Talk:Fractional-reserve banking/Archive 4

This is an archive of past discussions about Fractional-reserve banking. Do not edit the contents of this page. If you wish to start a new discussion or revive an old one, please do so on the current talk page.

Archive 1

Archive 2

Archive 3

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Unreferenced-since-March material

My attention was caught by the removal of an "unreferenced section" tag from this section by an editor stating that "references not needed, info is self evident." That's not right. When a reference is requested, one should be supplied. Here, the red flag is the attribution to "critics."

What critics, exactly, have said this, and wouldn't it be better to quote them if possible rather than to paraphrase? As it stands, having been tagged as unreferenced for half a year without the request for references being honored, one might think that an editor was stating his own beliefs but attributing them to "critics."

If this material is true and self-evident, then someone, somewhere will have written about it, and the burden of locating and quoting that reference is on those who wish to have this material in the article. Dpbsmith (talk) 23:34, 12 September 2008 (UTC)

i disagree. some may criticize wood stoves because they cause fires. a reference might be nice, but that doesn't change the fact that it is a criticism and fairly intuitive. same thing here. based on WP:EP i believe this information should be left up. if there is a specific criticism that you feel needs to be referenced, you should ask for that specific material be referenced...but it shouldn't be a gigantic unreferenced notice for a couple sentences that are largely self evident. —Preceding unsigned comment added by Yourmanstan (talk • contribs) 04:02, 15 September 2008 (UTC)

Inadequate government regulation

Critics of current bank regulations argue that:

Minimum reserve ratios put reserves beyond reach in a time of need;
Minimum capital ratios are poor regulators of financial risk, as they ignore other portfolio risk drivers such as scale and diversification and come at a heavy compliance cost;
Central bank support and government protection of creditors creates moral hazard and socializes credit risk.

Incompatible with a gold standard? How so? And other non-documented criticisms

The criticisms sections here is mostly undocumented, and with a fair bit of nonsense. The statement that it is incompatible with a gold standard - despite all the historical evidence - is just bizarre. I'm going to flag this for now with a view to deleting eventually unless there's some content added.--Gregalton (talk) 10:26, 8 March 2008 (UTC)

The incompatibility of FRB with the gold standard was demonstrated in 1971 when Bretton-Woods collapsed. Orangedolphin (talk) 20:42, 26 August 2008 (UTC)

Fractional-reserve banking and the gold standard coexisted for decades if not centuries prior to World War I. The collapsed of Bretton-Woods only demonstrated that the concept of Bretton-Woods was flawed. -- EGeek (talk) 19:32, 27 August 2008 (UTC)

I've discussed this in much further detail on the debt-based monetary system talk page. It's clear that historically there is an inherent antagonism between frb and the gold standard. There was never a harmonious and peaceful co-existence. The reason is simple: it's difficult to print gold, and when there is a bank run and depositors begin to distrust the integrity of the banking system, all hell breaks loose, because the game is up and there ain't enough gold to go around. That is the very DEFINITION of frb - having a FRACTION of (gold) reserves on hand even though you promise to pay out in gold if "at call" depositors ask for gold in specie. Gold exposes the game and therefore is a threat to the on-going viability of frb. It's as simple (and as obvious) as that.--Lagrandebanquesucre (talk) 06:39, 8 May 2008 (UTC)

I am reminded of the Princess Bride: I do not think that word means what you think it does. If the basis of FRB is based on a gold standard, clearly they are not incompatible. Your claims of inherent instability are an interpretation, and not at all obvious. If fractional reserve banking was used in systems where there is a gold standard, clearly they are not mutually incompatible.--Gregalton (talk) 07:02, 8 May 2008 (UTC)

User:Lagrandebanquesucre is documented sockpuppet of indef blocked user.--Gregalton (talk) 19:02, 8 May 2008 (UTC)

Fractional reserve banking can be done based on gold or fiat currency no problems. It is however harder to expand the money supply if you are based on gold, which of course has both positive and negative aspects - it stops the government abusing the currency, but equally the size of the economy becomes heavily dependant on how much gold is held/mined rather than innovation or productivity increases leading (hence all the wars during the ages of mercantilism and empire being significantly preoccupied with getting as much gold as possible to just sit around in vaults somewhere). --86.164.126.9 (talk) 21:49, 2 October 2008 (UTC)

Repayment of commercial bank money

The article says "when loans are paid back, the process moves from the bottom to the top and commercial bank money is canceled out, effectively erasing it from existence." It seems, given events in the economy during 2008, this is one of the most important points in the whole article, but I think this article does little more than skate over this issue.

How is FSB effected if debt is re-paid, even more importantly how is it effected if debt goes bad?

There is another connected issue. In an economy which is seeing rapid increases in productivity, which presumably leads to higher wages, it is possible to envisage a scenario in which people and business re-pay debt, without reducing expenditure. But how does this impact on FSB?

A criticism made of FSB elsewhere is that it can only work if debt continuously expands. This article implies that if commercial bank money is re-paid there would be a sharp reduction in money supply, apparently confirming this criticism. This is an important criticism, and if true a major flaw in FSB. Is this criticism valid?

It seems that a flaw with the gold standard was that as innovation led to greater potential economic output, the supply of money was constrained by the amount of gold in existence. Actually, if output rises and money supply stays constant, one would expect price to fall.

Presumably FSB enables the possibility of creating money in tandem with growth in potential output. Is this a major benefit of this system over gold based standards?

mikeiabn —Preceding unsigned comment added by Mikeiabn (talk • contribs) 13:28, 18 September 2008 (UTC)

Shouldn't history have dates?

I find the "History" section completely useless, as it gives no sense of when or where fractional reserve banking originated or developed. It would be better to eliminate it until someone puts some concrete facts and events in there. Right now, it isn't history at all. JoeFink (talk) 17:09, 1 October 2008 (UTC)

I just reverted Scientus' complete deletion of this section. Just because no exact date is given, doesn't mean the section is completely useless! This information is factually accurate and has been explained many times in books, documentaries, and at other sites. So I believe that full deletion is a disservice. By leaving it in, perhaps someone will take the time to research and edit the section, and bring it up to par in the future. Htfiddler (talk) 15:59, 15 October 2008 (UTC)

I put in the ambox but i really hate those, in general the section just really sucked, was very vague, uninteresting, and didnt really say anthing. I do not argue that what it is talking about is important and deserves coverage but i would certainly not enjoy reading it again, it needs a rewrite. Maybe it could be moved to the bottom of the page, or archived into talk?, or replaced with a really good external link?Scientus (talk) 16:07, 15 October 2008 (UTC)

I agree that it sucks and don't have time for the needed rewrite. It is in the right location for sure. Let's just hope someone will eventually come along and fix it. In the meantime, I am linking to this section, and would appreciate it being left in the article. Thx. Htfiddler (talk) 07:37, 16 October 2008 (UTC)

I already included a source for this but it was removed from this section. It is the same source that also explains how fractional-reserve banking led to the creation of central banks. It's from the Reserve Bank of India at: http://rbidocs.rbi.org.in/rbiadmin/Scripts/PublicationReportDetails.aspx?UrlPage=ReportonCurrencyandFinance&ID=454

It says:

The monopoly power to issue currency is delegated to a central bank in full or sometimes in part. The practice regarding the currency issue is governed more by convention than by any particular theory. It is well known that the basic concept of currency evolved in order to facilitate exchange. The primitive currency note was in reality a promissory note to pay back to its bearer the original precious metals. With greater acceptability of these promissory notes, these began to move across the country and the banks that issued the promissory notes soon learnt that they could issue more receipts than the gold reserves held by them. This led to the evolution of the fractional reserve system. It also led to repeated bank failures and brought forth the need to have an independent authority to act as lender-of-the-last-resort. Even after the emergence of central banks, the concerned governments continued to decide asset backing for issue of coins and notes. The asset backing took various forms including gold coins, bullion, foreign exchange reserves and foreign securities. With the emergence of a fractional reserve system, this reserve backing (gold, currency assets, etc.) came down to a fraction of total currency put in circulation.

I've also seen other sources that say it is generally accepted that this is how fractional-reserve banking evolved. I'm guessing, based on information I've dug up, that historic evidence hasn't been discovered that confirms with certainty the very first time a person conducted fractional-reserve banking. It looks like people generally just accept that paper notes representing a claim on precious metals were used in different societies around the world, and that this led to the current banking practice. Analoguni (talk) 02:49, 17 October 2008 (UTC)

Money Creation Table is Misleading

Although the table is correct it is misleading. To the layman it looks as if Bank A actually pays out 80 ( as a loan ) and leaves only 20. This is not the case as the Bank simply credits it's borrowers account with 80 in return for an IOU ( promissory note ) The 100 deposit remains untouched, and the bank's Assets increase to 180. This should be made clearer IMO. 81.79.255.0 (talk) 16:59, 7 October 2008 (UTC)

there's a problem with that, as it contradicts what the Federal Reserve says. A source already in the article from the Fed already says that the money comes from the deposit. See: http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html

It says:

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.

or you can take a look at the "purpose and function" section at the top of the page and see another explanation from the Fed:

The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to "create" money.

So what's wrong here? Why is there this talk that a bank does not actually spend deposited money? Analoguni (talk) 03:06, 17 October 2008 (UTC)

The table and the complete article is complete nonsense because it confuses the meaning of reserves. Reserves in banking terms ARE SHAREHOLDER FUNDS . . .i.e. money raised from investors in the bank and the retained (i.e. undistributed earnings or profits). They are not a share of depositors money held bank for a rainy day! It is the RESERVE ASSET RATIO that allows banks collectively to create money and the LIQUIDITY RATIO that constrains a particular bank. If Bank A starts business with 20 dollars as reserves in fresh capital (ie. 20 dollars in cash and 20 dollars as reserves) then it can create indeed create a loan of 80 dollars if the required ratio is 20 percent. It creates a debit balance of 80 dollars on the loan account and a credit balance of 80 dollars on the checking account. If there are 10 banks in the economy and all have the same share of business in the economy then Bank A is likely only to retain 8 dollars of that checking account money, the rest will spill into the other banks. This creates two problems. Bank A has a liquidity problem because it has to pay 72 dollars to the other banks and it only has 20 dollars in cash. It needs to borrow 52 dollars from the other banks! The other banks now have a reserves problem. Their collective balance sheets have increased by 72 dollars (72 dollars in fresh liabilities as customer deposits matched by a 52 dollar loan to Bank A and the 20 dollars that Bank A had shipped over in a Securicor van. They are now below their allowed reserves ratio. Indeed to support 72 dollars fresh balances they need to raise 18 dollars of fresh capital from their stockholders or make a profit of 18 dollars from 72 dollars (quite hard to do in a single day unless you are an investment bank selling a sow's ear as a crock of gold). Bank A meanwhile has liabilites as follows ... Share Capital 20 dollars, Interbank borrowing 52 dollars and a Customer credit balance of 8 dollars making total Liablilities of 80 dollars. On the assets side it still has the the customer loan of 80 dollars, so its reserve ratio is still 20 per cent. A single bank's ability to create new money is severely limited by the need to maintain liquidity (In practise Bank A has no liquid assets and could be put out of business by the other banks immediately). Collectively the banks can expand the money supply if they are all growing their business at the same rate, but they still need to get SHAREHOLDER FUNDS or MAKE AND RETAIN PROFITS to sustain their capital ratios. The table makes the fundamental mistake of thinking that money is created by the central bank placing deposits in the commercial sector. This does not normally happen. Nor does money stay in the same bank. It tends to get spent and spreads into other banks. Deposits move between banks but do not accumulate over time as the table suggests. The need to maintain both liquidity and reserve assets (shareholder funds... not held back cash are fundamental constraining factors. The present money crisis is a problem for the banks because they now have made huge losses. This has reduced their capital ratios and has been causing them to stop lending to maintain adequate reserve asset ratios. The action of central banks in Europe has been to pump in capital making this pressure reduce, and by lending against toxic assets (which rather unusually for central banks) places deposits at the disposal of the banks, increases liquidity. It also increases the money supply and will have impacts on inflation in the longer term, which will probably mean higher interests will be needed in the longer term (even if the flood of liquidity has decreased rates over the short term). I am amazed that this table has been in this article for so long without this even being questioned. --Tom (talk) 23:25, 17 October 2008 (UTC)

You said, "The table makes the fundamental mistake of thinking that money is created by the central bank placing deposits in the commercial sector. This does not normally happen." However, this does happen. You can see this occurring by looking at the statistics of the U.S. currency supply at: http://www.federalreserve.gov/releases/h6/hist/h6hist2.txt

I even made a nice chart of it:

You can even read all about how it works. See "The Principle of Multiple Deposit Creation", which is one of the sources for the table, which explains how when a U.S. Treasury security is purchased by the Federal Reserve, new central bank money is put into existence. You can see this document yourself at Federal Reserve Education - How does the Fed Create Money? http://www.federalreserveeducation.org/fed101_html/policy/money_print.htm

Analoguni (talk) 03:57, 18 October 2008 (UTC)

I see nothing in that table that indicates that the Fed has placed deposits with the commercial banks. The definition of M1 as I recall is "Near money" . . i.e. that which can be spent today, so it includes demand deposits (i.e. checking account balances in commercial banks), travelers checks, and cash (notes and coins), which is indeed what the table shows. But these statitics relate to holding by the PUBLIC (people and corprations), NOT holdings by the Central Bank. This is because the central bank (in this case the Fed) gets statistics for the nation and publishes them. Therefore the table represents the economy as a whole, not the holdings of the Fed.

As for the currency component, this does indeed represent notes and coins issued by the Central Bank. A certain amount of the money needed by the Commercial Banks costomers will be in the form of notes and coins, and the creation of deposits by the Commercial Banks tends to increase this demand over time. Suppose a large customer demands $10 million in notes which the commercial bank does not have. The Commercial Bank orders the notes from the Fed which (for arguments sake) the Fed has to print. Overall the money supply has stayed the same because the commercial bank will debit the customer with $10 million and pay this money to the Fed. Although there are more notes and coins there are less demand deposits in the banking sector. M1 stays the same. In time, the ten million temporary excess will decrease as the notes get paid back into the commercial banks who redeem their excess with the Fed. The Commercial Banks always have to pay the Central Bank for notes and coins. Commercial Banks at all times are constrained on their lending by the need to control their capital adequacy ratios as well as their liquidity.

As for the explanation by the education unit, the person that created this "explanation" should be sacked... tomorrow! It's complete nonsense! It says "B1 loans excess reserves to N2" but there are no excess reserves because near money circulates very quickly and as fast as customers get money into their accounts they tend to spend it... so almost all of it will leak out to other banks.

Commercial Banks do increase the money supply at the stroke of a pen (or by an electronic entry) by simply creating a credit balance on a customers checking account and putting a debit balance on his loan account. But because the bank has to maintain liquidity and capital adequacy ratios they can only do this at the same rate as the other banks. If they do it faster, then they need to keep more of their assets liquid (which is less profitable for them and reduces their abaility to generate capital reserves) or they have to issue more shares to get more investors to support the lending. These are the major constraints on deposit creation.--Tom (talk) 10:35, 18 October 2008 (UTC)

it's not misleading, please provide sources

Analoguni (talk) 05:11, 21 October 2008 (UTC)

please provide sources, as I am intersted in the subject. See http://en.wikipedia.org/wiki/Talk:Fractional-reserve_banking#High_power_money_in_the_.22Money_as_Debt.22_movie

Analoguni (talk) 07:41, 25 October 2008 (UTC)

OK.. here is the Federal reserve's PDF on the subject of money creation

http://www.federalreserveeducation.org/fed101_html/policy/frtoday_depositCreation.pdf

When a bank has,say, $10,000 deposited into it from the Fed's purchase of bonds the bank can then lend out 90% of it. It creates $9,000 out of nowhere and credits the account of the borrower with $9,000. The total deposits in the bank then become $19,000. - The PDF explains the rest of the process from which $100,000 will be created out of $10,000 84.68.2.55 (talk) 19:47, 26 October 2008 (UTC)

Lead misleading

I think the opening sentence is poorly worded and gives a misleading impression unless you already know what it means:

banks are required to keep only a fraction of their deposits in reserve

says that banks are forced to do this thing, rather than being permitted to. Perhaps better

banks are only required (obliged?) to keep a fraction ...

banks are not required (obliged?) to keep more than a fraction ...

This inversion of meaning seems to have come in at revision 206775658, 9 April 2008 and loses the intent of the source cited in the discussion leading to the change Lead: text suggestion

"The customary form of banking system prevalent worldwide in which banks need only keep a fraction of their deposits in reserve and may lend out the remainder."

- Royan (talk) 10:32, 20 October 2008 (UTC)

If you ask me the whole intent of the article is a bit suspect. It sounds like this is a PROCESS that has been cooked up by someone to create money. Even your proposed revision implies that there is a "fractional reserve SYSTEM". Systems are usually present for a purpose and nobody ever sat down to work this out. The reserve (or as I would call it liquidity) ratio evolved as a natural consequence of people's behaviour and bank's behavior. If banks kept their depositors money in the safe as liquid assets nobody would ever be able to borrow money from a bank. Elsewhere in the article it implies that banks USE this system as though it was something being exploited. Of course banks collectively have economic power and that is why that are USUALLY heavy regulated.

I come from a country (the UK, so English is my native tongue) in which RESERVES in banking parlance refers to CAPITAL (shareholders funds and retained earnings, so called by there in reserve to cover potential losses) and where LIQUIDITY is the term used to describe what this article calls RESERVES. So even the title of the article is confusing. I think it should be called Money mulitplier. It seems to be very US biased because of the peculiar terminology adopted by the Federal Reserve.

