The answer is, they are a mirror image of each other (but lead to much the same outcome).
* The FRB ratio restricts the ratio of liabilities (deposits) to a specific category of assets (gold coins in the safe) to a certain maximum (let's say ten) and
* Basel ratios restrict the ratio of assets (loans made to customers) to a specific category of liabilities (paid up share capital and retained profits - the bank, as an entity is under no obligation to repay them except as dividends or on a winding up) to a certain maximum (again, let's say ten). Remember also that "share capital and retained profits" are nothing in themselves - the assets are real, the liabilities are real and this is just a balancing figure (in the same way as "equity" in a house is nothing tangible, the house is real, the mortgage is real and your "equity" is just a mathematical or legal concept).
Which is why it is best to avoid the word "reserve" completely, as it can mean two completely opposite things. The FRB banker keeps ten gold coins "in reserve" and the Basel banker has "capital reserves"; the former is an asset and the latter is a liability.
In either case, the banker starts off with "ten" (call it gold coins, millions of pounds, cockle shells, sickles, galleons, whatever) and lends them out. The borrower spends them and the recipient deposits them back in the bank, so they can be lent out again and will be re-deposited and so on until the upper limit is reached.
The idea that banks lend out ten for every one taken as a deposit is a nonsense. Once the dust has settled, under FRB the bank has lent out ninety pence for every one pound taken as a deposit, and under Basel rules, the bank has lent out £1.11 for every one pound taken as a deposit, as the diagram shows (click to enlarge):
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42 comments:
Excuse my financial ignorance Mark, but in the case of FRB the gold coins have a "market" value, whereas in BCA the bank could value it's reserves at whatever price it sees fit to place on them.
Which is very much where we are nowadays, with our banks trying to convince us they have assets that are worth say X amount, when we all know that if they came to realize these assets they would probably only get X-90%.
Or am I missing something here?
BB, yes, the ten gold coins in the safe have a market value, but the bulk of the FRB bank's assets is the hope value that the people who borrowed the ninety gold coins will pay them back.
If our FRB banker got reckless and lent the coins to gamblers and alcoholics, then the bookmakers and publicans will deposit them back in the safe, but what happens if all the book makers and publicans turn up and ask for their one hundred gold coins back?
With BCA, there is no need to value "capital and reserves" as it's a balancing figure. You value assets and you value liabilities and then minus one from the other. Similarly, you can only work out the equity in your house if you know its market value and how much you owe on the mortgage.
For sure, our modern BCA banks try and convince us that they lent sensibly and that they will recover every single penny they lent out when clearly they didn't - but it's not as bad as "X - 90%", it's something like "X - 10%" (in the case of HSBC, maybe it's as much as "X - 1%").
If you look at the market value of UK banks shares plus UK bank bonds (i.e. people's best estimate of the net value), they appear to assume a write down on the book value of assets of about 10% (or whatever, it's months since i looked at this).
MW, you're assuming the market is trading on fundamentals and not technicals here.
Truth is we have no idea what those black boxes are thinking
Cowrie shells! They went inflation mad too cos the king could not tax them away faster than the forgery could grow them. Plus ca change.
Where is the interest in all this?
Have you read Steve Keen on this?
Have you read Steve Keen on this?
Well, Mike Shedlock and to quote him directly:
There is no money in savings accounts or checking accounts other than an electronic mark that says there is. Both contain money only in theory. That money that has already been lent out and redeposited, over and over and over.
Reserves? There are no reserves. Indeed, reserves are best thought of as negative.
in cases of “too big to fail”, capital (not reserves), is supplied after the fact by taxpayers (not the Fed).
Thus, concern that excess reserves will lead to lending and inflation is totally unfounded in theory and practice.
Fractional Reserve Lending is really Fictional Reserve Lending. In practice, the major constraints to lending are insufficient capital and willingness of credit worthy borrowers to seek loans.
I think Mark has made a mistake.
Under FRB the banking system lends 90% of deposits.
These Lends are Further Deposits.
So 90% of those original deposits are re-lent, "ad-infinitum".
So it's the expansion
1 + 0.9^2 + 0.9^3 + ...
Which comes to ~10.
In FRB The SYSTEMATIC credit volume = 1/reserve ratio
i.e. 1/0.1 = 10.
AC1
SL I'm explaining the book keeping. If people can't understand this much then there's no point discussing any further with them.
RS, yes.
DNA, that's all well and good, but does what does Keen mean by "reserves" - assets or liabilities? I'ts not clear to me from that quote.
