekeeping (de Soto, 2012)
• The gold coins were lent, with or without
  depositors knowledge.
• This theory has survived later developments in
  banking and remains the popular theory of banks.
• Theory 1 is true for that type of bank
  (historically very rare).

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7. (2) The fractional reserve theory fits a bank
with reserves

• Theory was invented for a gold-type banking
  system
• Here, deposit slips circulate as money (bank
  notes) and depositaries write fake deposit
  slips, passing them off as loans (Ravn, 2014).
• Reserves are banks and nations safeguards
  against bank runs.
• Reserve only makes sense here (not in warehouse
  bank no new money, thus no need for reserves).
• In the 1700-1900s this theory was a fair fit (if
  we ignore account money!)

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8. (3) Credit creation theory fits pure
account-money bank

1. Theory A bank credits the borrowers account
   with the deposit and enters a corresponding
   asset (the value of the loan) on the other side
   of the ledger. No funds transferred. Deposit is
   created from scratch.
2. Suitable for a banking and monetary system where
   all money is account money (no gold or cash)
   (Jakab Kumhof, 2015)
3. Bookkeepers discovered they could lend by
   adding numbers to a borrowers account, without
   honestly subtracting the same number from some
   other account.
4. When many amounts are transferred between
   accounts, they tend to clear. In the clearing of
   matching loans lies money creation.
5. As loans are not given as cash/gold today, this
   theory fits current banking system.

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9. The three theories evaluated

• Suitable to historically different banking
  systems.
• Past economists confused about bank lending?
• Keynes did little to enhance clarity in this
  debate, as it is possible to cite him in support
  of each of the three hypotheses, through which he
  seems to have moved sequentially (Werner, 2014,
  p. 12).
• British banks in 1925 were a combination of
  warehouse banks, gold-reserve banks, and
  account-money banks.
• Theory 3 holds today (Werner, 2014 Benes
  Kumhof, 2012). Our banking system is evermore
  account-based. For the other banking systems the
  other theories are fine.
• When banks use theory 1 concepts today it is
  misleading and self-serving
• - It justifies the charging of interest (no
  lender forgoes the use of their money)
• - It hides banks enormous power to create money
  and control the money supply
• - It portrays banks as humble servants of
  societys needs when pursuing own profits

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10. Example Theory 1 used for public
communication

• Finansrådets hjemmeside Banker skaber kontakt
  mellem de, der vil låne penge, og de, der ønsker
  at spare op. Bankernes unikke rolle som
  pengeformidlere skaber blandt andet værdi ved
  at gøre det nemmere og billigere at låne og spare
  op. Bankerne leder pengene i samfundet derhen,
  hvor de gør størst gavn.
• http//www.finansraadet.dk/Tal--Fakta/Pages/banker
  nes-betydning-i-samfundet/bankerne-og-vaekst/uddyb
  ning-om-ind--og-udlaan.aspx
• Translation The Danish Bankers Association
  website
• Banks establish contact between those who want
  to borrow money and those who wish to save. The
  banks unique role as money intermediators
  creates value by making it easier and cheaper to
  borrow and save. The banks channel the money
  in society to where it does the most good.

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11. Theory 1 terms that obfuscate

• Lending, loan. Warehouse terms conceal that banks
  create money
• Loanable funds funding. Suggest lent money
  derives from funds
• Make a deposit. Nothing is deposited. Its all
  numbers. No gold rarely cash.
• Repayment of a loan. No such thing. You dont
  repay freshly created money.
• Business cycle as if the boom-bust economy is
  normal, not preventable.
• Create money Id like you create 200,000 for a
  new home for us.
• Money creation. Unethical to pretend otherwise.
  Truth in advertising? Illegal?
• Coordinate numbers. Would you jiggle some
  numbers in my accounts?
• Destruction. Let me destroy 500 a month. Erase
  it from my account.
• Money bubbles to underscore the money-created
  origins of boom-bust

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12. Possible reasons why no change in terminology