The article IMHO should be renamed to something more neutral and limit the content to explaining the ratio of bank deposits in existence relative to promissory notes issued by the central bank. As well as discussing LIQUIDITY it should also mention CAPITAL RESERVE requirements as both factors are constraints on the creation of bank deposits in the commercial banking sector. --Tom (talk) 13:28, 20 October 2008 (UTC)

It is strictly speaking a recursively defined iterative function - but to be fair economists don't treat these things the way we do in comp sci, and they certainly don't understand recursion. The larger financial system depends on it, and i think it's fair to say that that system and its behaviour is the subject of ongoing research.

It's also my feeling that there are actually subtle differences between the way it's described in America and the UK. This is probably adding to the confusion. Some sources and accompanying work on that aspect would indeed be invaluable. There are also issues of theoretical description (how the recursive process works), versus the actual implementation - how the capital reserve is managed, where it comes from, what type of instruments can be used for it, what the initial source of funds for the bank actually is. These do need to be clarified.

imho. You can do a search for "fractional reserve banking" on the web site of both the Federal Reserve Bank and the Bank of England and you will not find a clear description of it, or more importantly its actual implementation. So this has to be pieced together here from a lot of different sources, and countries - some of which are divided by a common language - without a definitive text to refer to. This is definitely annoying, but afaik the current article, and ironically its talk page - warts and all - is the best description currently available on the Internet.

and btw. Let this be a lesson to any computer scientist students out there. When your lecturer tells you after you've mastered recursion that it's very neat and all, but in critical systems nobody uses it, remember. This is why! Mischling (talk) 19:55, 21 October 2008 (UTC)

it's not misleading, please provide sources

Analoguni (talk) 05:10, 21 October 2008 (UTC)

please provide sources, as I am intersted in the subject. See http://en.wikipedia.org/wiki/Talk:Fractional-reserve_banking#High_power_money_in_the_.22Money_as_Debt.22_movie Analoguni (talk) 07:42, 25 October 2008 (UTC)

That is a deeply flawed film. However - to the subject - according to the http://en.wikipedia.org/wiki/Capital_requirement page - lending institutions can lend a multiple of their capital requirement. —Preceding unsigned comment added by Mischling (talk • contribs) 23:40, 26 October 2008 (UTC)

The source of the confusion?

There seems to be a lot of confusion regarding the "creation of new money", also referred to as "commercial bank-money" throughout this article. Now, I'm not an expert on economics, however I think I have located two sources of confusion. The first seems to stem from lack of precision in defining fractional-reserve banking, and the second from confusion around whether or not federal-reserve banking implies something about what the real money should be.

In order to have some more precision in our discussion, let's make a few definitions.

We are in a fictonal community with currency Unit of Currency denoted $UC$ . We do not assume anything with respect to the nature of what $UC$ really is. Let $0\leq F\leq 100$ . Let $D_{n}(t)$ be the total deposits to Bank $B_{n}$ at time $t$ , let $R_{n}(t)$ be the reserve in bank $B_{n}$ at time $t$ . Here deposit effectively means the the number obtained by adding up the balance of all accounts held by all the banks customers, viz. the money deposited to the bank for safe-keeping by other parties. Reserves means the number of bank-notes kept in the Banks vault.

Now then, some participants on this forum seem to be employing the following definition:

Definition 1 Fractional-reserve banking (FRB) is the practise where, for some preordained $F$ , all banks $B_{n}$ are required to at all times $t$ maintain the inequality

${\frac {F}{100}}\cdot D_{n}(t)\leq R_{n}(t)$ .

This means that if $F=10$ and $t$ represents some point in time for which it is true that customers have total deposits of $100UC$ in bank $B$ , then bank $B$ is reqired to ensure that the reserve at those points in time is no less than ${\frac {10}{100}}\cdot 100UC=10UC$ . Note that $F=100$ reduces full-RB to a special case of fractional-RB.

Now, in my opinion, if this is the correct definition, there really is not much more to be said about FRB, and anything else could be nicely fit within one extra paragraph or so with proper references/links to articles on bank-runs, central-banks, money-supply etc. Clearly, with definition 1 and $F=10$ , a bank can upon a deposit of 100UC by person X lend out up to 90UC to person Y, and X clearly cannot withdraw more than 10UC until (some of) the loan have been repaid by Y, as there is nothing there to pay out. In fact, X cannot withdraw anything until some of the loan has been repaied by Y, lest the bank would violate the fractional-reserve constraint (Does this system sound like the one we all know?).

However, others seem to use a fundamentally different definition of FRB:

Definition 2 Fractonal-reserve banking (FRB) is the practise where, for some preordained $F$ , all banks $B_{n}$ are required to at all times $t$ maintain the inequality

${\frac {F}{100}}\cdot D_{n}(t)\leq R_{n}(t),$

and furthermore, bank $B_{n}$ may at time $t$ create/issue an amount $M$ of money, if (i)

$M\leq D_{n}(t)-R_{n}(t)$

and (ii) the money is created specifically for the purpose of being lent out.

If definition 2 is in fact the accurate one, then -- as many are claiming -- money is created by the banks, since the money lent out by the bank is not affecting its deposits-balance.

Example ( $F=10$ ) Upon a deposit of 100UC (in actual currency) from X at time 0 the bank first registers a deposit of 100UC made in the name of X. This means that $D_{n}(0)=100$ . 10UC is put aside to ensure that the FR-constraint is not violated, so $R_{n}(0)=10$ . Hence up to 90UC can be lent out. However, and actually obviously, they are still counted as part of the banks total deposits; imagine how X would react were he to check his balance and find it at only 10UC. Thus the 90UC's are created to be lent to Y. Evidently, under this scheema, any withdrawal by X -- not exceeding 90UC -- cannot lead to the bank $B_{n}$ violating the constraint even in the case that Y "deposits" the newly-created UC's at the bank. Why? they still have 10UC in "real" money in the vault to back up the (100-90)+90=100. Now assume Y leaves, reenters (t=1) and deposits his loan in the Bank. The bank now "forgets" where the money originated from, and adds 90UC to their total deposits, so $D_{n}(1)=190$ . They promptly place 9UC in the special reserves-vault, now totalling 19UC (10 backs up X's deposits, 9 Backs up Y's deposits). However, the "excess" 81UC's may be lent to Z -- again without affecting the balance in Y's account --- and so on.

This process yields the geometric series

$x\cdot (0.9)+(x\cdot (0.9))\cdot 0.9+\cdots =x\sum _{k=1}^{\infty }(0.9)^{k}={\frac {x}{1-0.9}}=10x$

where $x$ is the original deposit. So this is the mathematical explanation of how the 100UC's become 1000UC's as described in Modern Money Mechanics or on the home-page of the Fed. In general the series converges to ${\frac {x}{1-{\frac {100-F}{100}}}}={\frac {100x}{F}}$ , so that eg. $F=20$ yields the limit ${\frac {x100}{20}}=5x$ . (Note that $F=0$ is not defined for this formula, yet hints to $\infty$ as the limit.)

Feel free to play with this scenario, but note that if it is true that most of the money out there, at any given time, sits in some bank-account, then (i) the amount of money created is a function of the willingness to borrow money in the general public, limited by the series above and the initial deposit of "real money", and (ii) as long as we are willing to accept the mere adjustment of our bank-account balance as payment for goods and services, noone will ever notice a thing. To anyone outside the banks "new-money" and "real-money" is indistinguishable.

Which definition applies? Actually, on the web-page of the Federal Reserve much evidence is found suggesting that it is in fact definition 2 which is representative for the system implemented in the real world (at least the USA). Personally, I am quite disgusted to learn how the process works, and please note that no mention of interest has been made so far. Money = Debt seems to me to reflect accurately the truth. However, as demonstrated above, both scenarios can be described neutrally, and what remains is for the people editing this page to first agree upon what FRB actually means (which pretty much reduces to deciding on one of the above definitions, or possibly some other if neither is accurate). We are bound to have infinitly many re-edits if half the editors work with one definition, while the other half uses a second, since at any point in time the contents will be "false".

Secondly, there is confusion about what the real money is, and whether this is relevant to the article. Note that one can have FRB (with definition 1 or 2), and eg. a gold standard. There is nothing in the definition of FRB which implies what the "real" money should be. In fact, the US did have a system with FRB and a gold standrd until 1971, after which they have FRB with fiat money. Hence it is simply erroneus to make any assumtions as to what the UC's should "really" be. They could be gold, silver, silk or -- as is the case in most countries today -- federal/central-bank-bank notes (which are backed up by the goverments pledge to ensure all citizens accept them as currency...) Again -- personally -- I am strongly biased towards a commodities/precious-metals standard, and will not even attemp writing a neutral article about that matter. My point here is that such issues are irrelevant in an article titled Fractional-reserve banking, as long as it is understood that when there is an X-standard, the reserve may consist of a mixture of X and bank-notes, and when fiat-money is used, what is beeing created by the bank upon a loan request is no longer tokens of X, but more of X itself.

Best Mathias

Barra (talk) 13:14, 2 November 2008 (UTC)

Indeed. It is true that FRB operates independent of the money base. Base money could be sea shells and FRB could still operate on top. I also agree it's extremely difficult to write an NPOV article when it's much easier simply to state the following:

FRB consists of a bank (entrusted to preserve and safeguard depositors' savings) repeatedly embezzling a proportion of those savings to finance speculative lending to the bank's favored associates (including hedge funds and "private equity investors"), thereby exponentially inflating the broad money supply in a manner not unlike counterfeiting, until a bank run exposes the inherently fraudulent nature of the practice. Governments can assist in deferring the inevitable exposure of the deception by strictly enforcing a non-consensual monopoly paper or fiat currency system, which can allow the rapid and near-costless printing of paper money to satisfy depositors in the event of a bank run, which would not be possible with a gold standard, as it is extremely difficult (some argue impossible) to print gold.

However, based on extensive personal experience I know this clear and simple explanation is unacceptable to WP guardians - hence the need for ridiculous long-winded explanations to cover up the raw simple obvious truth that even a child could understand if explained simply. - Ron Paul...Ron Paul... (talk) 03:22, 3 November 2008 (UTC)

Recent edits (5th November)

There have been some recent edits made that change the sense (occasionally to non-sense) of various sentences/paragraphs and also change words in sections that are direct quotes. I am going to roll back these changes. I someone wants to add them back in, please hold off until it can be discussed as many of these edits are simply not good enough to add back in, and some are dangerous. BananaFiend (talk) 10:02, 6 November 2008 (UTC)

Tito80 (talk) 14:06, 8 November 2008 (UTC) My opinion about the used concepts:

Hello, I'm who have maked the edits. Sorry, but perhaps my English is not very good. I wanted improve some concepts, if someone can help me to edit correctly, to be thankful for it.
I think tha there are much confusion around the "Money Creation", and now a days, this terms must be avoided. Ever since standard gold stopped existing, we can not talk about money creation because the own money is an asset. Before, the gold was the asset, and the money (banknotes) was the credit (the reflection of the gold). With gold, we could say "the money creation" because the own money was the credit, but we couldn't say "the gold creation". Currently, the money is money, and the credits is the successive recirculation (chain of loans) of that money. In the world of finance diference this with the names:

Money = Central Bank Money (coins, banknotes, eMoney)

Credits = Comercial Bank Money (loans)

For example, in this link press release of European Central Bank about monetary developments we can read the used terminology. For example, "Turning to the main counterparts of M3 on the asset side of the consolidated balance sheet of the MFI sector, the annual growth rate of total credit granted to euro area residents declined to 8.5%". Always talk about credit creation, and not of money creation. In the Monetary Aggregates, the M1 is the amount of real money in circulation (currency + overnight deposit(electronic money)). The rest of monetary aggregates include the amount of credits (money recirculation <=> chain of loans).

In this web explain a Bank's Balance Sheet that can help to understand as a bank works.

I think that is high necesary to explain that a Comercial Bank DON'T create money. They lend the money that you've deposited (except the legal+own_bank reserves). From the system point of view, if you sum all bank's deposits + other products(liability)in the system, you'll have the monetary mass, but the monetary mass isn't money, is money + credits + other products.

Despite your appalling English, you do actually make sense. However, your defense of FRB is as weak as diluted milk. The problem is the tenuousness in the "credits + other products" part of your equation. Because those credits + other products are often (supposedly) available "at call" or consist of short term liabilities for the banks, it can be treated as "virtual" or quasi-money. And if people move to "real" (or even "hard") money quickly and unexpectedly, the whole game collapses into a Ponzi/John Law's Hell. See bank run for a neat description of the thousands and thousands of times shyster banks have blown up and the pathetic attempts of dumb government officials (including central banks) to clean up spilt milk by trying to put it back in the bottle (diluted, of course). - Ron Paul...Ron Paul... (talk) 06:39, 11 November 2008 (UTC)

It is fascinating on how people who may no better defend the "faith". The avoidance of fully explaining the true method of the creation of money as debt by using words like "credit" and such is silly at best. The math and rules as listed in the Federal Reserve references are fact. The lack of discussion of interest also is lost as well as the well know 1:9 creation ratio, but giving out loans as credit, but even with M3 running up fast it cannot keep up with the Debt creation cycle (esp. with deregulation) and thus eventually must cause revaluation or deflation. There are not infinite resources or people to take all these loans or lines of credit and they are setup such that they couldn't pay it back in most cases. The avoidance of this as well as the question of the monetary and wealth distribution is criminal...not just people, but corporations and governments end up owing everything to banks that make nothing...literally. The control and application of the system is relevant without conspiracy theories. Also what about derivatives? You know that banks and lending institutions were able to use these highly leveraged "financial instruments" to be considered reserves even though they were inflated to 100:1 in some cases? This is carefully avoided by the media right now as a mere $700B to $1.1T would pay off every single subprime and ARM mortgage...all of them...not just the at risk ones. But the derivatives (huge pyramid scheme) attached are estimated between $64T to $144T from this shadow betting pool which itself alone is expected to have between $600T-$1,000T or at least it did in August2008. This is more troubling since the World GDP is only $60T.

I expect this will be wiped out quickly, but the time is soon when the house of cards comes tumbling down and they gave the money to the wrong people. The $7.8T committed should have just given $1.2T to wipe out the mortgage crisis by buying all the mortgages outright and then the gov't handling the % to be paid by each owner back to the gov't to reduce or eliminate debt...not create more. The private banks are sitting on their piles of gov't cash as they know either the Derivatives table will be flipped over in 2009...or they will purposefully knock it over...after accumulating sufficient Real Economy property and wealth to weather the storm. They big money family investors cashed out some time ago. Buckle up folks...the banking scam is about to be exposed one way or the other...the math is against them and sadly too many of them can't do math at all.

http://www.webofdebt.com/articles/its_the_derivatives.php

http://www.webofdebt.com/articles/modest_proposal.php —Preceding unsigned comment added by 72.38.141.22 (talk) 21:21, 14 December 2008 (UTC)

Restructure Proposed

(This article -- and many "money" related articles have many problems -- because the articles are interrelated, I think it would be best to change them all Martycarbone (talk) 00:35, 7 August 2008 (UTC)):

Structure is not logical
Poor quality
Too many examples
Lack of NPOV -- it is basically a rant against FRB
Too many other topics are included, such as convertibility, financial ratios and government regulation of banking and history of banking
It is too long.

I propose to restructure the article as follows:

Start with a clear definition and description of FRB, (why not start with "money"? Martycarbone (talk) 00:35, 7 August 2008 (UTC) ) without including pros and cons, and stating its alternative would be full reserve banking (that approach seems to assume that there are only two choices how the money supply should be handled. That is not logical Martycarbone (talk) 00:35, 7 August 2008 (UTC)). (The FRB was formed to handle our money and money supply -- before the FRB is discussed, it would be helpful to most people to know what the Constitution say about who should run or money supply -- it is very simple) (how and why the Congress set up the FRB would also be of interest Martycarbone (talk) 00:35, 7 August 2008 (UTC))( Salient parts of the U.S. law regarding the FRB and the FDIC -- they are tied together in the law -- should be referenced Martycarbone (talk) 00:35, 7 August 2008 (UTC))
Give an example of FRB in the context of a bank balance sheet and a maturity analysis of assets and liabilities.
Clarification of possible confusion between reserve ratio and other liquidity ratios, and capital ratio. (reserve ratio can and should be discussed on its own -- it is fundamental and easy to understand. Adding a discussion of other ratios near a discussion of reserve ratio would tend to complicate understanding rather than facilitate understanding and is probably unwise Martycarbone (talk) 00:35, 7 August 2008 (UTC))
Brief discussion of liquidity management under FRB.( I doubt if that is needed -- but perhaps I do not know what you are driving at. I personally do not know what liquidity management means. "Liquidity" is one of those words that is used in lots of contexts and should always be used with care. For the most part "liquid means "can be turned into cash" as in "government bonds are liquid because they can easily be turned into cash -- that is, government bonds have high liquidity Martycarbone (talk) 00:35, 7 August 2008 (UTC))
FRB in the context of both central banking and commercial banking (I would think that the different types of banks would be handled as separate issues -- it is only after you know what each bank-type is and what it does, can you understand how the FRB should interact with any one type of bank. I for instance know something about consumer banking and know that the reserve ratio applies to consumer banks -- I can only assume that it also applies to commercial banks and foreign banks operating in the United States Martycarbone (talk))
FRB and the money stock/money multiplier (This sounds like unecessary jargon to me, I have no idea what the "money stock/money multiplier" is Martycarbone (talk) 00:35, 7 August 2008 (UTC)).
Regulation of FRB (i.e. required reserve ratios) under regulations intended to control the stock of money.
Criticisms of FRB and responses to them. (This is important if you are fair to all sides Martycarbone (talk) 00:35, 7 August 2008 (UTC)) (You should also give alternatives to the FRB, and criticism to those alternatives Martycarbone (talk) 00:35, 7 August 2008 (UTC)) (I am willing to license my contributions under the GFDL Martycarbone (talk) 00:35, 7 August 2008 (UTC))
See also, links etc. as now

This structure enables NPOV to be maintained, and pushes the controversy to the later part of the article. Remember the purpose of the article is to explain the term rather than to engage in the controversy. 122.57.90.63 (talk) 19:26, 16 December 2007 (UTC)

I would agree. I also note that the tables appear to be original research, and the one that gives the bank's asset/liability table is wrong (as far as I know). There appears to be significant confusion about the fact that there are different types of reserves (like loan reserves), that may be in either assets or liabilities or contra-accounts. If one looks at a bank's accounting statements, the reserves are not a liability, but an asset - they are a requirement to keep a certain amount of assets in liquid form (often with deposits with the central bank). So the progression works like this (for a bank that has no equity where required deposit reserves are 10%):

Step 1: Bank has zero assets, zero liabilities.