AC1, that's the same explanation but starting from the other end. There are, for sake of argument, ten gold coins in existence. Total lending cannot exceed ninety gold coins. It does not go up ad infinitum.
And when we get to the 'investment bank' 30-40 type lending ratios and the cowrie shell devalues?
Ok, so how come the banks need neither liabilities nor assets to create the peoples money, in the real world?
This logic though perfect is based on a false presumption. Obfuscating of what really happens.
Ch, that sort of thing always goes horribly wrong.
RS, are you asking me a question which you would like me to answer, or are you just dropping in to tell me that I don't know what I'm talking about?
If it was a serious question...
1. It's easiest if you start with the point in time when the loan is made, that comes first.
2. The value of the loan depends on how willing and able to borrower is to repay it. If it's a couple with a big deposit in good, steady jobs who want to borrow a small multiple of income to finance a modest home, that's what's we call "a good quality loan".
3. So the bank makes the loan to them, they buy the house, the vendor gets the cheque and puts it back in the bank.
4. The bank plays no part in this apart from hyping up house prices and doing the book keeping entries and charging the borrower more interest than it pays the depositor. The wealth (as such) is in the bricks and mortar and in the fact that the buyers have good, steady jobs.
5. The bank and the depositor merely tap into that pre-exisiting wealth.
But of course, as a banking guru you will now explain to me that I am completely wrong.
As I understand it, and I am still trawling through lots of stuff and trying to piece it together, in this sense reserves are neither assets or liabilities. The "money" classified as reserves only becomes and asset/liability when it is loaned out. All the QE money pumped into the system takes the form of reserves, not really doing any work it is just sat there. This is because, as we all seem to be agreed, loans come first and deposits later. So despite the central banks "depositing" a load of money it is not doing anything because there is no demand for new lending. The politicians and central banks seem to think the lack of lending is a supply problem (because they appear to believe in FRB) but it is in fact a demand problem, the economy is saturated. The economy is tanking, house values are falling, who would lend or seek a loan in such a climate?
Mw Im asking you a simple question, no need to try and read my mind again, just find a quiet moment, pause, listen to what I say, think about it and reply.
Though your explanation is intellectually stimulating and logically perfect, banks do not have any reserves, liabilities or assets upon which to give credits in the first place.
The premise they do is false. So my question is what is your point here? Its in grave danger of implying that banks today have a social purpose.
X
DNA, don't say "reserves" it's meaningless.
RS, my point is exactly as stated:
The FRB ratio restricts the ratio of liabilities (deposits) to a specific category of assets (gold coins in the safe) to a certain maximum (let's say ten) and
* Basel ratios restrict the ratio of assets (loans made to customers) to a specific category of liabilities (paid up share capital and retained profits.
That was all. I was not making any sort of moral judgment, I was explaining the terminology and logic. That neither means that I support or oppose any of this.
Re-reading your post and some of the comments, I think I've now got my head around this, I was confusing FRB with a gold standard type of banking.
Whereas the "ten" in either case can be anything with a value on it.
Thanks.
BB, I'm always glad to be of assistance.
The 'Gold standard' is a completely different topic, and I can't say I'm a big fan. What's the point in Africans removing the stuff from the ground at enormous expense merely so that Western banks can go to a further enormous expense digging underground vaults and storing it again?
It'd be quicker and cheaper for Western banks just to buy up those bits of Africa with gold reserves/resources and leave it underground.
I agree with you banks dont lend up more than they have on deposits , but you must agree they create what internet gold bug skeptics call "bank money" and in your FRB diagram the bank money is 10 X the ten gold coins.
I don't agree with the gold bugs by the way, and I say
Gold is not money - gold is barter
gold has intrisic value therefore using it as money is a form of barter
whereas money is actually a record of who has a claim on the goods and services of the community.
Question : What is your understanding of how Central banks work. If a loan made by a central bank is defaulted on what happens next. Does it cause an inflation in the amount of currency in circulation as the loaned money it does not come back to the central bank or is the shortfall made up by the tax payer as Ambrose Evans Pritchard often seems to suggest on his finance Blog.
Den, yes they create 'bank money' if that's what you want to call it. But really they just impose themselves between buyers and sellers, and the higher the price they can persuade the buyer to pay for a house the better (from the bankers' point of view). All pretty damaging from everybody else's point of view.
"If a loan made by a central bank is defaulted on what happens next.?"
In practice, things look pretty bleak for a few months and then the economy invigorates itself and after a couple of years that country is in a much better state than it was before.
I think it's pretty obvious Robin Smith doesn't really know what he's talking about. Sometimes I'm not sure he's even on the same planet.
Whatever you're smoking Robin, stop it.