• Ignorance When early trading houses allowed
  customers to go into debt and still trade, they
  didnt know they were creating money.
• Gradual awareness of deception E.g., goldsmiths
  writing fake deposit slips.
• Deliberate silence for gain. Why call attention
  to a fraud by naming it so?
• Bankers responsibility to guard the publics
  trust (Nielsen, 1930, s. 59)
• Scholars unaware. Money and banks virtually
  absent from economics. Neutral veil can be
  ignored.Highly convenient for bankers. Shared
  interests?
• Major failing
• Bankers practical use extant concepts
• But finance scholars and economists should have
  updated theory (from no. 1 to 3) and
  reconceptualized ages ago.
  www.tinyurl.com/keen-krug

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13. Conclusions

1. Lending and other terminology hidden behind a
   veil.Not veil of neutrality, but a veil of
   deception (Häring, 2013)
2. Three banking systems overlap, as do three models
   of lending.
3. (1) The warehouse theory legitimizes the charging
   interest and glorifies banks role (2) Banks
   seen as having gold reserves fractional reserve
   banking(3) Best fit today banks add to the
   money supply when lending money creation
4. Responsibility of academics in (critical)
   finance This really matters. Business cycles
   concentrate wealth at the top and deprive
   millions of their just share.
5. If we dont understand this causal factor,
   bubbles will return. The nature of bank lending
   needs to be clear banks money creation feeds
   bubbles and crises.
6. Help design a more equitable monetary system
   which controls bank credit creation (Werner,
   2005) or strips banks of their power to create
   money (Wolf, 2014 Jackson Dyson, 2012
   Sigurjónsson, 2015)

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14. References (a)

• Benes, J., Kumhof, M. (2012). The Chicago Plan
  revisited. IMF Working Paper WP/12/202.
• De Soto, Jesús Huartes (2012). Money, bank
  credit, and economic cycles. 3rd edn. Auburn, AL
  Ludwig van Mises Institute.
• Häring, Norbert (2013). The veil of deception
  over money How central bankers and text-books
  distort the nature of banking and central
  banking. Real-world economics re-view, 62 2-18
  (25 March).
• Jackson, Andrew, Dyson, Ben (2012). Modernising
  money. London Positive Money.
• Jakab, Zoltan, Kumhof, Michael (2015). Banks
  are not intermediaries of loanable funds and
  why this matters. Working paper No. 529, Bank of
  England, May.
• Jensen, Hugo Frey (2014) Money at the bank is
  also good money. Danmarks Nationalbank, Press
  Release, Sept. 23, www.tinyurl.com/hugo-money
• McLeay, Michael, Radia, Amar, Thomas, Ryland
  (2014b). Money creation in the modern economy.
  Bank of England Quarterly Bulletin, Q1, 14-27.
• Nielsen, Axel (1930). Bankpolitik. Bd 2 Læren.
  København Hagerups Forlag.

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15. References (b)

• Norman, B., Shaw, R., Speight, G. (2011). The
  history of interbank settlement arrangements
  exploring central banks role in the payment
  system. Working Paper No. 412, Bank of England,
  June.
• Ravn, Ib (2014). Private bankers pengeskabelse
  belyst ud fra en episode i 1600-tallet med
  Londons guldsmede. Samfundsøkonomen, nr. 2,
  april, 4-10. Money creation by commercial banks,
  explained through an episode in the 1600s with
  the goldsmiths of London
• Sigurjónsson, Frosti (2015). Monetary reform a
  better monetary system for Iceland. A report
  commisioned by the prime minister of Iceland.
• Werner, Richard A. (2005). New paradigm in
  macroeconomics Solving the riddle of Jap-nese
  macroeconomic performance. Houndmills, UK
  Palgrave Macmillan.
• Werner, Richard A. (2014). Can banks individually
  create money out of nothing? The theories and
  the empirical evidence. International Review of
  Financial Analysis, 36, 1-19. A bloggers fine
  summary here www.kortlink.dk/frkv
• Wolf, Martin (2014) Wolf, M. (2014). Strip
  private banks of their power to create money.
  Financial Times, 24. April.