Step 2: Customer deposits $1000 cash. Bank has assets of $1000 cash, liabilities of $1000 customer deposit. (This is standard business accounting, but it has nothing to do with fractional reserve banking Martycarbone (talk) 00:35, 7 August 2008 (UTC). This is one reason why hardly anyone understands the way our Money Supply is managed. A large percentage of the public know how business accounting works and they assume that same type of accounting applies to fractional reserve banking. That is unfortunate -- because it simply is not true Martycarbone (talk) 00:35, 7 August 2008 (UTC)) I think we should be careful to make sure we solve this problem and eliminate that misunderstanding Martycarbone (talk) 00:35, 7 August 2008 (UTC))

Step 2a (notional (notional? Martycarbone (talk) 00:35, 7 August 2008 (UTC))step): Bank creates "reserve" of $100 (perhaps by placing a deposit with central bank). Assets of cash $900, liquid cash reserves of $100; liabilities are $1000 deposit from customer.

Step 3: Bank loans $900 to customer B. Bank has assets of $900 due from customer, $100 liquid cash reserve, liabilities: $1000 customer deposit.

If one looks at a bank's actual balance sheet (depending on jurisdiction), the "reserve" may be shown as e.g. mandatory cash balance with central bank or something similar (it may not be shown at all); but it is not a liability. An example can be seen here on page 255, this is Economics: Principles, Problems, and Policies By Campbell R. McConnell, Stanley L. Brue. It is clearly shown that the reserves are shown as an asset, not a liability. (Note in this example, the "total reserves" is shown, not the minimum reserves; a bank's financial reports may or may split these out.--Gregalton (talk) 20:58, 16 December 2007 (UTC)(commenting on the words from step 2a above to here, I doubt if this is correct or relevant. Many texts and FED publications have examples that read like this and whenever I have examined them in detail, I have have come to the conclusion that they are essentially worthless, confusing information that is not germane to the subject at hand Martycarbone (talk) 00:35, 7 August 2008 (UTC). By the way -- I studied accounting in engineering school and have kept a full set of books for a small but substantial company Martycarbone (talk) 00:35, 7 August 2008 (UTC).)

To put forward a reliable source, see [1] - Economics: Principles and Policy, By William J. Baumol, Alan S. Blinder. Impeccable sources without the rhetoric. This would be a good starting point.--Gregalton (talk) 21:09, 16 December 2007 (UTC)(Do you accept plain old ordinary books as an impeccable source? In my opinion that is a dangerous thing to do when considering banking. Much of what is published is simply not correct. I suspect that most of the incorrect stuff was written by and published by people who had an ax to grind. This would not be surprising in light of the historical political controversy about the control of the money supply Martycarbone (talk) 00:35, 7 August 2008 (UTC))

Greg, Yes, the term reserves can be used for capital reserves (e.g. when the bank revalues the land under its branches upward), for loan loss provisions, for employee entitlement provisions and probably more. Reserves in banking, for the purposes of this dicusssion, really means legal tender reserves, i.e. assets that can directly discharge the bank's liabilities, without needing to be sold or redeemed. Fractional reserve banking means, at least to some extent, the bank is relying on its ability to sell or redeem assets that it can't directly pay out to discharge its liabilities, so for this discussion we need to be strict about the term. Liquid assets are really secondary reserves that anti-FRB people won't admit as reserves.

I have bought in data from a particular bank, ANZ National as an illustration, to avoid claims of original research. Is this the right thing to do?

The steps you propose to illustrate are good, except you can't dispense with equity capital, it is an essential ingredient in getting people to hold the bank's liabilities. Really a model bank illustration should include equity capital, demand deposits/notes, term deposits, loans and advances, marketable securities, and cash reserves. 122.57.90.63 (talk) 09:20, 17 December 2007 (UTC)

Actually, I didn't really like leaving out equity either, the existing table didn't have it either. The article should, as you say, be much more specific what type of reserves and what they consist of - certainly not liabilities. I also think the article could use some more language on minimum reserves vs "preferred" reserves, that is, the reserves the bank chooses to keep (which also depends on definition).--Gregalton (talk) 11:03, 17 December 2007 (UTC)

In your example, shouldn't you include central bank balances in the reserve ratio?--Gregalton (talk) 11:06, 17 December 2007 (UTC) (Be careful -- in this case, less may be more. If you try to explain every accounting and legal nuance up front, you might leave even very well educated readers with glassy eyes and numb minds. Stick to the basics up front and refer to the details in another section. Too much information can be a killer Martycarbone (talk) 00:35, 7 August 2008 (UTC)"

Greg, If a customer walks into a bank branch and demands repayment, the customer has a right to insist on legal tender, and the bank can't directly use its balances with the central bank to pay the customer (they aren't legal tender), instead the bank has to redeem its balance with the central bank in legal tender which can then be paid to the customer. (This may or may not be correct, but why should you be discussing legal tender here? Most of us think legal tender is money such as dollar bills. If that is not correct -- and perhaps it is not, it should be discussed elsewhere Martycarbone (talk) 00:35, 7 August 2008 (UTC)) Really the only difference between balances held with a central bank and balances held with a commercial bank is that the former may be safer. 122.57.90.63 (talk) 21:11, 17 December 2007 (UTC)

Of course - but in some countries / banking systems, "reserves" in the sense they are used in this article are required deposits with the CB. They are part of the tool used to adjust monetary transmission (as well as protect depositors). In fact, required reserves may be subject to restricted usage (i.e. not available under normal circumstances for banks to meet day-to-day cash requirements). Of course, part of the assumption behind this is that the bank can quickly - if not immediately - convert CB deposits into cash, and hence count as "cash reserves."

In essence, this is dependent in part on local regs. My (very weak) understanding is that deposits with FRB count as reserves.--Gregalton (talk) 22:43, 17 December 2007 (UTC)

Greg,

I think this article is supposed to be pan-jurisdictional and relate to the principle of the thing first, and the variants under regulatory law later.

I've checked out another bank's financial statements, Westpac New Zealand Limited has a less complex balance sheet and it only lists $102m in 'cash and balances with central banks' without breaking it up between the two, and it has a maturity analysis that lists 'on call' separately from 'less than one month'. Interestingly this gives a reserve ratio of just 0.78%, basically the same as the legal tender cash reserve ratio of ANZ National Bank Limited. Perhaps we should put both the balance sheet and the maturity analysis there as the example. David.hillary (talk) 23:20, 17 December 2007 (UTC)

I agree - in fact my comments about the proposed restructuring is that it seems to focus predominantly on FRB approach. For another one, the financial statements for Russia's Vneshtorgbank are available here. The relevant quote that relates is in the notes, "Mandatory cash balances with the CBR and other Central banks are carried at amortized cost and represent non-interest bearing mandatory reserve deposits, which are not available to finance the Group’s day-to-day operations and hence are not considered as part of cash and cash equivalents for the purposes of the consolidated statement cash flows." This is the Russian Central Bank's approach to deposit reserves (there are entirely separate requirements for liquid assets available, etc).--Gregalton (talk) 00:14, 18 December 2007 (UTC)

===Lets keep the table and graph that explains the essence of the fractional reserve system=== ( If that table are graph are the ones I think they are, think they are, in my opinion, they are completely misleading and have nothing to do with the way the fractional reserve system works Martycarbone (talk) 00:35, 7 August 2008 (UTC)) Since this article is about fractional reserve banking, and the purpose of wikipedia is for people to have the ability to understand things, I think it's necessary to explain what essentially fractional reserve banking is in the simplest way possible. (unless that simple way is erroneous Martycarbone (talk) 00:35, 7 August 2008 (UTC)) The table that displays the fractional reserve lending system at work does just that. There are a lot of people trying to explain in many words how fractional reserve lending works and this graph does it all for them. There's no need to have long discussions about how much can be lent out. Just look at the table.

Also, the intro to this article is horrible. I have no idea what it's saying. Since wikipedia is supposed to be for people all over the world of different age groups and from different educational backgrounds, I think this article should be designed to be as easy to comprehend as possible. I don't think the intro needs to get too technical or complicated. Just say what fractional reserve banking is: when a bank lends out most of the deposits and increases the money supply without physically creating new money. (That is an erroneous description. New money is essentially created and there is nothing wrong with that. Read the information from Wright Patman on my website --- links above Martycarbone (talk) 00:35, 7 August 2008 (UTC)) The table then displays how this works. Not much more is needed in this article after that other than the purpose of this system and the arguments supportive of it and arguments against it.

Here is the table again. Could someone please explain why this shouldn't be in this article?: (It is simply wrong in my opinion. It has no relation to how fractional reserve banking works Martycarbone (talk) 00:35, 7 August 2008 (UTC))

Table 1: $1,000 of actual money loaned out 10 times with a 20 percent reserve rate
Individual Bank	amount deposited at bank	amount loaned out	amount left in bank (reserves)
A	$1,000.00	$800.00	$200.00
B	$800.00	$640.00	$160.00
C	$640.00	$512.00	$128.00
D	$512.00	$409.60	$102.40
E	$409.60	$327.68	$81.92
F	$327.68	$262.14	$65.54
G	$262.14	$209.72	$52.43
H	$209.72	$167.77	$41.94
I	$167.77	$134.22	$33.55
J	$134.22	$107.37	$26.84
K	$107.37
			total reserves:
			$892.63
	total deposits:	total amount loaned out:	total reserves + last amount deposited
	$4,570.50	$3,570.50	$1,000.00

I think this simple table explains things more than sufficiently. Who does or does not like this table? Please state your reasons. (It is so wrong, it is hard to comment on Martycarbone (talk) 00:35, 7 August 2008 (UTC). I simply think the source is wrong. As far as I can tell the source is simply a publication from the Fed and may or may not been approved by someone who knows the system. Is it not incumbent on you to show where the information in that table agrees with or is supported by a written description in an authoritative source --- such as an FRB law or the other sources on my website? Trying to tell how this chart or table is wrong is like trying to prove something does not exist -- it is virtually impossible Martycarbone (talk) 00:35, 7 August 2008 (UTC))

 Analoguni (talk) 19:32, 19 December 2007 (UTC)

The problem is that the table above and the one in the current article, do not correctly reflect how the banking system works. In particular, the table claims that loans are made from reserves, which is not correct. Bank loans are not made from reserves. From: "Modern Money Mechanics, by the Federal Reserve Bank of Chicago": (a statement like "bank loans are not made from reserves is one of those silly statements which are usually deceptive and misleading. Bank loans -- (if the borrower takes cash) are taken (made) from the cash on hand at the bank. Since the bank does not label each dollar of cash on hand with its source, it can't be said that the the dollar comes from any particular account. It is just wrong to say where the loan comes from. You can refer to the accounting entries when referring to a loan and show thereby which accounts are reduced and which are increased when a loan is made -- but that is quite different, I think than saying the loan is made from a certain account -- unless you explain what you are doing, it is just goofy. In your reference -- where does the reference say "loans" are made from? Martycarbone (talk) 00:35, 7 August 2008 (UTC))

No, bank loans are not made from cash on hand at the bank. It is not wrong to say where the money comes from because bank loans are newly-created money. THAT is the whole essence of fractional reserve banking. From the reference above by the FRB of Chicago:

"It does not really matter where this money is at any given time. The important fact is that these deposits do not disappear. They are in some deposit accounts at all times. All banks together have $10,000 of deposits and reserves that they did not have before. However, they are not required to keep $10,000 of reserves against the $10,000 of deposits. All they need to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is "excess reserves." This amount can be loaned or invested.

If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system."

AceNZ (talk) 00:04, 28 September 2008 (UTC)

Of course, they do not really pay out loans from the money they receive as deposits. (They might. Once the bank has the deposit on hand, they might turn around and lend some of that money to their next customer Martycarbone (talk) 00:35, 7 August 2008 (UTC)) (Wrong: as described above, money on-hand is not used to fund loans AceNZ (talk) 00:04, 28 September 2008 (UTC)). If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system. (in my opinion, this is way too much information even if it is correct. Can't you simply say "when someone gets a loan they sign a contract to pay that loan back"? You do not have to mention "promissory notes. Also -- why do you have to tell how that transaction is recorded "in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system.", that just complicates things Martycarbone (talk) 00:35, 7 August 2008 (UTC))

It also neglects the fact that new money is created when loans are made. Loans are in fact just bookkeeping entries (they are far more than Just bookkeeping entries Martycarbone (talk) 00:35, 7 August 2008 (UTC)), where the maximum amount is determined by the amount of excess reservesthat are available (I don't want to make a big deal out of this -- but when a loan is made there does not have to be "excess reserves" available. The reserves needed are created precisely by the dollar amount of the loan. Martycarbone (talk)). That is, in my opinion, precisely the essence of fractional reserve baking Martycarbone (talk) 00:35, 7 August 2008 (UTC)). In fact for every dollar lent -- that dollar creates about $10 that can be lent out Martycarbone (talk) 00:35, 7 August 2008 (UTC)) (Again, not correct. New loans don't create reserves. Reserves can only be created by the Federal Reserve, usually through open market operations. And yes, before a loan is made, "excess reserves" must be available. The process is fully described in the reference above that was written by the Federal Reserve themselves AceNZ (talk) 00:04, 28 September 2008 (UTC)). Here's a revision of the table that tells the story more accurately:

Table 1: $1,000 of actual money loaned out 10 times with a 20 percent reserve rate
Individual Bank	amount deposited at bank	required reserves	excess reserves	new loan
A	$1,000.00	$200.00	$800.00	$800.00
B	$800.00	$160.00	$640.00	$640.00
C	$640.00	$128.00	$512.00	$512.00
D	$512.00	$102.40	$409.60	$409.60
E	$409.60	$81.92	$327.68	$327.68
F	$327.68	$65.54	$262.14	$262.14
G	$262.14	$52.43	$209.72	$209.72
H	$209.72	$41.94	$167.77	$167.77
I	$167.77	$33.55	$134.22	$134.22
J	$134.22	$26.84	$107.37	$107.37
K	$107.37
		total required reserves:
		$892.63
	total deposits:	total reserves + last amount deposited		total amount loaned out:
	$4,570.50	$1,000.00		$3,570.50

As the number of banks and loans increases, the total required reserves approaches the amount of the initial deposit and the total amount loaned plus the initial reserve approaches 1 divided by the reserve requirement times the amount of the initial deposit (1*1000/0.2 = 5000x in this case).

