/1
A thread on credit creation, money supply, and how the printer does (and doesn't) go brrrr π§΅π¨πΈπ
First, banks donβt lend reserves β banks make a loan first, then they find reserves second (if necessary)...
#monetarypolicy #FederalReserve #Fed
A thread on credit creation, money supply, and how the printer does (and doesn't) go brrrr π§΅π¨πΈπ
First, banks donβt lend reserves β banks make a loan first, then they find reserves second (if necessary)...
#monetarypolicy #FederalReserve #Fed
/2
If a bank extends a new loan, it creates a loan asset and a deposit liability on their balance sheet βοΈ:
loan deposit
π π΅
asset liability
If a bank extends a new loan, it creates a loan asset and a deposit liability on their balance sheet βοΈ:
loan deposit
π π΅
asset liability
https://twitter.com/AnthPB/status/1238607000759685120?s=20
/3
The bank only needs reserves against that loan in case the borrower wants to move his deposit to another bank:
e.g. A borrower from Bank ABC is a construction co who needs to buy materials from a supplier whose checking account is at Bank XYZ...
π·ββοΈβοΈπββοΈ
πΈβοΈπͺ΅
The bank only needs reserves against that loan in case the borrower wants to move his deposit to another bank:
e.g. A borrower from Bank ABC is a construction co who needs to buy materials from a supplier whose checking account is at Bank XYZ...
π·ββοΈβοΈπββοΈ
πΈβοΈπͺ΅
/4
... so Bank ABC π¦ moves both a deposit liability πΈ and an equivalent reserve asset π§Ύ to Bank XYZ π’ in order to settle the payment:
π·ββοΈβοΈπββοΈ
πΈβοΈπͺ΅
=
π¦β‘π’
π§Ύβ‘οΈπ₯
... so Bank ABC π¦ moves both a deposit liability πΈ and an equivalent reserve asset π§Ύ to Bank XYZ π’ in order to settle the payment:
π·ββοΈβοΈπββοΈ
πΈβοΈπͺ΅
=
π¦β‘π’
π§Ύβ‘οΈπ₯
/5
Banks are allowed to hold fractional reserves (bank assets) cuz all of their customers, in aggregate, are unlikely to move all of their deposits (bank liabilities) to another bank simultaneously β e.g. a "run on the bank" (for which we now have backstops like FDIC)...
Banks are allowed to hold fractional reserves (bank assets) cuz all of their customers, in aggregate, are unlikely to move all of their deposits (bank liabilities) to another bank simultaneously β e.g. a "run on the bank" (for which we now have backstops like FDIC)...
/6
β¦ plus, if both the construction co and his supplier have checking accounts at the same bank (e.g. Bank ABC), then no reserves necessary to settle a payment fm π·ββοΈβ‘οΈπββοΈ:
The deposit liability just shifts fm π·ββοΈ's to πββοΈ's account, so Bank ABCβs reserve assets are irrelevant π
β¦ plus, if both the construction co and his supplier have checking accounts at the same bank (e.g. Bank ABC), then no reserves necessary to settle a payment fm π·ββοΈβ‘οΈπββοΈ:
The deposit liability just shifts fm π·ββοΈ's to πββοΈ's account, so Bank ABCβs reserve assets are irrelevant π
/7
Fractional reserves are only required because regulators want to make sure every bank has enough for any reasonable amount of customer transfers/withdrawals from one bank to another (again, transfers from one customer to another within the same bank don't require reserves)...
Fractional reserves are only required because regulators want to make sure every bank has enough for any reasonable amount of customer transfers/withdrawals from one bank to another (again, transfers from one customer to another within the same bank don't require reserves)...
/8
After Bank ABC has made a loan (π€=πβοΈπ΅), it can then acquire the required fractional reserves from a number of means, including:
β’ idle reserves on its own balance sheet (π¦π§Ύ);
β’ the interbank market (Fed Funds π¦β¬ οΈπ§Ύπ’); or
β’ the Fed (Discount Window π¦β¬ οΈπ§Ύπ©)
After Bank ABC has made a loan (π€=πβοΈπ΅), it can then acquire the required fractional reserves from a number of means, including:
β’ idle reserves on its own balance sheet (π¦π§Ύ);
β’ the interbank market (Fed Funds π¦β¬ οΈπ§Ύπ’); or
β’ the Fed (Discount Window π¦β¬ οΈπ§Ύπ©)
/9
Yes, Bank ABC borrowing from the Fed Discount Window creates new reserves πͺπ§Ύ...
but those reserves are both collateralized (e.g. the bank has to swap Tbill assets from its own balance sheet in exchange for the reserves π¦π«βοΈπ§Ύπ©) and relatively expensive...
Yes, Bank ABC borrowing from the Fed Discount Window creates new reserves πͺπ§Ύ...
but those reserves are both collateralized (e.g. the bank has to swap Tbill assets from its own balance sheet in exchange for the reserves π¦π«βοΈπ§Ύπ©) and relatively expensive...