I think it's all down to a confusion as to what FRB actually is. The Gold FRB is the 'right' one. The Basel FRB is the 'wrong' one.
Heard a blokey interviewed on telly say when asked about the origin 4% or 8% 'capital ratio' confess it was 'simply a wet your finger and stick it in the air' figure. 'We thought it sounded baout right' quoth he.
Now, it might be that on MW's 'gold standard' banking model, retaining 10% of funds to satisfy demand deposits was the number 'the market' came up with over many years. In other words this was the minimum safe amount that banking had got to after years of doing it and that it would - in normal times - be more than adequate to satisfy demand deposit requirements. This figure, whatever it is, will always be better than one dreamed up by a bunch of beaureacrats having a nice time on our wealth in Basel.
Which then brings us on to bank runs, and how to manage them...
Lola, since you have gone off the main point allow me to as well.
MW makes a fine logical point about an imaginary accounting scenario which is not active in the real world. At length.
MW then goes on to discount the real world of systemic robbery by the financial world of the worker and producer. And discounts this real world as if it were irrelevant.
I'm asking WHY are we persist in apologising for this corruption? Its a simple ask I make regularly here and never gets answered. Only attacked.
Nevertheless, one thing is certain, banking in its current form is unnaturally riskfull and does not need to be for 2 reasons.
1) It creates the peoples money out of nothing, with which all people must pay taxes, making it the de facto government. By what right?
2) Capital already exists across the myriad industrial and economic network... somewhere. Banks proper function is to find it and match the supply with demand. Thus setting the free market and natural interest rate.
Then leave all else well alone including the money.
As finance is the worlds government today, I agree, this will never happen. We vote for it. And are ready to crucify the first one to point it out.
There is a raw account of what I mean here for those who choose to think. Please post your comments:
The Robin Smith Institute: There is plenty of capital. Banks just need to get out of its way.
L, yes, agreed, although there is no need to use gold coins.
RS: "WHY are we persist in apologising for this corruption?"
OK, let's imagine your criminal law lecturer explains the difference between "robbery" and "aggravated burglary". That does not imply that he approves of either offence, he is just explaining what the words mean.
That's all I'm doing here, explaining how banking works and what the terms mean, in the same way as a physics teacher explains how a burglar uses a jemmy as a lever to force open a window. That doesn't mean that the physics teacher approves of or condones burglary.
MW I truly appreciate your explanation of how things do not work.
That's all I'm doing here, explaining how banking works
But we all know this is NOT how banking works in the real world.
You have done a great job of explaining an imaginary scenario, thank you.
But you then go on to discount what that obscures that really happens in the real world, no thank you.
By doing that the teacher has implicitly condoned burglary as much as by doing it explicitly.
Why not use your enormous skills talking about what really happens.
I'm thick as shit. You are very clever. So what is stopping you and encouraging me?
RS, I give in.
So could you perhaps explain to the audience the difference between FRB and BQA ratios? It'd be helpful if you can actually show this impacts banks' balance sheets to illustrate how either ratio restricts the total amount of credit which a bank can give out (or indeed create).
Why would I want to describe something that doesn't happen? I don't need to understand the mechanics of something exactly to know its premise is false. I only need to understand the premise does not match observation.
You are doing deduction. Very dangerous. I'm doing induction. The observed facts.
You seem to live under the illusion that banks follow accounting rules.
Why are you apologising for them so fiercely? Why not just look at the facts of what actually happens.
Banks have no reserves, they use ours. They charge us rent for them to boot. They destroy the economy. We let them off. You are helping them by attaching a high sounding analysis of how they want us to think it works.
Banks are the worlds biggest landlords. Lets abolish them fast, no exemptions, no compensation.
RS: "You seem to live under the illusion that banks follow accounting rules."
Oh I see.
So it's just a coincidence that all depositors, borrowers, bondholders, shareholders etc get sent regular statements showing who owes whom how much, how much interest they had to pay or have earned etc, and that these statements are usually very accurate?
For sure, in their financial statements banks might be a tad optimistic as to the true value of their assets, but that's a separate issue.
AFAIAA, even drug dealers and gun runners operate basic bookkeeping and profit and loss accounts, even though they prefer not to write too much down on paper, for obvious reasons. Or how the heck would they know whether these crimes are worth committing?
RS, further, you insist on using the word "reserves", which is a meaningless term unless you define whether you mean "assets" or "liabilities", so it's best not to use it at all.
Show me where the rents are accounted for on these statements please. With clarity.
See my point yet?
I believe we are both going in the same direction on this.
But you get so far, then ... stop.