I suggest the table above be included in the article instead of the current one. --AceNZ (talk) 10:20, 6 May 2008 (UTC)

Sorry I find this table and the explanation of FRB as 'lending out deposits' as confusing and unhelpful. What happens to the money lent by the bank in a sense isn't what FRB is about: it is about the money the bank doesn't lend out but hold in reserve, hence the term FRACTIONAL RESERVE BANKING. Since deposits are the bank's liabilities, to talk about lending deposits I think is very confusing. (I agree that it is confusing, but not for the reason you give. As strange as it seems the banks do take in deposits and then lend out about ten times the amount of those deposits Martycarbone (talk) 00:35, 7 August 2008 (UTC))

No new money is "created". As you bring deposit to a bank you take it out from the cash in the rest of the economy. As you take a loan to pay for a car, you return the money from the banking system to the rest of the economy (car producer). One cannot look at the banking system as something isolated from the rest of the economy. Looking at the tables above one can see that "with initial $1000 they make $5000" which looks like money creation. In reality we should look at the money supply across the whole economy which in this case would not change (ignoring the interest on both deposits and loans, everyone will get their own in the end). This should be mentioned in the discussion, otherwise gives support to the conspiracy theory of money creation. Kura440 (talk) 12:49, 5 February 2009 (UTC)

I think we should start with the individual bank, and then move to the system as a whole, and then introduce the controversy concerning the stock of money and price of money as close to the end of the article as possible. For this reason I have restructured and edited the article to start with an example of the balance sheet of the fractional reserve bank, showinging that the bank's stock of legal tender reserves are a small fraction of its demand liabilities, which is the essence of fractional reserve banking. (Sounds way to complicated to me -- it is not that complicated. Read the sources at the URLs I give above. Patman starts by simply talking about a single bank, the owner of that bank, his customers and the King. It is hard to beat his description for simplicity Martycarbone (talk) 00:35, 7 August 2008 (UTC)) David.hillary (talk) 04:59, 20 December 2007 (UTC)

I disagree strongly with David's comments. I find the table and the associated explanation clear, factual and worth re-inserting. I find David's comments unconvincing. The diagram associated with the table was also very useful. Frankly I don't know why so many edits have occurred on this page over the last couple of weeks. There was a very clear version of frb only a few weeks ago and it seems to have been wiped. Also the Libertarian stuff has basically been wiped. A lot of "wiping" seems to be going on here with very little explanation. I, for one, don't like it.--Karmaisking (talk) 15:42, 25 December 2007 (UTC)

I agree with David's comments and didn't find the table and graph useful - just an opinion. And the "wiping" of libertarian stuff was on this talk page for some time with no argument proposed as to why this page should contain a section devoted to a single political party or movement's viewpoints (why not Communist? Why not every other?) This is an economic/academic topic, and if there is a need for viewpoints, no particular party's approach should receive special attention.--Gregalton (talk) 17:15, 25 December 2007 (UTC) (I agree completely. The more opinions the better if they are reported as opinons Martycarbone (talk) 00:35, 7 August 2008 (UTC)

I have reverted Karma's re-addition of this material while being discussed on talk page. David's comment above is accurate: FRB is about what the bank does NOT lend out, not what it does lend out. In addition, this whole geometric progression thing is a gross oversimplification: a) the reserve is a minimum, not the actual amount; b) leaves out bank equity and capital, which is often more significant than the resrves; c) makes no account for 'friction' in the system (i.e., relative desire of recipients of loan money to keep money in the banking system, or hold reserves at different levels, etc; d) makes no account of other restrictions on lending, such as minimum capital requirements, etc. So it tells you something in theory (maximum amount that could be created) but not much in practice (how much will be created). If others have a strong opinion, please let us know, but at minimum, this type of "illustration" should be further down the article.--Gregalton (talk) 09:45, 26 December 2007 (UTC) (In my opinion, the reserve that can be calculated by the existing reserve requirement ratio is not a minimum. See the links above to information on my website Martycarbone (talk) 00:35, 7 August 2008 (UTC))

FRB must include its EFFECTS, not just the simplistic anodyne statement that the bank lends more than it has in cash deposits. That's almost deceptively simplistic and doesn't explain the dynamic implications of frb. The table and the easy-to-understand diagram convey accurately the GENERAL effects of frb, which are undeniable and acknowledged by all monetary economists. (I could not disagree more. Most monetary economists certainly must understand the multiplying effect of the fractional reserve system, but I can't believe any competent economist would agree that the chart under discussion represents the facts of the system Martycarbone (talk) 00:35, 7 August 2008 (UTC) )It should be at the start of the article as it is the "main" economic effect of frb and is the issue of most interest to people ignorant of frb. Can someone else please comment, as Gregalton is strangely insistent that this stuff remain deleted.--Karmaisking (talk) 12:19, 26 December 2007 (UTC)

here is the source for the table

Here is a good source for the data in the table. It's from the New York regional reserve bank of the US Federal Reserve System: http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html Scroll down to the "Reserve Requirements and Money Creation" section. Here is what it says:

"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity." (in my opinion, that analysis is completely wrong and out of sync with Patman's explanation and the current law and probably the books of any bank. You can't trust FRB reports -- they are not produced under oath. Take the first sentence "Reserve requirements affect the potential of the banking system to create transaction deposits" that is not correct -- a "transaction deposit" -- the legal definition is is on one of the links to URLs on my website -- is created when a bank accepts a deposit from a depositor. The bank -- or the system -- is never restricted in any way from accepting deposits or creating transaction deposits Martycarbone (talk) 00:35, 7 August 2008 (UTC))

I rest my case. By the way, I am the creator of that table. Analoguni (talk) 09:38, 27 December 2007 (UTC)

Great job. You are amazing. That's the best explanation of frb I've EVER seen. If I had a hat, I'd take it off to you :-) --Karmaisking (talk) 12:37, 29 December 2007 (UTC)

Just a quick note - diagrams are even more informative and show the effects of lower reserves. Excellent work. Don't let troll Zenwhat discourage you. He has clearly indicated his obsessive interest in defacing this page - and has even asked Gregalton to help him remove references to the great Ludwig von Mises. Specifically, he has asked Gregalton help him delete references to Mises.org here, stating in unambiguous terms to Gregalton: "Also, in case you're interested, one of the easiest ways to find economics articles that have been vandalized is to do a search for links to Mises.org". References to von Mises amount to VANDALISM??? What a sicko! Both "editors" appear to be interested in defacing articles relating to monetary theory or frb. Sad to say, but given these comments, the only conclusion one can draw. I, for one, am grateful for your persistence in the face of repeated silly attacks by monetary trolls.--Karmaisking (talk) 11:22, 10 January 2008 (UTC)

Be Careful Analoguni!!! - you have to keep reading the Fed article that you are citing. The paragraph after the example states, "In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest ... Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves." This indicates that Fractional Reserve Banking is about RESERVES - and not deposits. - http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html

Example - A brand new bank opens up with no assets/money whatsoever. The day that it opens, it loans Joe Schmo $1,000 by opening him a checking account and putting $1,000 in it (it doesn't actually put real cash in the checking account - it just marks down on its books that Joe has an account with $1,000 in it). At the end of the day, the Bank notes that it has "lent" $1,000 to Joe (still just noting an amount of $1,000 in his checking account), but that it has no actual money in reserve - as nobody has made any deposits with the bank. At this point, if Joe tried to take any money out in cash, the bank would say "Sorry - we ain't got any." So the bank goes to the money market and borrows $100 at the prevailing federal funds rate. Now the bank has $100 from the money market in actual money and puts it in its vault ("in reserve"). Why only $100? Well because it is equal to 10% of what it lent out to Joe. This way they are meeting the statutory regulations imposed on them of having 10% reserves. This way, when Joe tries to take some cash out of the checking account, the bank has some cash to give him. Chances are he won't ask for the whole amount, and that is why the law says that the bank only has to keep 10% on hand. (All of this is basically and wholly untrue -- Joe Schmo's $1000 deposit can immediately be lent out 10 times over. I know that is hard to believe but that is fractional reserve banking and it has essentially worked for hundreds of years. There has never been a more proven system Martycarbone (talk) 00:35, 7 August 2008 (UTC))

So, including your chart only confuses what Fractional Reserve Banking is about. It is true that your example shows a way that transaction deposits can be created through Fractional Reserve Lending, but is seperate and distinct from what Fractional Reserve Banking is. —Preceding unsigned comment added by 70.64.6.187 (talk) 06:08, 13 January 2008 (UTC)

So if they lend Joe $1000, where does the money come from? What if Joe wants cash? You're absolutely wrong. They have to get all the money from the fed and pay interest on that money. 167.1.150.121 (talk)
You don't understand what that page is describing. What it means when it mentions the reserves is that in the U.S. system specifically, the government regulates things my influencing the cost of interbank lending of reserves. This is U.S. specific and doesn't apply to fractional reserve banking in general, although there are probably other nations who regulate the banking system in the same specific ways that the U.S. government does through the Federal Reserve system. As far as deciding whether fractional reserve banking is about either deposits, loans, reserves, or the money supply, I would say that it's about all of these, not just one of them. (that statement is, in my opinion, absolutely correct Martycarbone (talk) 00:35, 7 August 2008 (UTC)) You said:
"This indicates that Fractional Reserve Banking is about RESERVES - and not deposits."

This is incorrect because it is about reserves AND deposits...and loans...and the money supply. For the information about reserve requirements:
"In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest"

What this is referring to is that individual banks will not usually lend out the maximum permitted amount based on the reserve requirements. This happens for a number of reasons. One reason is that the more a bank loans out, the higher the risk is that it could go bankrupt or that there could be a bank run. Remember, a bank is a private business and exists to make a profit and it's not in the private bank's interest to go bankrupt. Also, in the U.S. specific case, government regulations can be used to prevent an individual bank from loaning out money even if it still has more reserves then the legal reserve requirement. If you want to see how this applies in a real world situation, just look at the current housing bubble in the united states. The banks didn't necessarily lend out the maximum amount permitted but they still gave loans to people who didn't have enough income to pay back these loans. The Federal Reserve System has regulators in place that are supposed to be able to stop a bank from giving out loans to people who cannot possibly pay them back. The Federal Reserve regulators failed to properly regulate the subprime loans. This is how the U.S. system is supposed to prevent bad loans from being given out even though the banks have more money available then the reserve requirement. This is U.S. specific and doesn't apply to fractional reserve banking in general. ( I think fractional reserve banking works essentially the same way in every country -- in fact, it has proven to be such a wealth generator, a country would have to be dense to not follow it.Martycarbone (talk) 00:35, 7 August 2008 (UTC)) Analoguni (talk) 23:38, 26 January 2008 (UTC)
I haven't seen any discussion of interest on loans. Banks count future interest on mortgages as assets too. They discount it at the rate of inflation but big deal the damage is still done. Thus the fractional reserve that they claim as a basis for making additional loans in inflated wildly by the interest on mortages. The table doesn't show that! The interest over 30 years far exceeds the initial principle amount. Additionally it far exceeds the present day value of the real asset (the house), especially after a recession when housing prices fall. These loans were bundled and sold to larger banks and investors invested in them. Those banks and investors were counting on principle + future interest for the bundled loan assets. When all the forclosures hit, the problem was compounded because the banks writedown inlcluded the fact that the real asset values (housing prices) were falling as the market crashed. Once investers realized that the assets were never going to pay out at the value promised (principal + future interest) everyone pulled out and several large banks no longer exist because of it. This practice is at least as bad as anything Enron did and no one is calling the banks on it. Instead we bailed them out without asking one question while at the same time car companies which actually produce goods are left out in the cold.
The net effect of this practice is the general public pays interest to banks for money the bank never had to begin with. And now the government has bailed them out at the expense of that same general public. And if this practice isn't inflationary, please tell me what is.Mbrisendine (talk) 03:53, 4 December 2008 (UTC)
A statement from the Federal Reserve on money creation through fractional reserve banking
Fractional reseve banking isn't just about the reserves but it is also about the money supply in a banking system and/or economy. (back in the 1800's, in the free banking era, private banks controlled their own money. This is why I say banking system (free banks) and/or economy (govt regulated banks)). Fractional reserve banking has a direct effect on the money supply and it is not only important, but necessary to include the effects on the money supply in this article.
The table above shows how the money supply is expanded through the fractional reserve lending system and I think it's necessary to include it in this article.
Here is a quote from the U.S. Federal Reserve's official education website (www.federalreserveeducation.org). It is from a document that was created to educate people on how the federal reserve system works. It is titled, "The FED Today". Some text on the cover says, "Histroy, Structure, Monetary Policy, Banking Supervision, Financial Services, and more", and, "Lesson plans and activies for economics, government, and history teachers". The link to it is: http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf
Myth: The Fed is not a good supervisor of banks because it allows banks to keep only a fraction of their deposits on hand.
Fact: The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) (or collateral Martycarbone (talk) 00:35, 7 August 2008 (UTC)) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money (and lending out the deposit about 10 times over Martycarbone (talk) 00:35, 7 August 2008 (UTC).) If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to “create” money.( this is more or less true -- but it is not quite complete and more or less self serving thereby. What they left out is that in general the banks can lend out ten times as much money as they have on deposit. That multiplier has over time worked well for the FRB and for the country -- I do not begrudge the banks the fruits of that multiple -- but it would be nice if everyone understood all the IMPORTANT details of how the system works). (I forgot to sign the preceding entry, so I am signing it now Martycarbone (talk) 14:19, 15 August 2008 (UTC))
This is on page 57 of the document. Analoguni (talk) 07:51, 27 December 2007 (UTC)
Now let's contrast the statement from the federal reserve with the statements by users above:
"Sorry I find this table and the explanation of FRB as 'lending out deposits' as confusing and unhelpful. What happens to the money lent by the bank in a sense isn't what FRB is about: it is about the money the bank doesn't lend out but hold in reserve, hence the term FRACTIONAL RESERVE BANKING. Since deposits are the bank's liabilities, to talk about lending deposits I think is very confusing." David.hillary (talk) 04:59, 20 December 2007 (UTC)
"David's comment above is accurate: FRB is about what the bank does NOT lend out, not what it does lend out." Gregalton (talk) 09:45, 26 December 2007 (UTC)
Clearly, the loans and resulting deposits are important because new money is created this way. The money supply is expanded through this system. Analoguni (talk) 08:21, 27 December 2007 (UTC)
Need more information for the two types of money
There are several characteristics of fractional reserve banking that aren't included in the article. For example, commercial bank bank money gets its value from the fact that it can be exchanged at a bank for central bank money. It only exists "on paper" in the form of checks or electronic transfers. Also, some more info on how deflation occurs as debts are paid back can be helpful. The addition of new money has a multiplying affect since it can be used to create more commercial bank money. There is much more commercial bank money in existence then there is central bank money. Official money supply statistics show how much more commercial bank money exists then central bank money. I put in a list with these things but it was changed and some information was removed without at least putting in citation tags. I think all of these things describe fractional reserve banking and help to give an understanding of how it all works.
An analysis of how much money is needed to pay back the loans is probably necessary too, since it would show if and how new money would be needed within a system in order to be able to pay back a loan plus interest. The banks make their profits from taking money out of the system, but it also might be important to point out that the banks spend the money they make so it could still be within the system. An analysis of this could be useful. Analoguni (talk) 04:03, 7 February 2008 (UTC)
keep it simple so ordinary people can understand what fractional reserve banking is
There's too much complicated stuff in this article. I think it would be best to have sufficient information so that someone who doesn't know what fractional reserve banking is will know what it is after reading this article. Analoguni (talk) 20:05, 19 December 2007 (UTC)

I think everyone agrees with this, the debate is on what we can lose and how to structure and word the article so it is clear and unbiased. David.hillary (talk) 04:59, 20 December 2007 (UTC)

this article is just wrong. cash reserves deposited at a central bank allow banks to MULTIPLY their money by the reserve requirement. 1 dollar may be turned into 9 with a 1:9 ratio. (that is absolutely correct in my opinion Martycarbone (talk) 00:35, 7 August 2008 (UTC))
if the chequebook money created by the bank is deposited at another bank they are now required to keep a portion of it as a reserve. ( I do not think that is true. Deposits in new banks continue the process -- they too can be lent out over and over. Hard to believe -- but true -- as far as i know, nobody has ever calculated a safe upper limit. As long as the loan is covered by collateral and most of the loans are used by businesses and people to create wealth -- it is a healthy situation Martycarbone (talk)) see
http://uk.youtube.com/watch?v=hfXavRTM4Fg&feature=related
why can't i edit the article to make it accurate? —Preceding unsigned comment added by 91.110.50.216 (talk) 06:39, 31 December 2007 (UTC)
Why do multiple banks need to be involved? The first bank can keep all the money deposited and write loans for $400 to the next customers that come in wanting a loan, and they keep all the business that way. Doing it the way in this article would lose the majority of the profit to be gained. --86.164.126.9 (talk) 21:32, 2 October 2008 (UTC)
New Table Proposal
I see the following problems with the current table that is used. 1. It does not clarify, or show where the "money" is going. This particular example, although not wrong, does not provide sufficient clarity or explanation of the a reserve system with a central bank. 2. It doesn't make sense. I could basically show the exact same thing, as that table in one line. BANK A gets a $1000 cash deposit, and uses that money to lend out 10,000 chequebook dollars. 3. It does not include what is really going on, purchase of assests, fed funds lending, payment of collection of interest.
So I propose the following. We need a table which while it includes many more details, it is as simplified as we can make it. This table must include the central bank accounts, it must include chequeing accounts at private banks, it must include people.
I don't know how to post my table here, but the following table is what I recommend. I have included many "steps" that could be shrunken down, but I think my model is the simpilest that can be used. I would like to add various types of transactions to this table..ie what happens when the asset devalues(mortgage crisis), what happens when people want their money, etc...
Here is the link to my spreadsheet... please let me know if this clears some things up..
http://spreadsheets.google.com/pub?key=pWw-cpEDjoPazmAoiOIgTfQ
Thoughtbox (talk) 19:44, 13 February 2009 (UTC)
benefits of Fractional Reserve
The current content is unclear as to what the benefits are and to who. Some comments below.
"According to the United States' Federal Reserve, fractional reserve banking provides benefits to the economy and the banking system:
The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business."
Not a benefit just a fact of how the system works
"Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds)."
This is just saying banks act as middle men, this is not unique to fractional reserve banking.

"Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money."
Not having to pay safekeeping fees is a possible benefit. Getting interest on deposits is a possible benefit but you could argue that it is the cost of potentially not getting all your money back as fractional reserve implies. Banks making money from the interest rate differential is a possible benefit to the banks.

"For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect." What is the benefit? it says its important but doesn't say why it is important or what the benefit is.
"Referred to as the fractional reserve system, it permits the banking system to "create" money.[4]" Again what is the benefit?
Quoting the Federal Reserve Bank on the benefits of the system it is involved in is likely to be biased.
It would also make sense to have a section on benefits next to the section on criticism -- both near the bottom.

