Re: Loans Create Deposits or Deposits Create Loan Positions?
Jay Mills
I’ve come to accept the notion that at loan origination - loans create deposits. This seemed like an important explanation connected to QE and the notion that banks don’t lend reserves and increasing them would not automatically increase loans and inflation.
That said, I’ve read more and spoken to more folks and have a bit of confusion.
Loan departments are given, from bankers I’ve spoken to, an approximate amount of loan growth they can expand. This is based on many factors (loans to deposit ratio, LCR, quality of borrowers, etc.). They predicate much of their limit on their deposit base since most come into banks with corresponding reserves and is a cheap funding position for banks (they pay so little on deposits to earn cash/reserves versus money markets, CDs, borrowing reserves etc.).
Another fact is that on the asset side of their balance sheet, banks pool cash/reserves when considering inflows/outflows and netting positions each period depending on how they’re settling (Fedwire, etc.). So while a bank isn’t loaning your deposit in a literal sense, your deposit brought in cash/reserves that sit on the banks asset side in a pool of money that is used to meet LCR/requirements and settle payments out of the bank. So when someone/banker says they use your deposit to loan, in a sense they’re not wrong.
Simply put:
1. Banks have chosen deposits as the number 1 way to fund loans (cheapest)
2. Those deposits are liabilities to the bank but the corresponding cash/reserves from incoming deposits are pooled and do serve to settle payments/fund the loan
3. Yes at the specific point of origination a brand new deposit is created and wasn’t reduced from somewhere else and then reallocated to the borrower.
Does this line up? Also, I think I have missed the specific reason Warren, Mitchell, etc. really hammer home on the idea that loans create deposits. Is it to demystify the fact that there are not a fixed supply of loanable funds?
Thanks for any help in this!
Best,
Jason
Warren Mosler
--
You received this message because you are subscribed to the Google Groups "Modern Monetary Theory" group.
To unsubscribe from this group and stop receiving emails from it, send an email to modern-monetary-t...@googlegroups.com.
To view this discussion visit https://groups.google.com/d/msgid/modern-monetary-theory/F79E614D-1DDD-4D1D-91A6-CDB2217D2A21%40gmail.com.
Warren Mosler
--
You received this message because you are subscribed to the Google Groups "Modern Monetary Theory" group.
To unsubscribe from this group and stop receiving emails from it, send an email to modern-monetary-t...@googlegroups.com.
To view this discussion visit https://groups.google.com/d/msgid/modern-monetary-theory/F79E614D-1DDD-4D1D-91A6-CDB2217D2A21%40gmail.com.
Jay Mills
Warren Mosler
Thanks for clarifying and confirming my understanding!That said, what banking/macroeconomic reason did you and Bill Mitchell focus on the line “loans create deposits”?
Bijou Smith
Jay Mills
I agree that the software/payment system does not automatically go out and “fetch a replacement deposit” in the retail sense. If a bank originates a loan, the accounting entry can be made by crediting the borrower’s account, and if the borrower transfers the funds elsewhere, the payment system then has to settle that outgoing payment through the relevant settlement rail.
Where I am still trying to be precise is the difference between loan origination, payment settlement, and ongoing funding.
At origination, I understand the point that the bank creates a loan asset and a deposit liability. It is not literally taking an existing depositor’s balance and transferring it to the borrower.
But once the borrower spends the proceeds, the originating bank may lose reserves or settlement balances to another bank. At that point, it needs some way to handle the outflow: existing reserves, incoming payments, intraday credit, repo, FHLB advances, wholesale funding, replacement deposits, asset sales, or central-bank credit.
So I think the replacement issue is not part of the origination accounting entry, but it is still very real for settlement and liquidity management. Even if all the records are electronic, a negative Fed balance or overdraft is still credit from the central bank, not just a neutral scorekeeping entry. It may be operationally seamless if permitted, but it still raises questions about pricing, collateral, credit risk, supervision, and moral hazard.
I also agree that some of these constraints are institutional and self-imposed in the broad sense. The central bank could design the system to allow more automatic overdraft capacity. But under the current system, banks do not have unlimited costless overdraft access, so they actively manage deposits, reserves, liquid assets, collateral, and funding sources.
So my current synthesis is:
Loans create deposits at origination. If the created deposit leaves the originating bank, the bank must settle the payment. The payment system does not fetch replacement deposits automatically, but the bank must obtain or use settlement liquidity in some form. Prudential rules like LCR and Basel formalize this discipline, but the underlying need to settle payments is not merely regulatory. It is part of the payment-system architecture.
Does that sound like a fair framing of the distinction?
Jason
Warren Mosler
--
You received this message because you are subscribed to the Google Groups "Modern Monetary Theory" group.
To unsubscribe from this group and stop receiving emails from it, send an email to modern-monetary-t...@googlegroups.com.
To view this discussion visit https://groups.google.com/d/msgid/modern-monetary-theory/92F60A7A-4290-4997-804F-93C5C8134431%40gmail.com.