/10
... so Bank ABC better make sure itβs loan asset is good enough to pay it more than the cost of borrowing from the Fed β or it can find cheaper sources of reserves π
... so Bank ABC better make sure itβs loan asset is good enough to pay it more than the cost of borrowing from the Fed β or it can find cheaper sources of reserves π
/11
... to replace expensive reserves from Fed, Bank ABC can try:
β’ interbank mkt (Fed Funds π¦β¬ οΈπ§Ύπ’);
β’ attract new customer deposits+reserves from another bank (π¦β¬ οΈπ§ΎπΈπ’π§π»); or
β’ raise capital from equity/bond investors (also comes with deposits+reserves π¦π«βοΈπ§ΎπΈπ¨βπ©βπ§βπ¦)
... to replace expensive reserves from Fed, Bank ABC can try:
β’ interbank mkt (Fed Funds π¦β¬ οΈπ§Ύπ’);
β’ attract new customer deposits+reserves from another bank (π¦β¬ οΈπ§ΎπΈπ’π§π»); or
β’ raise capital from equity/bond investors (also comes with deposits+reserves π¦π«βοΈπ§ΎπΈπ¨βπ©βπ§βπ¦)
/12
All these banks making all these balance sheet management decisions is a very distributed system of money/credit creation, for which banks are constrained since required reserves acquired on unsecured basis (e.g. printed ex nihilo/by fiat πͺπ§Ύ) are prohibitively expensiveβ¦
All these banks making all these balance sheet management decisions is a very distributed system of money/credit creation, for which banks are constrained since required reserves acquired on unsecured basis (e.g. printed ex nihilo/by fiat πͺπ§Ύ) are prohibitively expensiveβ¦
/13
Each bank has to manage its own cost of liabilities (e.g. deposits or debt) vs return on assets (e.g. loans) βοΈ...
Reserve assets have little-to-no rate of return β they usually weigh on Bank ABC in either nominal (expensive Discount Windowπ₯΅) or real (inflationποΈββοΈ) terms...
Each bank has to manage its own cost of liabilities (e.g. deposits or debt) vs return on assets (e.g. loans) βοΈ...
Reserve assets have little-to-no rate of return β they usually weigh on Bank ABC in either nominal (expensive Discount Windowπ₯΅) or real (inflationποΈββοΈ) terms...
/14
... but the Fed can choose to pay banks interest on required or excess reserves (IOER), which are monetary policy means of toggling credit creation by changing banksβ IRR equations βοΈ and opportunity costs (e.g. IOER from sitting on excess reserves vs ROA from lending)
... but the Fed can choose to pay banks interest on required or excess reserves (IOER), which are monetary policy means of toggling credit creation by changing banksβ IRR equations βοΈ and opportunity costs (e.g. IOER from sitting on excess reserves vs ROA from lending)
/15
Again, banks are incentivized to not indiscriminatly lend/create credit, because:
β’ Bank ABC needs to squeeze a required rate of return from its assets (loans/reserves/Tbills) less its liabilities (debt/deposits)βοΈ;
β’ Fed is constantly rebalancing that systemic spread
Again, banks are incentivized to not indiscriminatly lend/create credit, because:
β’ Bank ABC needs to squeeze a required rate of return from its assets (loans/reserves/Tbills) less its liabilities (debt/deposits)βοΈ;
β’ Fed is constantly rebalancing that systemic spread
/16
If a Bank ABC loan asset defaults ππ, it won't receive future deposits+reserves that it needs (from borrower's P&I repayments), so it will eventually have to deplete or acquire other reserve assets to honor other customers' transfers to other banks...
If a Bank ABC loan asset defaults ππ, it won't receive future deposits+reserves that it needs (from borrower's P&I repayments), so it will eventually have to deplete or acquire other reserve assets to honor other customers' transfers to other banks...
/17
... all else equal, loan asset impairment ππ hurts the value of Bank ABC's capital base (βοΈequity = assets - liabilities)
... too much loan asset impairment ππ₯ wipes out the bank's capital β and it won't be able to sustainably source new capital:
... all else equal, loan asset impairment ππ hurts the value of Bank ABC's capital base (βοΈequity = assets - liabilities)
... too much loan asset impairment ππ₯ wipes out the bank's capital β and it won't be able to sustainably source new capital:
https://twitter.com/AnthPB/status/1478789377362993152?s=20
/18
These foundational banking/finance misunderstandings are important knowledge for Bitcoin, crypto, inflationistas, nihilists, etcπ
π °οΈ money supply:
π ±οΈ monetary velocity:
π ΎοΈ quantitative easing (QE):
These foundational banking/finance misunderstandings are important knowledge for Bitcoin, crypto, inflationistas, nihilists, etcπ
π °οΈ money supply:
https://twitter.com/AnthPB/status/1442565761017565185?s=20
π ±οΈ monetary velocity:
https://twitter.com/AnthPB/status/1458151747680079875?s=20
π ΎοΈ quantitative easing (QE):
https://twitter.com/AnthPB/status/1238607074684293126?s=20
/19
β¦ since it would be nice to avert the wrongheaded misadventures that result from such misunderstandings:
β¦ since it would be nice to avert the wrongheaded misadventures that result from such misunderstandings:
https://twitter.com/AnthPB/status/1386465956608856066?s=20
... other sources π
β’ "banks don't lend out reserves": hks.harvard.edu/sites/default/β¦
β’ The Fed, reserve management, and monetary policy tools: frbsf.org/education/publβ¦
π
β’ "banks don't lend out reserves": hks.harvard.edu/sites/default/β¦
β’ The Fed, reserve management, and monetary policy tools: frbsf.org/education/publβ¦
π
β’ β’ β’
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