Tridy (talk) 17:42, 20 January 2009 (UTC)
Proposing rename to banking reserve rules
The term "fractional-reserve banking" is irrelevant to the way actual finance works and demonstrably so at present - it's certainly no more than a theoretical principle and that from a long-dead theory. In practice, it's not clear what the 'fraction' is of, there is no value in the central bank to 'reserve' against or hold a 'ratio' of, and other problems. Read gang8 for a few months to become convinced of the truth of this... So:
This article and criticisms of fractional-reserve banking need to be merged with a proper accurate statement of how the global financial clearing system really works, including a lot of explanation of the Bank for International Settlements and its role. A title that neutrally reflects the scope of the discussion is banking reserve rules. Why this title? Several reasons:
While there isn't anything for there to be a 'fraction' of, and the 'reserve' is only a psycholgoical one, there are objectively 'rules' being applied to tell banks what they are not allowed to lend, that are vestiges of past rules regarding actual held reserves.

A proper explanation of capital adequacy, the real system used to determine banks' lending constraints (and yes bank lending constraint is another reasonable title), would fit within banking reserve rules but is out of scope for "fractional reserve" een though you cannot possibly understand how real banking works without capital adequacy.

The term actually appears in the World Mayors and Municipal Leaders declaration on Climate Change, 2005, an ICLEI-sponsored and thus UN-sponsored agreement that was the result of extensive negotiations among the most representative local government agency in the world - accordingly it's not controversial at all to represent the issue.
clause 4.3 specifically calls on national governments to change "tax, trade, credit and banking reserve rules"
"fractional reserve" anything is tied inexorably to the "embezzling goldsmiths theory" and so is POV in actual usage, you never or rarely see it used by any real economist(s)
Hopefully this will resolve the NPOV issue that seems unresolvable in any other way.
See also monetary reform and talk:monetary_reform for more context on all this, and what other approaches to reforming financial regulation have been considered and why.
We could also keep criticisms of fractional-reserve banking and monetary reform as places for goldbugs to gather. As things stand I had to add a POV tag after my own edit just because I couldn't get all the goldbug nonsense out on the first edit - we might as well redirect all these articles to goldbug if we can't get rid of their POV.
Meanwhile sane people who know we are never heading back to any mythical never-existed supposedly-honset gold standard could just develop parallel banking reserve rules, capital adequacy and monetary policy articles. But in that case neither of the goldbug articles should be included in the monetary economics category, they should be in their own category:goldbug. ;-)
removing my own comments
Fractional Reserve banking is how this practice is referred to by not only the federal reserve of the US but also those of other countries.Smallman12q (talk) 14:36, 14 February 2009 (UTC)
I think we should keep the title Fractional Reserve Banking, this is how it has been referred to in Economics textbooks since the 19th century. Nor does the use of gold as the token for the reserve change the fractional part. We should (imho) concentrate on describing how the fractional reserve process works, and how it is in fact implemented, as clearly and as well as possible. Mischling (talk) 13:28, 2 March 2009 (UTC)
I highly agree with Mischling and Smallman12q, the article name should remain. Vexorg (talk) 02:14, 3 March 2009 (UTC)
I agree as well I think the article name should remain. Wikiiscool123 (talk) 17:03, 3 March 2009 (UTC)
Statement Dispute
The statement in the leading paragraph This practice is universal in modern banking. is very much against WP:POV. I would like to get a consensus to change it to This is a common practice in modern banking. Some foreign banks do use sound banking. Smallman12q (talk) 14:39, 14 February 2009 (UTC)
Find some properly cited examples, and I don't think you will have much difficulty in obtaining consensus for this change. It's not a question of POV but of accurately summarising the article. BTW, we obviously can't refer to "some foreign banks" - this is a global project.JQ (talk) 00:18, 15 February 2009 (UTC)
In addition, the statement that "Fractional reserve banking is a necessary consequence of bank lending" is not supported with any citations. I would argue that this statement is an evidence of the "confusion between loan banking and deposit banking" that is quoted later in the article. The two sentences seem to state that a) fractional reserve banking is necessary, so therefore b) it is universally practiced in "modern" banking. While(b) may be true, (a) is just an assertion. It also seems to equate "bank lending" with "when banks lend out a fraction of the deposits the receive." But are demand deposits the only source of funds for banks to lend? They are not. A bank lending structure based exclusively on lending funds from time deposits or other instruments is possible, and would not constitute fractional reserve banking. Bshow (talk) 18:49, 24 February 2009 (UTC)
Again, find a source saying this. The claim you don't like is supported by the US Fed which is a WP:RS JQ (talk) 00:17, 26 February 2009 (UTC)
Where is the citation from the Federal Reserve saying that fractional reserve banking is necessary? Bshow (talk) 05:21, 7 March 2009 (UTC)
Staged money expansion is nonsense
The graphs and the table are complete nonsense. A bank can lend out the whole amount in a single loan if it wants to. Banks do not lend cash. Banks lend chequebook money. Below is an illustration of the issue with a 10% reserve requirement:
Symbols: $ = cash # = chequebook money (bank liability to deposit holder) Stage 1: Bank has no (available) cash and can't lend Stage 2: A depositor walks in with $100 in cash: Bank vault: $$$$$$$$$$ ($100) Depositor account: ########## ($100) Stage 3: Bank lends chequebook money Bank vault: $$$$$$$$$$ ($100) Depositor account: ########## ($100) Debtor account(s): ########################################################################################## ($900)
The point is: There can be any number of lending operations to achieve the full money multiplier effect, including just one.
The same example with a 50% requirement:
Stage 1: Bank has no (available) cash and can't lend Stage 2: A depositor walks in with $100 in cash: Bank vault: $$$$$$$$$$ ($100) Depositor account: ########## ($100) Stage 3: Bank lends chequebook money Bank vault: $$$$$$$$$$ ($100) Depositor account: ########## ($100) Debtor account(s): ########## ($100)

Reiska (talk) 21:02, 8 March 2009 (UTC)
Typo - 3rd paragraph of "How it works"
Don't have "autoconfirmed" authority yet to correct this myself, but the sentence "Holders of demand deposits can withdraw all their at any time" should probably be "their money" or "their funds at any time". Luke831 (talk) 21:08, 4 March 2009 (UTC)
Dreadful
Sorry, but this article is currently in a dreadful condition. There is a lot of good information, but it needs radically organising and some parts need re-writing to explain the process of deposit multiplication under Fractional Reserve Banking and to properly explain the good info that is already present. Vexorg (talk) 07:49, 12 March 2009 (UTC)
Agreed. When I first referred people to this article in late 2007, it was simple and easy to read. Now it's a horrible, obfuscatory mess and one long violation of NPOV. Putting "Benefits of Fractional Reserve Banking" at the beginning, before it's even explained or defined? Is there an opposite term to "goldbugged"...maybe "bankrolled"? I've never edited a page before, but am sorely tempted to register and do so just to fix this abomination.
In the meantime, the best and simplest thing anyone could do is revert this article to its late-2007 state. 173.75.70.109 (talk) 04:21, 1 May 2009 (UTC)
I just had a look a the 2007 version, and it get's many things terribly wrong and furthermore, it is largely unsourced. It represents a POV view from a certain school of thought (which I need not name). Just like the page on the big bang should represent the mainstream view from cosmology, this page should represent the mainstream view from economics and banking. LK (talk) 16:28, 2 May 2009 (UTC)
Contradiction of History of Banking
The article on History of Banking seems to indicate that fractional-reserve banking has been going on since the third millenium BC, having traced its origins to temples and palaces. This article, on the other hand, seems to indicate that fractional-reserve banking is a new development circa 1800 AD. The first reference from antiquity that I immediately think of, comes from the Bible in Matthew 25:27 (NIV): "Well then, you should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest."
Either Jesus is saying that these first millenium bankers know something we don't, or they were making money by lending out their deposits. Jsharpminor (talk) 05:50, 17 March 2009 (UTC)
Just because deposits are being lent out for interest doesn’t mean that fractional-reserve banking is taking place. It is, for example, entirely possible for me to deposit money with a banker under a contract that I won’t be able to withdraw that money for one year. The banker then lends out my deposit to someone who wants to borrow for a year. Because there is no danger of me wanting me deposit back (because of the contract), the banker is not compelled to keep back a reserve to meet deposit demands and this is therefore not an example of fractional-reserve banking, but rather an example of a money-lending operation where I am supplying the capital. It’s a completely different beast. There is no contradiction between the two articles.

Fractional-reserve banking happens when the capital being lent out is a demand deposit. Rubisco (talk) 12:01, 17 March 2009 (UTC)
Since Rubisco gave such an excellent point, I am removing the contradiction warning in the history section. Hendrixjoseph (talk) 02:01, 18 March 2009 (UTC)
Okay. And thanks, you've educated me on something I don't know very much about. But shouldn't someone update some banking article somewhere to mention this possibility? All that is said is that "the practice is universal in modern banking," without explaining that a profitable alternative (non-demand accounts) may exist.

Forgive me, because I'm probably making a mockery of some of these terms, but again, I don't know very much about economics or banking. Jsharpminor (talk) 02:48, 31 March 2009 (UTC)
I'm not sure that Rubisco's statement about the relationship with demand deposits is completely correct. Doesn't it also depend on what happens to the money that is lent? That is to say, the original deposit is put into a 1 year fixed contract. The money lent by the banker against that fixed term deposit is then put into a demand deposit at some other bank. Here it can be lent out again, subject to reserve requirements, etc. where it does act to expand the money supply. Mischling (talk) 22:15, 16 April 2009 (UTC)
The example I gave with the demand deposit was just one example of how banking and lending can happen outside fractional-reserve banking. Ultimately, FRB happens because those that regulate the banking industry place restrictions on how much of a customer's deposit can be lent out by a bank. It is this regulatory requirement for holding some of the deposit in reserve that defines FRB. The reason that regulators insist on this reserve being held is so that banks are able to meet demands from customers holding demand deposits. They could, in theory, insist that banks hold some deposits in reserve for a whole host of reasons; it just so happens that the most common reason is to do with demand deposits. In summary: the link between demand deposits and FRB is incidental and the real defining feature of FRB is the regulatory stipulation that only a fraction of deposits may be lent out by a bank. This regulatory system has been in place only since the 1800s and therefore there is no contradiction between this article and the one on the History of banking.Rubisco (talk) 08:37, 17 April 2009 (UTC)
Could you provide a source for the statement that "the defining feature of FRB is the regulatory stipulation?". The current article does not read that way, nor do I see any support for it in the sources. I would say instead that the term fractional reserve banking arose from a regulatory framework, but that FRB was well known before - as simply banking.

I think the point raised above by JSharpMinor may be valid if the history of banking article contradicts it. (And the quote from the bible would at least seem to be prima facie support for the point that fractional reserve banking/banking existed before the 18th century. Unless of course one wishes to claim that the son of God doesn't know the difference between a term deposit and a deposit ;)--Gregalton (talk) 08:44, 18 April 2009 (UTC)
So not going there Greg - this topic is religious enough as it is :) But i agree with your point - i think if you go back through the precedents involving collectivised grain storage, it's very hard to see how you wouldn't end up with something like fractional reserve banking as people worked through the various issues. Incidentally, the restriction to demand deposits appears to be of recent origin. Feinman has quite a good overview at: A History of Reserve Requirements Mischling (talk) 12:10, 20 April 2009 (UTC)
I too agree that the history of fractional reserve banking probably stretches back further than currently implied by the article. I suggest 'borrowing' some of the relevant text from the History of banking and incorporating it into the history section of this article. Anyone want to be WP:BOLD and do it? LK (talk) 18:29, 23 April 2009 (UTC)
This source, while avoiding the terminology, is pretty strong evidence that 13th century already saw fractional reserve banking, as well as the negative parts of limited regulation, etc. I see no evidence here that this system is somehow new at this point in medieval history.--Gregalton (talk) 14:53, 14 May 2009 (UTC)
All banking, in the way we use the term, is FRB. Anything else is money-changing or gold storage. Banks in the fully modern sense only arose in C18, so FRB in the full sense also started then. But the precursors of banks generally operated some form of FRB.JQ (talk) 04:46, 20 May 2009 (UTC)
Could you clarify what you mean by "in the full(y modern) sense"? I agree that all banking is FRB, and if we say that, it would seem preferable to clarify what changed in the 18C (or remove this distinction).--Gregalton (talk) 18:24, 20 May 2009 (UTC)
I don't think it's correct to say that all modern banking is FRB banking. It's true that all banks (modern and historical) practice FRB, but some banking functions could still occur even without FRB. For instance, checking accounts, debit cards, travellers checks, letters of credit, telegraphic transfers, etc. Also, lending could still occur, as long as it's financed out of stock-holder capital.

As an aside, does it strike anyone else as strange that libertarians (who are against government regulations of any kind), are in favour of strict government restrictions against the historically prevalent practice of borrowing and lending? LK (talk) 03:37, 21 May 2009 (UTC)
On the aside, it is indeed amusing. On the main point, it's true that banks offer a range of services, but (i) checking accounts are used for FRB, (ii) an institution (say, Western Union) that offers travellers checks, telegraphic transfers and so on does not, thereby become a bank. Conversely, a bank can offer all these services in addition to the things that make it a bank
Coming back to Greg, the basic idea of a demand deposit account, with non-negative interest, requires FRB. Otherwise the bank is simply offering free storage and safekeeping facilities. I'd say the crucial thing that defines a bank is participation in a monetary system that consists of some kind of abstract claim such as a banknote or debit settlement system. To finance this, FRB is essential.JQ (talk) 10:03, 21 May 2009 (UTC)
This article doesn't get the basics of fractional reserve banking correct
The very first paragraph is downright false. Banks do not lend deposits. when you take out a loan from the bank you aren’t receiving other people’s money. your promise to pay (legally binding) becomes a form of money (a piece of paper with value). With this signed paper the bank is allowed to write the amount of the loan into your account. No money is subtracted from any other place. Of course your promise to pay X dollars by 2030 isn’t worth X dollars now, it’s worth X minus some amount based on the risk that you’ll default, the nominal interest rate, etc. This discount is determined by the market for loans. what does the bank do with your deposits? well your loan is worth X-some amount. The bank needs to cover the discount. It uses deposits to do this, despite the fact that demand deposits are liabilities and not assets.
in terms of the number of loan dollars you can see that the number of actual cash the bank has is quite low, probably only a few percent of the value of all the loans. 24.5.25.157 (talk) 20:23, 24 May 2009 (UTC)
This has been covered before and is simply false (see the discussion about Money as Debt for some related discussion below). 82.181.73.101 (talk) 11:23, 29 May 2009 (UTC)
It would be helpful if the people who come in with comments like this were to pick up any modern (within last 10 years) macroeconomics textbook first and at least find out what the mainstream thinks about modern banking. LK (talk) 04:42, 30 May 2009 (UTC)
High power money in the "Money as Debt" movie
Quite recently the author of the movie together with his team provided answers to the two of the questions that are discussed below. Yes they said, it is not all 100% according to official banking rules but these are also not 100% obeyed in various countries. In general, all this was done in the film to simplify some more complicated parts of fractional reserve banking, and certainly those too complicated for wider audience. The general picture of the banking system was not malformed - they say. These explanations can be found under the following address: http://paulgrignon.netfirms.com/MoneyasDebt/disputed_information.html —Preceding unsigned comment added by Maciekskje (talk • contribs) 20:24, 12 January 2009 (UTC)
At one moment the movie states that an initial deposit by THE FOUNDERS OF A BANK of their own capital in the central bank 1111,12$ of high power money enables them to give out their first loan of 10000$, but then the customers credit money who deposits in the bank enables them only to give a loan of 9000$ to the next customer and the ladder begins. Is this an accurate paraphrase? If so, is it true?Mik1984 (talk) 03:16, 25 July 2008 (UTC)
Not really. It would only work if everyone who borrowed money from the bank agreed to leave it in the bank as a deposit. Since deposits pay lower rates, they could do it, but it would cost them money. On a system basis (that is, across all banks) it can be represented as accurate, but only if you ignore the fact that there will be some friction in the system (such as cash withdrawals, delays of various sorts, desire of the bank to hold extra liquid assets, unwillingness of customers to take loans, payments of taxes, etc). As an illustration of theory, it makes a bit of sense, but it is only an illustration.--Gregalton (talk) 10:53, 25 July 2008 (UTC)
That's NOT what I was asking for. I'm really looking for the answer to the first part of the question.Mik1984 (talk) 11:36, 25 July 2008 (UTC)—Preceding unsigned comment added by Mik1984 (talk • contribs) 11:33, 25 July 2008 (UTC)
Then no, it is not an accurate paraphrase. Even with the capital deposit, the bank cannot lend the $10000 until it has it (i.e. from another deposit), UNLESS it can be certain the borrower will not withdraw it. Which it cannot be certain of, and hence cannot do. In short form, it's wrong.--Gregalton (talk) 13:16, 25 July 2008 (UTC)
No no, this 1111.12$ doesn't have a borrower. It's own capital of the bank deposited at the central bank. There will be nobody ever to come to withdraw it.Mik1984 (talk) 13:35, 25 July 2008 (UTC)