Why?
All that matters is who is collecting the rents. All the rest is fluff.
RS: "Show me where the rents are accounted for on these statements please. With clarity."
Simples.
You have to download their accounts and go to the segmental reporting bit, where they explain how much money they have lent people to buy land & buildings (or how much of their loans are secured on land & buildings) and how much interest they charged. That is the figure you are looking for.
The fag packet says that total lending secured on L&B in the UK is about £1,500 billion and the interest charged is about 4% = about £60 billion a year (i.e. even more approximately, a third of UK ground rental values).
The fact that you call it "rent" and they call it "interest" is, as ever, a separate issue. What you also have to take into account is that this is a gross figure, it is also of great interest as to how this rent/interest income is paid out again - as bonuses, salaries, interest on deposit accounts, dividends to shareholders etc.
Uh hum . . . with clarity. Not obfuscation.
No one except you and me seem to agree on this fact. You could call it a tax too.
The profits of monopoly are a tax to everyone else. Line them up against all other taxes.
What matters is what it IS.. an unearned income. Living off the labour of others.
But we cannot see this because we have refused to define terms with clarity.
This is what needs to be made clear to the people so they can debate it and vote on it.
CLEARLY not the case today.
RS I didn't think I'd gone 'off-topic' at all, but hey ho.
MW re 'gold' . Of course, but I actually quite like a 'gold' standard, or perhaps a bimetallic standard. I understand the idea of competing currencies and so forth but I am soooo distrusting of gummint, central banking, banks etc etc that I cannot really see any other way to keep the buggers vaugely honest.
RS, I can't make it much clearer than telling you exactly where to find the figures you are looking for and giving you a reasonable approximation of what the total figure might be.
All of this is in the public domain, there's no secret about any of this.
L, well that's the thing. In theory, paper money is doomed to failure; but in practice, it works surprisingly well.
MW
Private property in land is in the public domain.
Fully: The primary social organisation of the civilised world.
Banking the biggest beneficiaries. As the biggest landowners (collecting the rents)
Nothing could be clearer.
Yet no one understand the consequences.
Infinite evidence is up to 156? now right?
Lola, glad you dont mind:
1) Government creates the money and taxes it away by collecting land rents. AND LEAVES ALL ELSE ALONE
2) Banking does its proper job, matches supply of capital with its demand. AND LEAVES ALL ELSE ALONE
Gold has always led to the same problems as any other money. I cannot understand why this obvious fact is so difficult to see across history. The money is the money. There is nothing you can do about it.
Depends on who you feel we truly elect.
MW - Oh yes, any form of 'token' works fine, as long as you 'believe' you can redeem it for real value somewhere. In the late 18th century central money failed in England all sorts of people started making coin. Where these manufacturers were substandtial - Matthew Bolton say - users of their coin had no problem. Plus ultimately Bolton could redeem his coin against Bills redeemable in Gold at the Mint or Bank of England.
Money as such does not have to have intrinsic value to be acceptable. We just have to believe in it.
L: "Money as such does not have to have intrinsic value to be acceptable. We just have to believe in it."
Correct.
Money issued (or borrowed) by a government is secured on future tax receipts, that's what gives it value. And seeing as most taxes will be raised from land and buildings when I am in charge, a £1 coin issued by the government is tantamount to ownership of one unit of rental income from land worth £1.
Under LVT, money just becomes "LVT discounts" i.e. you can pay the state using that item.
The state would have a good function in matching the total LVT discounts with the amount raised by the LVT.
AC1
AC1, round these parts we refer to this as "DBC Reed-onomics" or 'stimulating the economy, balancing the budget and preventing house price inflation' or 'Modern Monetary Theory'.
MW. I like that. £1 the is asort of mortgage on land - I would omit the buildings.
Hence when we the UK mess things up our international creditors can turn up and repossess us (as they already do - e.g taking the Rover factory away).
If everyone knew that the Government was funded by this 'mortgage' they'd have a pretty jaundiced attitude about any government getting us into even more debt.
Is Robin Smith a Marxist by any chance?
My brain refused to continue half way down that comment thread, so I can only assume so...
Hollando,
The above is complex. Given that Smith states that the tasks of private banks is to allocate capital not create it.
The answer to your question is no.
Hope this helps.
Best,
MikeW
H, RS can speak for himself, but that all depends on how you define 'Marxist'.
I am a small-government, free-market social and economic liberal, but it is clear to me that we'd all be far better off if we scrapped taxes on income and output and taxed land rental values instead, which according to Home-Owner-ists and Faux Libertarians makes me even worse than a Marxist.
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