This is all about distinction between money deposited at the bank by a third party and money owned by the bank. The implication is that only 10% of the money deposited at the bank counts as a reserve, however 100% of banks personal capital(money that the bank owes to nobody)is reserve money. Thus the bank can de facto borrow more than 90% of what's deposited there and still meet the minimal reserve requirements. The movie implies also that the bank can borrow more that even 100% of money deposited and still keep up with the ratio if it only has enough personal capital.Mik1984 (talk) 13:56, 25 July 2008 (UTC)
A bank can not loan out more money than it has available, which includes loans from other banks, deposits, or owner's capital. The amount of money and the orientation of the money that the bank deposits at its reserve/central bank is irrelevant. In addition, the amount of reserves or orientation of those reserves does not effect the amount of money the bank can borrow. A bank must present some form of collateral (asset) greater or equal to the amount they wish to borrow. -- EGeek (talk) 17:50, 25 July 2008 (UTC)
There are ways to artificially inflate the balance of the accounts, so what I'm asking is weather a bank who is required to hold an amount equal to 10% of it's deposits can use its own capital at a 100% value to fulfill this requirement.Mik1984 (talk) 21:31, 25 July 2008 (UTC)
Logically speaking, the bank can use its own money (non-borrowed) for the reserves instead of the depositor's money, but that is dependent of the rules by the authorities that govern that bank. However, the amount of money available to loan would not change in this scenario no matter how much is reserved. I think the central banks of the G8 countries require reserves to be deposits on demand accounts. I'll look this up when I have time -- could be useful to the article. Accounting fraud is a completely different issue. --EGeek (talk) 21:59, 25 July 2008 (UTC)
Are you completely sure the banks in US cannot lend somebody a loan of i.e. 10000$ and by some accounting trick use the borrowers mortgage to cover the books for the resources lent out, while using only 1000$ of own capital to cover the ratio, while effectively borrowing 9000$ the bank never had?Mik1984 (talk) 12:34, 26 July 2008 (UTC) —Preceding unsigned comment added by Mik1984 (talk • contribs) 12:31, 26 July 2008 (UTC)
In accounting, with every debit there must be a credit. The scenario you suggest would only debit the bank's assets. The additional money would have to come from another source as a loan, or capital investment. If you have information that backs the scenario you propose, please provide this information as it may become useful to improve this and/or other articles.-- EGeek (talk) 22:59, 26 July 2008 (UTC)
I don't think about the debit/credit thing is the biggest obstacle here, because when a bank gives somebody a loan, both happen at the same moment. The bank pays out i.e. 10000$ and gains a financial credit of 10000$ at the same moment. The left side of the balance sheet, the Assets remains unchanged. Problems begin with a cash flow statement, that's why Enron never produced any. I have no specific information however how exactly they might be doing it, but I believe that this might be pinned down as the main point of the suspicions that banks "lend money they don't have".Mik1984 (talk) 17:35, 28 July 2008 (UTC)
First, if you use double-entry accounting as implied by your example, for assets to increase, liabilities, equity, or a combination of both must increase. For a bank to make a $10,000 loan from $1,111.12 per the movie you reference, the bank would have to increase its assets by $8888.88. Since assets must equal liabilities plus equity, the bank would require additional funds from investors or another bank. When a bank make a loan, the cash is credited and the loan is debited. This requires no change in assets, liabilities, or equity.
Second, I do agree that "banks borrow money they don't have" because that's the point of borrowing; however, I do not think this is what you meant since this is not seen as a problem even buy critics of fractional-reserve banking.
Third, accounting fraud is a completely different issue. Even if you found references to banks that have committed fraud, I don't see what relevance they would have in this article. Of course references to the contrary are welcomed.
Finally, while I enjoy these discussions, Wikipedia is not a forum. I continue these discussions because I thought something may come out of it to affect the article (e.g. new references, source of misunderstanding, section rewrites, etc.). Unfortunately, this discussion is now going in circles that will lead to no affect on the article. As far as "Money as Debt" is concerned, read this discussion on the Federal Reserve System talkpage. The discussion brings up a good point on the author's drive to make the film and his bias of the banking system.-- EGeek (talk) 19:36, 28 July 2008 (UTC)
I would note that it is obvious that the bank needs 10000$ to fulfill the transaction, but the quirk is that those 8888,88$ only end up being joggled through the transaction and remain to bank's disposition. I don't have any specific idea how this can affect the article.Mik1984 (talk) 00:26, 29 July 2008 (UTC)
PS: I still remain unsatisfied with the answers. Thought it might not directly serve to help the article I would be glad to hear more saturating info.Mik1984 (talk) 03:44, 1 August 2008 (UTC)
In order to pay out 1000$ and record a loan of 1000$, the bank must have the sum on the account initially. The claim would be fair if any commercial bank could deposit $100 in a central bank (Fed) and require the central bank to give it $900 extra - which is not (legally) working.Kura440 (talk) 12:23, 5 February 2009 (UTC)
I would suggest starting with a reliable source like a good macroeconomics or banking textbook, rather than a cartoon. You are looking for answers to questions that may not actually make sense.--Gregalton (talk) 10:13, 1 August 2008 (UTC)
If you can't attack the message attack the medium? The correct way to handle this is to evaluate the individual sources credibility substantively (ie/ expert analysis rather than biased opinion), rather than in a dismissive fashion as you have just done. --Xtraeme (talk) 20:24, 31 May 2009 (UTC)
The point of confusion
In the Money as Debt cartoon [about 13:00 to 15:00], a hypothetical new bank gives out a loan of nine times more than its assets.

Here's the relavent narration from the movie:
To illustrate this in a simple way, let's imagine that a new bank has just started up and has no depositors yet. However, the bank's investors have made a reserve deposit of $1111.12 of existing cash money at the central bank. The required reserve ratio is nine to one.

Step 1: The doors open and the new bank welcomes its first loan customer. He needs $10,000 to buy a car. At the 9:1 reserve ratio, the new bank's reserve at the central bank—also known as high-powered money—allows it to legally conjure into existence nine times that amount, or ten thousand dollars, on the basis of the borrower's pledge of debt. This ten thousand dollars is not taken from anywhere; it's brand new money, simply typed into the borrower's account as bank credit. The borrower then writes a check on that bank credit to buy a used car.

Step 2: The seller then deposits this newly-created ten thousand dollars at her bank. Unlike the high-powered government money deposited at the central bank, this newly-created money cannot be multiplied by the reserve ratio. Instead, it's divided by the reserve ratio. At a ratio of 9:1, a new loan of $9000 can now be created on the basis of the $10000 deposit.

So, is this accurate? Specifically the part where it says the bank can "legally conjure into existence" nine times more money than it has on deposit at the central bank. --loqi (talk) 15:22, 13 October 2008 (UTC)
I'm curious about this too. Step 2 is as described in this article - the banks lend out deposits, and keep only a fraction R in reserve. But Step 1 claims that with the bank's own money, it can lend out at several times that amount (1/(R-1), apparently). Is this mentioned in the article - or is it even true? To put it another way, he claims that ultimately, $100,000 can be created from the initial $1111.12 of central bank money, a ratio of 90 times. This article states that it's a ratio of 10 times, or 1/R - and that's how I've always understood it. Is this film wrong - or are both right, and I'm just not understanding the complexities of modern banking? Mdwh (talk) 01:40, 14 October 2008 (UTC)
add me to the "confused" list. I pulled information from the Federal Reserve that says banks borrow funds from depositors. Now, the statement from "money as debt" does agree with this, but it looks like the video is saying that "currency", or "central bank money", is "high-powered money". It looks like what the video is saying is that having actual cash gives a bank the power to make a loan many times the amount of cash, whereas with "commercial bank money", or "loan money", the process as described by the Fed is what takes place. See my statement below in the "money creation table is misleading" section. Analoguni (talk) 03:12, 17 October 2008 (UTC)
A customer walks into a national bank and deposits $100,000 cash. The impact on the bank’s books is an increase in the cash assets account of $100,000 and a corresponding $100,000 liability of the bank (additional checking account balance) in favor of the depositor. Also, the $100,000 cash increases the bank’s total reserves, and if the reserve requirement is 10%, then the bank’s excess reserves have increased by $90,000.
The bank is now authorized, to create a new loan of $90,000. Assuming the bank feels it has a credit-worthy customer wanting to borrow that amount, the bank simply creates a loan asset for itself of $90,000 and a corresponding $90,000 liability in favor of the borrower. That’s new, real electronic money in the borrower’s checking account, and the original $100,000 cash asset is not touched. It is still there, and none of its value was transferred to the borrower. The original cash deposit merely allows the new loan, and the bank has created $90,000 out of thin air.
After the loan, the bank’s new assets are $190,000 ($100,000 cash + $90,000 loan) and its new liabilities are $190,000 ($100,000 depositor checking + $90,000 borrower checking). Required reserves are $19,000, total reserves are still $100,000 cash, excess reserves are $81,000, so the bank is now authorized to create another new loan of $81,000. The process could repeat until the original $100,000 cash deposit resulted in a $900,000 increase in the nation’s money supply.
It should be noted that when borrowers pay down their debt, money is destroyed, but in aggregate, new loans are created faster than they are paid off, and the money supply naturally increases. So, banks DO create money out of thin air, and their ability to do so is regulated by the reserve requirement set by the Federal Reserve. Macroeconomics-101 (talk) 03:39, 30 April 2009 (UTC)
There's a problem with your analysis above. As anyone who's worked in a bank will tell you (I have), as soon as a loan is made, the money is withdrawn. After all, why would a person take a loan unless they needed the money to pay someone else. So, you cannot depend on the money being on deposit to make another loan. Therefore, after the initial loan has been made, no more loans will be made until new deposits are received. LK (talk) 03:43, 1 May 2009 (UTC)
The $90,000 going immediately to another bank (let’s say Bank B) doesn’t change anything in the big picture. Remember the reserve requirement is a mathematical relationship between a bank’s RESERVES and its deposit liabilities. Look carefully at the definition of bank reserves. Reserves are the bank’s capital on deposit with the Federal Reserve and vault CASH.
Bank B getting a deposit of $90,000 increases its assets and liabilities but does NOT affect its reserves. So the $90,000 moving to Bank B slightly REDUCES the amount of money Bank B can loan because its liabilities have increased while its reserves are unchanged. This reduction offsets what will now happen back at Bank A.
Bank A is back to where it was after the cash deposit. The CASH (ie reserves) never moves in either example. So Bank A’s reserves are still $100,000, liabilities (the original cash depositor’s checking) are $100,000, so 10% of deposit liabilities is $10,000, so the bank’s excess reserves are $100,000-$10,000=$90,000. Bank A is now allowed to create a 2nd loan of $90,000, instead of only $81,000 in the single-bank example.
Banks do not DRAW on reserves (or deposits) to “make” loans. (Why do you think we use the term “make a loan”?) Rather, the reserve requirement establishes a MATHEMATICAL LIMIT on the amount of loans they can create. And creating a loan is creating money out of thin air. No wonder there’s a limit on it. Macroeconomics-101 (talk) 18:46, 1 May 2009 (UTC)
You're getting something very fundamental very wrong. Reserves are either cash held in a vault at the bank, or are deposits of the bank at the central bank. When a person gets a loan, he quickly writes a check for that amount which is deposited into another bank (Bank B in your example). Once this is done, Bank B will either ask for the amount in cash from bank A, or have the amount transferred from bank A's account to Bank B's account at the central bank. Either way, Bank A's reserves fall by the full amount of the loan.

Anyway, this discussion is not helpful to improving this page, so bring it around to how to improve this page, or lets not continue this discussion. LK (talk) 16:19, 2 May 2009 (UTC)
The purpose of my input was: 1) to defend the current wiki article as a correct explanation of fractional reserve banking as a system whereby member banks participate in the inflation of the money supply as regulated by the central bank (which has its own means of creating money out of thin air as well), and 2) to use an example you can find in any macroeconomics textbook that illustrates how initial infusions of reserves results in an inflation of the money supply, controlled by the reserve requirement.
I don’t think the article needs to be improved. It needs to be defended against (admittedly the vast majority) of the public who have cherished but tragically wrong beliefs that banks need X dollars on deposit before they can loan the same X dollars to someone else. Macroeconomics-101 (talk) 19:15, 3 May 2009 (UTC)
That 'banks need X dollars on deposit before they can loan the same X dollars to someone else' is a correct belief, and is what is currently stated in the article. LK (talk) 11:15, 20 May 2009 (UTC)
possible source of confusion between the two different ways of doing it
I have looked up more information on fractional-reserve banking and I think I found a source for the 2 different ways of doing it. Here is an analysis by the austrian economist Murray Rothbard, which I think gives a good description of what is going on (with the exception of him referring to the process as "counterfeit"):
(source: http://mises.org/story/2882) Let's see how the fractional-reserve process works, in the absence of a central bank. I set up a Rothbard Bank, and invest $1,000 of cash (whether gold or government paper does not matter here). Then I "lend out" $10,000 to someone, either for consumer spending or to invest in his business. How can I "lend out" far more than I have? Ahh, that's the magic of the "fraction" in the fractional reserve. I simply open up a checking account of $10,000 which I am happy to lend to Mr. Jones. Why does Jones borrow from me? Well, for one thing, I can charge a lower rate of interest than savers would. I don't have to save up the money myself, but can simply counterfeit it out of thin air. (In the 19th century, I would have been able to issue bank notes, but the Federal Reserve now monopolizes note issues.) Since demand deposits at the Rothbard Bank function as equivalent to cash, the nation's money supply has just, by magic, increased by $10,000. The inflationary, counterfeiting process is under way.

Hence the drive by the bankers themselves to get the government to cartelize their industry by means of a central bank. Central banking began with the Bank of England in the 1690s, spread to the rest of the Western world in the 18th and 19th centuries, and finally was imposed upon the United States by banking cartelists via the Federal Reserve System of 1913.
Here's how the counterfeiting process works in today's world. Let's say that the Federal Reserve, as usual, decides that it wants to expand (i.e., inflate) the money supply. The Federal Reserve decides to go into the market (called the "open market") and purchase an asset. It doesn't really matter what asset it buys; the important point is that it writes out a check. The Fed could, if it wanted to, buy any asset it wished, including corporate stocks, buildings, or foreign currency. In practice, it almost always buys US government securities.
But this is only the beginning of the inflationary counterfeiting process. For Chase Manhattan is delighted to get a check on the Fed, and rushes down to deposit it in its own checking account at the Fed, which now increases by $10,000,000. But this checking account constitutes the "reserves" of the banks, which have now increased across the nation by $10,000,000. But this means that Chase Manhattan can create deposits based on these reserves, and that, as checks and reserves seep out to other banks (much as the Rothbard Bank deposits did), each one can add its inflationary mite, until the banking system as a whole has increased its demand deposits by $100,000,000, ten times the original purchase of assets by the Fed.
Let's assume that the Fed buys $10,000,000 of US Treasury bills from some "approved" government bond dealer (a small group), say Shearson Lehman on Wall Street. The Fed writes out a check for $10,000,000, which it gives to Shearson Lehman in exchange for $10,000,000 in US securities. Where does the Fed get the $10,000,000 to pay Shearson Lehman? It creates the money out of thin air. Shearson Lehman can do only one thing with the check: deposit it in its checking account at a commercial bank, say Chase Manhattan. The "money supply" of the country has already increased by $10,000,000; no one else's checking account has decreased at all. There has been a net increase of $10,000,000.
In conclusion, the U.S. system must be different. One way of looking at it is to try to understand how things worked under a gold standard. For example, a bank could start off with 100 ounces of gold and no paper money. Since only 10% of the paper representing gold is redeemed at any given time, the bank could just write up paper claims for 1,000 ounces of gold immediately. This is where I think this idea of lending out more than there is available comes from. However, when the Federal Reserve System was set up in the United States in 1913, the rules were changed a little bit so that banks in the United States must have funds available to lend out. Analoguni (talk) 16:08, 25 October 2008 (UTC)
Leveraging.
I understand that there is a lot of controversy on Fractional banking, and so in order to clarify what to me is one of the most contentious points I am asking this question: Is it legal to take a depositor's money (say $1000) and then loan out $9000 with the $1000 in reserve instead of lending out $900, and having $100 in reserve? This seems to me to be where most of the inflation attributed to banks is supposed to come from. Wikiiscool123 (talk) 05:31, 3 March 2009 (UTC)
You can't lend out money you don't have. So, what happens is, a bank receives a deposit of $1000, it lends out $900, and has $100 in reserve. However, over time (about a year or so), the $900 gets redeposited and lent out again and redeposited and so on till in theory, all the $1000 can be reserves backing $10,000 in deposits. Fractional reserve banking makes prices higher than they otherwise would be (causing inflation when the system was implemented), but does not cause on-going inflation today. LK (talk) 10:13, 3 March 2009 (UTC)
Just to clarify your final sentence, this is what would happen in the event of a hypothetical once-off shift from full-reserve to fractional-reserve banking. Actually, banking emerged gradually from the safe-keeping activities of goldsmiths and others. This corresponded to a gradual increase in the velocity of money and allowed for an increase in the nominal value of output for a given supply of base money (gold in the period when FRB emerged). Further innovations have generally tended to create more near-money with the same effect.JQ (talk) 21:54, 3 March 2009 (UTC)
The portion of the article starting with "A Simple Example – A Single Bank" is simply incorrect. It states:
"For example, a bank may be fractionally reserved at a 1:5 ratio (or 20%), which means it has $1 in reserve for every $4 it has loaned out."
No, no, no! The "fractional" of fractional reserve banking refers to the fraction of deposits that a bank may lend out and not, as the article states, a fraction of the amount being lent out. Further errors are made lower down in this section:
"loaning $80 of the original $100 without creating any more money, or 2) creating an additional $400 out of thin air and loaning out that newly created $400. In the first case there would be a total of $100 (the original deposit), whereas in the second case the money supply would be inflated to a total of $500."
Again, this is hogwash. Banks cannot create money out of “thin air”. Every penny of the money lent out by banks has to be funded from somewhere on a 1:1 basis. If banks really could lend $400 based on holding $100 in reserve, their balance sheets wouldn’t balance: they would have assets worth $400 and liabilities worth $100. I am removing this section as it is at best misleading and at worst a fabrication.Rubisco (talk) 15:33, 3 March 2009 (UTC)
No! Private Banks do create money out of 'thin air'. They do it by deposit multiplication. And the balance sheets are kept 'balanced' Please read the Federal reserve document wikisource:Modern Money Mechanics which explains how they do it. Vexorg (talk) 07:46, 12 March 2009 (UTC)
This is nonsense. Let's say I could immediately loan out $1000 on a $100 deposit. Let's say my borrower took this money and deposited it in bank B. Then bank B could lend out $10,000 on that $1000. This borrower took this money and deposited it into bank C. Bank C could lend out $100,000 on that $10,000. The money supply would grow exponentially to no end - and nobody's balance sheets would be balanced...
It is true that federal reserve can create money out of thin air but they a a mechanism within the government and it should not be surprising that they can do so any more than it is surprising that the govt can print paper money. The FED controls how much they can create to help stabilize the economy and inflation so they don't just do it willy nilly. Nevertheless, banks absolutely can't create money out of thin air. Saying so confuses the two topics. (167.1.150.209 (talk) 14:43, 23 April 2009 (UTC))

Wow Rubisco, I'm surprised I didn't catch that. I really must go through this article with a fine tooth comb someday. I get the impression that large parts of this article were written by people who dislike, but don't really understand banking. LK (talk) 06:49, 4 March 2009 (UTC)
Thank you Lawrencekhoo for the prompt response. Rubisco, would you please clarify? You say that you are removing the section but it seems as if you are referring to the actual article than to this talk section. I would appreciate if you did not delete this talk section and maybe made your own so that you can elaborate on "A Simple Example - A Single Bank". Or at least it would be nice to know that the aforementioned article is what you are talking about. LK, how is it that people get the idea that you can inflate via bank's fractional banking capabilities? Does this have to do with special rules for the base supply of money?
Thx so much both of you, Wikiiscool123 (talk) 16:05, 3 March 2009 (UTC)
The fractional reserve system does allow the banking system as a whole to expand the supply of money. So take the hypothetical $1000 example you started with. Without commercial banking, $1000 printed by the central bank would lead to a $1000 increase in money supply – end of story. However, the lending, redepositing and relending of money by commercial banks would mean that eventually, money supply would expand closer to something like $5000. This is called the money multiplier. In my example, the multiplier is 5, but in real life, it's something between 2 to 20, depending on the country, and on the measure of money you use. This money multiplier ratio is relatively constant.

How it affects inflation is complicated. Since there is a money multiplier, the amount of money in the economy (M2) is much larger than the amount of money printed by the central bank (often called M0). What this means in practice is that for any $1 increase in money created by the central bank, there is a higher percentage increase in prices (than there otherwise would be without a commercial banking system), since the $1 goes through the money multiplier creating maybe $5. However, for any percentage increase in money created by the central bank (M0), there is an equal percentage increase in money suplly (M2) and an equal percentage increase in prices (inflation). This is because the ratio between M0, M2, and inflation, remain relatively constant. LK (talk) 07:05, 4 March 2009 (UTC)
Hi Wikiiscool! The section I was referring to was the one in the article entitled “A Simple Example - A Single Bank”. This is the section I have removed. The rest of the article does a pretty good job of explaining the topic. Rubisco (talk) 09:18, 4 March 2009 (UTC)
Thank you very much everyone, I'm beginning to understand more of the principles behind fractional reserve banking. Is there a forum where we can discuss fractional reserve banking because I am interested in learning more but I don't think it has anything to do with the article (at least directly). It also seems that John is saying that fractional reserve banking doesn't cause inflation because we are on the fractional reserve banking standard. I understand that you are saying the Federal Reserve (or other central bank) has to just incorporate how much the banks will "print" (over the lifetime of the loan) in order to keep inflation under control.
So the inflation that many people seem to be talking about is not a figment of imagination so much as just something that is regulated by the Federal Reserve correct? One more question, Rubisco especially would you be able to explain a little more on the balance sheet of banks? If this is inappropriate and should be moved to a forum please tell me.
Wikiiscool123 (talk) 19:25, 6 March 2009 (UTC)
Rubisco said above: "Banks cannot create money out of “thin air”. Every penny of the money lent out by banks has to be funded from somewhere on a 1:1 basis. If banks really could lend $400 based on holding $100 in reserve, their balance sheets wouldn’t balance: they would have assets worth $400 and liabilities worth $100."
Erm, not quite. Let us suppose that I deposit $100 in cash into the bank and Rubisco borrows $50, and that the $50 is put into Rubisco's checking account. So now the bank's balance sheet is: Assets = $150 ($100 cash + $50 loan Rubisco); Liabilities = $150 ($100 demand deposit Bshow, $50 demand deposit Rubisco). Where did the $50 come from? What is "backing" it? Nothing; the bank has created $50 out of thin air and then loaned it to Rubisco, while still pretending to be safekeeping my $100. If Rubisco withdraws his loan proceeds of $50 in cash, they will just give him $50 of my cash, and the balance sheet will show: Assets = $100 ($50 cash + $50 loan Rubisco); Liabilities = $100 ($100 demand deposit Bshow). Now I go down to withdraw my demand deposit... Oops!
Bshow (talk) 05:32, 7 March 2009 (UTC)
Close, but not quite right. The flaw is that that Assets = Liabilities + Equity. So, if banks were not required to have any equity, then indeed they could in some sense create infinite amounts of money out of thin air. However, banks must have equity. This means that they must have a certain amount of assets above and beyond any loan assets created. To re-frame your example, lets assume the bank starts out with $100 liabilities (deposit Bshow). The bank must have the $100 from Bshow plus $5 from the banks owners. Assets = $105, Liabilites= $100 Equity = $5, a 5% equity ratio. Now, if the transaction proposed occured, the bank would now have Assets = $155 (cash plus the loan), Liabilities = $150, Equity = $5.... an equity ratio of 3.3%. Ooops! The bank is seized by regulators. (In the U.S., multiple specific ratios are used, but typically banks must have 5% equity to be considered "well capitalized" ... e.g. not subject to government seizure)
I think confusion arises because while it is true that the Federal Reserve can quite literally print money (in digits really, but its not really any different than printing currency), and it is also true that banks are part of the mecahism by with this is done. However, the conclusion that banks themselves are able to create money out of thin air is false; they cannot.
Interesting discussion on capital requirements, but irrelevant to my initial point. The bank has absolutely created money from "thin air", capital requirement or no. Bshow (talk) 23:03, 19 May 2009 (UTC)
As a side note, given the "Money as Debt" meme going around, I think its important to point out that the assets could be anything. Yes, it is true that it is most often the case that banks will use deposits to make loans... but they don't HAVE to make loans. They could buy gold bars. Or stuff currency in a mattress. Or buy a factory. Banks choose to deploy deposits into loans because they expect the best risk adjusted returns from doing so. (there is also admitedly certain regulatory pressures to do so) The key point is that there is no necessary relationship. Whether a bank will make loans is related to the price they can get, which is determined by supply and demand, vs. various alternative investments as well as perceptions of risk. In other words, there is a market for debt, and the quantity of debt is related to supply and demand. There is an indirect relationship between the amount of debt and the money supply, through the mechanisms of the market prices for savings and investment, but there is no absolute necessary link, as the "Money as Debt" video states. —Preceding unsigned comment added by Mathgeek321 (talk • contribs) 03:01, 3 April 2009 (UTC)
Bshow said: "If Rubisco withdraws his loan proceeds of $50 in cash, they will just give him $50 of my cash, and the balance sheet will show: Assets = $100 ($50 cash + $50 loan Rubisco); Liabilities = $100 ($100 demand deposit Bshow). Now I go down to withdraw my demand deposit... Oops" That is not creating money, that is how banks work. Banks have to have reserve to be able to fulfil short term liabilities and banks need to plan their cashflow so that short term liablilities (f.ex. deposits) can be mached with long term assets (f.ex mortgage). If you call your example creating money then I can create money out of thin air with my friends. Example: I have 100 pounds, Peter borrows 100 pounds from me, John borrows 100 pounds from Peter and I borrow 100 pounds from John. So I still have my 100 pounds but we also created 300 pounds of assets/liabilities for each other. If we repay our loans, 300 pounds of new money would be destroyed.
Another nice try, but your example doesn't parallel my bank example. If you loan 100 pounds to Peter, you can't spend that 100 pounds. But in my example, I deposit 100 dollars in the bank, and gives me a checking account with a 100 dollar balance. It then uses FRB to create (via a loan) a checking account for Rubisco with a 50 dollar balance. Together, we can go out and write checks for a total of 150 dollars against our accounts. So the total money supply has expanded by 50 dollars, and the 50 dollars was created out of "thin air" (i.e. it is not "backed" by anything in the vaults of the bank). In your example, the total money supply remains 100 pounds; you and your friends only have 100 pounds to spend between you. The bank with its fancy offices, impressive vaults, etc. can get away with this trickery, but poor Peter cannot. Once the money is loaned to John, he can't pretend that he's still holding it for you. Bshow (talk) 18:15, 25 June 2009 (UTC)
Banks as financial intermediaries
A financial intermediary accepts funds from depositors, and lends those funds to borrowers. To do so, an institution (usually called a bank) must lend out money than it receives from depositors. When it does so, it necessarily no longer has enough cash-on-hand to pay back the full amount owed to depositors. That is, its reserves only equal a fraction of its deposits; hence it is practicing fractional reserve banking. Full reserve banking requires that a bank always has the full amount of deposits as cash-on-hand, so it cannot lend any funds deposited out, therefore, it cannot act as a financial intermediary.
I believe this point is adequately explained in the article, but please feel free to explain more clearly if you feel that is necessary. LK (talk) 02:41, 28 June 2009 (UTC)
Videos-Documentries
I came across these two videos tonight. Very detailed history of the US Federal Reserve up to its current monetary system. (my own opinion: Slightly conspiracist. States in plain terms the threat of the potentially nefarious power to print money in private hands; private bodies other than the citizenry. However, very informative.)
Links not working... http://video.google.com/videoplay?docid=-2665915773877500927 http://video.google.com/videoplay?docid=-8753934454816686947
The creator, Paul Grignon has acknowledged that there were important errors in the original version of the movie (see http://www.moneyasdebt.net/) and has made a new version "Money as Debt II" with the errors corrected. Unfortunately the new version is not available online and is only available for purchase on DVD (via http://www.moneyasdebt.net/). Should Wikipedia still link to the original flawed movie?
Reissgo (talk) 16:23, 1 August 2009 (UTC)
There are no stages in money multiplication
For all practical purposes, the banking system does not "lend out" money. Loans are "promissory notes" that are deposited into accounts, not counted out as cash at the bank counter. The money that is lent sits in deposit accounts just as any other money that is deposited in bank accounts. By definition, the reserve requirements are supposed to be high enough to withstand the usual needs of withdrawal.
Imagine a banking system with just a single bank, where everybody keeps their deposits, excluding an insignificant fraction that they keep in cash. Assume that the bank has exhausted its reserve requirements and has no excess reserves. Now somebody deposits $100 (say in newly printed cash from the Federal Reserve). The deposit liabilities increase by $100 and the reserves increase by $100 as well.
As only (say) 10% of deposits need to be kept in reserve as cash (or equivalent central bank deposits) the bank now has excess cash reserves of $90. Thus, the bank can now lend another $900 to somebody, bringing its excess reserves to zero.
We have to remember that even that $900 (or even $9000000) loan is just a drop in the bucket of the whole deposit base of the bank. If the money is transferred to some other bank, there is no problem. The reserves can (by definition) withstand these transfers, and transfers between banks cancel each other out during the reserve maintenance period. If the bank is lacking reserves in the end of the reserve maintenance period (about a month or so), it can get an inter-bank loan or sell assets to another bank, but for the whole banking system the reserves and deposits are in balance.
The fact is that banks do create money by accepting promissory notes. There could be no bank lending otherwise, unless the loans and deposits were perfectly matched by term. The significant issue is the level of reserve requirements, which I personally think have been taken outrageously low, in addition to the fact that no reserves whatsoever are required for savings accounts, which is a problem when a lot of money is suddenly transferred from savings accounts to checking accounts.
Reiska (talk) 08:39, 3 July 2009 (UTC)
All cited reliable sources back the current exposition of monetary expansion. Kindly cite a reliable source that backs your version of events. Otherwise it's just a rant, and should be deleted per WP:SOAPBOX. LK (talk) 15:31, 3 July 2009 (UTC)
One definitive guide to the calculation of required reserves in the US monetary system is the Reserve Maintenance Manual of the Federal Reserve. A most authoritative source for ECB reserve maintenance are the actual regulations (more here).
Can you please point out where lending is somehow directly coupled to deposit transactions? Is there a definitive source that has a good explanations of the actual mechanism that prevents the bank from accepting the $900 promissory note in the simplistic example above?
The amount of lending is limited by the amount of excess reserves and regulations on minimum bank capital, as well as a multitude of other considerations. While limiting the amount of credit transactions, capital constraints do not directly limit the money multiplier, as the promissory notes are assets just like any other assets. A new bank with a enough starting capital can immediately start to utilize the full money multiplier.
There is one mistake in my previous comment above. The minimum reserves as applied by both the Fed and the ECB are not evaluated periodically at the end of the reserve maintenance period, but as an average of daily balances over the maintenance period. The ECB regulation states:
An institution shall have complied with its reserve requirement if the average end-of-day balance on its reserve accounts over the maintenance period is not less than the amount defined for that period in accordance with the procedures set out in Article 5. ([2], Article 6)
The Fed manual states:
By the end of each maintenance period, an institution must ensure that its average daily balance requirementis satisfied. An institution’s end-of-day account balance may exceed or fall short of the total balance requirement on any given day of the maintenance period. An institution can offset a daily surplus or shortfall by maintaining lower or higher balances on subsequent days in the maintenance period because the balance requirement need only be met on average over the maintenance period. ([3], page III-5)
This doesn't have much effect on the point that I was trying to make. Banks can take care of reserve maintenance over a period that covers possibly millions of transactions, and the impact of individual money withdrawals or transfers are quite insignificant. Both the accounts and the reserves are huge lumps of money. It doesn't make any sense to even mention a single loan being "lent out" of the bank, even less of the whole banking system, which is the level at which the money multiplier is actually having its effect.
The last sentence in my previous comment was a rant, that much I concede, and I am hereby withdrawing it from this discussion page. Anyone who wants to get the facts on the reserve ratios used by the ECB should take a look at article 4 in the regulation linked above. Maybe a zero should be taken off from the 20% example reserve ration that is used in the article.

Reiska (talk) 22:09, 3 July 2009 (UTC)
Here is a quite understandable explanation of how banks can actually commit to lending even in the absence of any free reserves at all by borrowing reserves at inter-bank money markets during the reserve maintenance period and by depending on the central bank to provide the additional reserves. If banks can indeed be even short of reserves on any single day, how can there be anything to prevent them from fully exhausting their excess reserves in a single transaction.
To produce the stages described in the article, there would have to be a rule that basically states: "No single loan shall ever be larger than the current amount of excess reserves." Where is this rule stated and how is it enforced? If I may be so bold as to state that such a rule would actually be impossible to enforce, as nobody can have any firm knowledge of the actual amount of excess reserves at the closing of the loan while the loan is being negotiated.
Reference 14 in the article simply states that "B1 loans excess reserves to N2". It does not tell us what exactly constrains the bank to not lend a bigger amount. For some reason reference 15 doesn't exist anymore on the New York Fed server. Again the reference quote ("a bank that receives a $100 deposit may lend out $90 of that deposit") is equally non-specific. Clearly such a limit is not imposed by the reserve requirements, which by definition allow the bank to expand deposits to a multiple of excess reserves.

Reiska (talk) 23:49, 3 July 2009 (UTC)
This article is wrong
The concept of fractional reserve banking is completely wrong, and this article is way too influenced by conspiracy theorists.
Let's say I'm a stock investor. Together with some others I'm putting 1.000.000 dollars as equity in New Bank Inc.
New Bank opens and needs money to lend out. It prints 5.000.000 worth of debt in the form of tradeable bonds. The bonds yields 5 pct and martures in ten years. The money is transferred from the bond owners to the bank.
Then New Bank accepts 5.000.000 worth of deposits.
Now the bank has 11.000.000 dollars, but the bank doesnt actually own any money. It owes 1.000.000 to the shareholders, 5.000.000 to the bond owners and 5.000.000 to the depositors.
Now the bank can lend out 10.000.000 dollars. It has 1.000.000 dollars (equity) which serves as a margin capital if the bank has to write down some of it's assets (i.e. what the bank has lended).
Now tell me where new money was created. (--guest) —Preceding unsigned comment added by 80.202.109.224 (talk) 01:21, 14 July 2009 (UTC)
In your example, new money hasn't been created yet. New money is created when the bank lends in excess of 6.000.000 and begins to loan out funds backed by demand deposits. When a bank loans out demand deposits, new money is created. There are several simple examples of this process above. (Why is this so hard for folks to grasp?) --Bshow (talk) 17:45, 14 July 2009 (UTC)
Actually, BShow, you're wrong there. New money is created as soon as any money is lent out, as both the deposits in the bank and what is lent out are counted as money. So the total amount of money in the example above is $5,000,000 deposit money plus $10,000,000 currency that has been lent out and is in the hands of the public. LK (talk) 02:38, 15 July 2009 (UTC)
Acutally, LK, you're wrong. Loaning the proceeds from investor capital or bond issue does not increase the total money supply. The capital and debt liabilities of the bank are not part of the money supply, while demand deposits are. Only lending the proceeds from demand deposits does, because only cash and demand deposits are included in the (narrow) money supply. The bank creates money when it increases demand deposits (or issues cash) without an offsetting reduction in other demand deposits (or receipt of cash). --Bshow (talk) 14:31, 16 July 2009 (UTC)
Suggest reading an economics text book before editing economics articles. Money supply = Deposits + Cash. How exactly can you refute my simple observation that there now exists $5 million in deposits and $10 million in cash? LK (talk) 15:40, 16 July 2009 (UTC)
You're right; there now exists $5M in deposits and $10M in cash. My point was that not all of the $10M is new money; only $4M is. The original money supply was $11M; the new money supply is $15M. Your claim that "New money is created as soon as any money is lent out" is false, as I illustrated above. As long as the bank lends less than $6M, no new money is created. ~~But you're right, my first statement to the OP was wrong; money has been created ($4M) when $10M has been lent.~~ My first statement to the OP was correct, since he had not posited any actual lending. (BTW, I've not edited any economics articles; only trying to respond to the persistent claims of those who deny that banks create money.) --Bshow (talk) 17:39, 16 July 2009 (UTC)
The OPs fallacy is where deposits are equated with purchases of debt and stock. The holders of the bonds and stock have a claim on the company, not the money they used to acquire their holdings. The depositors on the other hand did not make a purchase or receive a transfer of equal value for their deposits; therefore, they do have a claim on the money they gave to the bank. In the example presented, the first 6.000.000 dollars can not be claimed by any other party; therefore, no additional money will be created because only the bank can make a claim on this money. The next 5.000.000 dollars are claimed by the depositors; therefore, if this portion of the money the bank holds is lent out, then there will be an additional claim on this money by the depositors and the person or entity to which the bank lent. -- EGeek (talk) 22:36, 16 July 2009 (UTC)
You are all wrong here. After the equity, bonds and deposits, the bank has $11,000,000 dollars in cash. This stash of cash makes up the bank's assets. The assets are perfectly matched with the liabilities of equity, bonds and deposits. This cash also makes up the bank's current reserves. Under 10% reserve requirements, the bank is now allowed to have reservable liabilities up to $110,000,000. As the bank currently has at most $10,000,000 of these liabilities, it may proceed to create new loans of at least $100,000,000. These loans are provided to the customers as checkable deposits.
As these loans are both assets and liabilities to the bank, the absolute amount of equity is not changed (until the borrowers start to pay interest). Naturally this would take the bank's leverage ratio to 100, which is (hopefully) not allowed, but limits on leverage are a different issue from fractional reserves. The actual amount of reservable assets depends on the types of bonds and deposits that are issued.
There have been some signs that the reserve requirements are practically not even binding anymore. US banks need to hold more cash than is required just to handle everyday transaction purposes. Reiska (talk) 21:35, 24 July 2009 (UTC)
Well that clears things up....NOT. C'mon folks, Fractional reserve banking is quite simple. At its most basic, it has nothing to do with equity, reserve requirements, central banking, government regulations, etc. It simply means that banks create more demand deposits (immediate claims to cash) than they have cash (or cash equivalents) available to pay those claims. When banks do this (practice FRB), they create money, because demand deposits are counted as money. The OP said: "The concept of fractional banking is completely wrong". I assume he means factually wrong, not morally wrong (if he meant the latter, I agree with him). But factually, it's not wrong. This is how it works and this is how banks create money. Bshow (talk) 19:08, 28 July 2009 (UTC)
Fractional-reserve banking is about reserves, and reserves are about deposits. In a free banking system for instance, depositors would have to weigh the incentive of getting better returns on their deposits from banks that keep lower reserves against the risk of said bank going insolvent. So FRB has much to do with reserve requirements, central banking and governement regulations (especially deposit insurance), to the extent that this is what creates the system where all banks operate with fractional reserves instead of some, or all, operating with 100% reserves. You need to keep in mind that the fundamental purpose of a deposit is its safekeeping and availability on demand. This would technically suggest that banks charge depositors for their services. FRB reverses this. From the moment that a bank is allowed to make double-entry bookkeeping, to claim property of the funds that it accepts as deposits, and to keep reserves that do not cover to the full extent the deposits it accepted, it can generate returns on these assets/liabilities and pay out interests on deposits. On the other hand, the deposit is no longer "safely kept" unless the bank is forced to follow a set of risk management rules and is covered by a deposit insurance scheme.

I agree with you about the morality of it. As the always insightful Jesus Huerta de Soto says, " (...) private bankers soon realized they needed to turn to the government for an institution to act on their behalf as lender of last resort and provide support during stages of crisis (...)" [4] Those interested can figure out from there the implications this has on the money supply (and therefore on inflation). --Childhood's End (talk) 20:43, 28 July 2009 (UTC)
Reiska, can I ask why you think the way you do? Having worked in a bank, it's been my personal experience that a bank (at least the one I worked in) does not lend out money more than the excess cash on hand that it currently holds. In the example above, that would be about $9million. LK (talk) 06:03, 28 July 2009 (UTC)
Can you elaborate more on how the excess cash is evaluated? Is some "excess cash" earmarked for each loan? There probably are some internal rules for managing the maximum sizes of individual loans, but do you have any references to binding legal requirements for such limits? Reiska (talk) 23:46, 31 July 2009 (UTC)
Just had a look at Reiska's ref, in which I did not see any reference to the Basel Accords, something that I cannot understand for such a topic. In most countries, banks are forced through regulation to comply with the Basel Accords, and it is under its approach to the Basel Accords that a bank manages its capital structure and therefore its balance between cash on hand and risky assets. --Childhood's End (talk) 13:11, 29 July 2009 (UTC)
The Basel accords are not directly related to fractional reserve banking. The Basel accords concern the management of bank capital levels. Capital is made of assets in excess of liabilities. The Basel accords set limits on the amount of capital a bank must have as a buffer against losses in the value of its assets.
Fractional reserve banking involves using checkable deposits as money beyond the base money supply. A bank could quite possibly be considered adequately capitalized with zero cash reserves, if there is enough equity. The Basel accords would be equally relevant to a system that doesn't involve fractional reserve banking. There are multiple kinds of reserves in banking: capital reserves (Basel), which regulate bank solvency, and cash reserves (FRB), which regulate the amount of checkable deposits, are two of these. There are additional liquidity requirements. These should not be mixed up.
Cash reserve requirements are crucial in limiting the amount of money that can be "created" by commercial banks. Banks create money by accepting promissory notes on deposit. This is how normal bank lending happens in fractional reserve banking and the article has this correct.
Fluctuations in the amount of money created by commercial banks has been found to be highly procyclical. (Michael Bordo and Anna Schwartz, A Retrospective on the classical gold standard, 1821-1931, National Bureau of Economic Research 1984, p. 564)

Reiska (talk) 23:46, 31 July 2009 (UTC)
Reiska, am I correct in surmising that you do not believe in the staged monetary expansion laid out in the article? That you beleive that a bank with $1million in cash reserves will immediatedly lend out $10million? If so, I'ld like to invite you to consider why, you hold a position contrary to the accepted mainstream viewpoint. Why exactly did you come to believe in this? What has been your experience, training, education, reading, etc, that makes you believe so? Please don't quote me bank regulations, instead, what is the process by which you came to believe what is contary to the views held by experienced bankers and economists? I really do want to know.

In answer to your question about ready cash available for loans. It is cash on hand (including deposits at the central bank or other appropriate clearing house) minus the required reserves for current deposits. An important thing to realise is that in general, as soon as a loan is made, the money is withdrawn. Banks know this from experience, and they plan their loans based on this. If you just look at required reserves, you might think that a bank with $1 million deposits and $1 million cash can make $10 million in loans, but it can't. If it makes more than $1 million in loans, it will not have the money to pay out when the checks written by the customers it made loans to come in, and funds are withdrawn from the bank. In order to make sure that it has it's required reserves, the above bank can only loan out $900,000. Now, it is possible that some of the customers it has loaned to, use the loans to pay some other customer in the same bank, but the bank cannot rely on this. The consequences of running out of funds are severe. A bank with a liquidity problem can be, and have been, taken over by the central bank, the assets liquidated and the management fired. That is why we have a staged monetary expansion.

This contrasts with the past, when banknotes were issued by commercial banks. When a bank note is issued, the bank can safely issue 10 times more banknotes than the gold reserves it holds, keeping with a 10% resrve requirement. This is because, people use the banknotes as money, and the people who are paid with the banknotes do not in general bring it back to the bank to redeem it. This is an essential difference between the monetary environment that exists today, and the monetary environment in the 1900's.

--LK (talk) 07:10, 1 August 2009 (UTC)
Yes, you are correct in that surmise. I do not believe that monetary expansion follows such rigid withdrawal-deposit stages.
I am not trying to claim that a bank with $1 million in excess reserves would immediately lend $10 million to a single customer. This obviously very rarely happens. But the bank is not legally bound in its lending to the $1 million either. (If it is, can you provide the reference?)
Newly lent funds obviously do not stay very long in the debtor's account. Very small banks can be quite sure of newly loaned funds being immediately withdrawn, but larger institutions have much more leeway. As you stated, the funds are not very often withdrawn in cash, but instead transferred to another account by writing a check or by wire transfer.
From the point of view of the banking system, the loaned funds, even if temporarily cashed out, are not permanently withdrawn at all. They just move between account balances. This is the gist of fractional reserve banking.
All of this happens in the margin. Temporary deficits of required cash reserves during the reserve maintenance period are quite acceptable. Banks do not completely halt lending if this happens. Has anybody actually witnessed a bank saying to its customers that "sorry, we have just run out of excess cash, please come back later"?
I have no banking experience. I am simply trying to gain a better understanding of the role of banking in the economy. I do accept the possibility of being completely mistaken. My education (in engineering) is of no importance. This is the discussion page. I haven't modified the actual article. I'll leave that to experts.
You asked for authoritative sources. What is more authoritative than the actual regulations?
I would like to know what is the basis of the claim that banks can not make loans in amounts that are larger than their excess reserves. The original sources in the article do not explain this, but merely state it as an assumed fact. One of the links I posted earlier, on the other hand, seems to be in direct contradiction.
If you have more references about the "views held by experienced bankers and economists", please feel free to amend the article. I consider the staging, as presented in the article, badly justified.
Adopted practices of individual banking institutions in their management of reserves do not apply here, as the article gives the impression that banks in general are somehow legally restricted from accepting promissory notes beyond their immediate excess reserves. A temporary deficit in required reserves does in no way constitute "running out of funds". Additional reserves can be readily acquired after the fact by borrowing in the interbank lending market, by engaging in repurchase agreements, by issuing commercial paper, etc. If the loss of reserves is not temporary, banks can sell their liquid assets, or engage in securitization. As a last resort, a banking institution can use the discount window.
I really don't see the big difference between the gold standard and a fiat monetary base. The nature of the monetary base is of no consequence to fractional reserve banking. People use their checking account balances as money, just like they used bank notes in earlier times. Settlement of transfers is a lot faster nowadays, but so is interbank lending, which is used to spread the cash reserves around to those institutions that currently happen to need them. Reiska (talk) 10:34, 1 August 2009 (UTC)
Thanks for your reasoned response. If I have been brusque before, I do apologize. As far as I know, you are correct that there are no explicit bank regulations that a bank must not lend out more than their excess cash-on-hand (actually excess reserves) as I outlined above. Rather, the regulation is that they must fulfill all reserve requirements on a periodic basis (usually on a weekly or monthly basis). In practice, this has the same effect. What a bank does, is to look at its current excess reserves, forecast net future deposits over the next period, and use that to set lending targets for the period leading up to the next date when its reserves are checked. Note that for an individual bank, forecast net future deposits are not affected by new lending. ie. if I lend out an extra $1million, I cannot expect my future deposits to increase by $1million because of my extra lending. Although for the banking system as a whole, increased lending leads to increased deposits, this is not true for an individual bank. (Think of pissing into a swimming pool. If I piss while in a public swimming pool, it doesn't affect the saltiness of the water I swim in, but if everyone pisses, the water everyone swims in will get much saltier.)

In effect, this means that if a bank has $1 million in excess reserves today, and forecasts that over the next month deposits will roughly equal withdrawals, it will try to lend out a little less than $1million (it usually wants to keep some excess reserves). If the bank misses its target, and over- or under-lends, it will go to the interbank market to borrow or lend money so as to keep its excess reserve target. (The issue is complicated by interbank lending, in that some banks regularly take in more deposits than they lend out, and lend the excess on the interbank markets, and other banks do the opposite. But it doesn't fundamentally affect our discussion.)

As to why things were different a hundred years ago. The difference lies not with the gold standard, but with the printing of banknotes. Today, only central banks and monetary authorities print banknotes. In the past, commercial banks printed banknotes which were used and circulated as money. In such a monetary environment, a bank can safely print out much more in banknotes than the reserves it holds (in the past, usually gold coins). It can immediately lend and print out banknotes equal to 10 times its reserves if it wants to keep 10% reserves. This is because, unlike with checks today, those banknotes were not immediately presented back to the issuing bank with the demand that funds be withdrawn. The fundamental difference is that the banknotes themselves were money and did not normally return to the bank, whereas checks are merely instruments with which to transfer deposits. In contrast, in today's environment, checks are not money, only the deposits themselves are money, and these deposits are transferred out of the bank whenever the money is spent, reducing bank reserves (compare with banknotes, when banknotes are spent, they do not involve a change in bank reserves). This fundamental difference renders many treatise on fractional reserve banking written in the past (e.g. von Mises) invalid today, causing a lot of confusion among libertarians on the internets.

You also ask about references for the staged monetary expansion described in the article. Every single undergraduate macroeconomics textbook I know of has a similar description of the process of monetary expansion (if they have one at all). I could add citations from the half dozen or so macro textbooks that I have in my office, but did not think it was neccesary. However, if anyone thinks I should, I'm more than happy to do so. --LK (talk) 12:40, 1 August 2009 (UTC)
I think you are correct about the difference of banknotes and modern day checkable deposits.
References to textbooks, even if of no use to professionals, are quite appropriate in a Wikipedia article. One cannot place assumptions of basic knowledge on a reader of an encyclopedia.
One additional note on the money stock expansion: Not all of it is made through lending. Banks are fully capable of issuing new deposits for the acquisition of other assets as well. Even the salaries of the bank staff are in practice paid by issuing new deposits. Such new deposits are not in any way more susceptible to withdrawal than the existing stock of deposits. Reiska (talk) 14:56, 4 August 2009 (UTC)
Interesting! <thunderbolt> I think you are right. A bank will make gross revenues, bringing money in, and will have to pay regular expenses (including wages), moving money out. The effect of that must be that if a bank has a net positive cashflow (making net operating profits), it must plan on increases in its excess reserves equal to its net profits. If it has a net negative cash flow (making net operating losses), its excess reserves will fall by the amount of the net loss. What this means is that a bank can make net operating losses as long as those losses can be covered by its excess reserves. Therefore, a bank that is fearful of making operating losses in the future, has a very high incentive to accumulate excess reserves. Fascinating, I didn't think of it like that before. Thank you. LK (talk) 15:24, 4 August 2009 (UTC)
application of interest section
added an application of interest section under criticism. what do you think? Please help to add better sources. Cstof j (talk) 12:52, 16 August 2009 (UTC)
I'm afraid it's just synthesis and non reliable sources. It's wrongheaded, and as it reads currently, it doesn't belong in an encyclopedia. 3rd opinion before I delete it? LK (talk) 08:13, 17 August 2009 (UTC)
removing POV, explanation given in discussion
Fractional-reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) [but banks don't need to be in receipt of deposits to be a fractional-reserve bank, they can simply make loans] and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand.[1][2] Fractional reserve banking necessarily occurs when banks lend out any fraction of the funds received from deposit accounts [Not if the deposit accounts are locked up as in the case of time deposits...]. This practice is universal in modern banking. Orangedolphin (talk) 15:52, 21 September 2009 (UTC)
That's not the way to argue that the current version is POV. Remember that Wikipedia is about "Verifiability, not Truth". The version there now uses wording similar to what is found in the reliable sources given. As such, I believe it is a balanced statement of the position of reliable sources. If you wish to argue your version, you will have to find reliable sources (journal articles, textbooks, etc) that argue your position. We can then craft a suitable consensus version that reflects all the reliable sources found. Also, please refer to the previous discussion on this page. AFAIK, there are no reliable sources to back the assertion that banks regularly lend out more than they have in deposits. LK (talk) 16:52, 21 September 2009 (UTC)
Why isn't that the way to argue that the current version is POV the error has been identified, what more verifiability do you need? What makes you think my claim is that banks regularly lend out more than they have in deposits? Orangedolphin (talk) 17:15, 21 September 2009 (UTC)
My main point is that you cannot argue your own position, that is WP:OR. Find a source that argues it, or stop reintroducing it – that is edit warring and against policy. Keep in mind that you should not keep on reintroducing a disputed change to a page, as you will break WP:3RR and will be sanctioned. LK (talk) 17:41, 21 September 2009 (UTC)
Poor start
This article is off to a very poor start. The second sentence "This may result from either the depositors being ignorant of the shortfall, or trusting of the Government guarantee" is fringe POV. Although this sentence is cited, it's an extremely non-mainstream POV to suggest that the entire modern banking system is largely predicated on ignorance. This would maybe be acceptable in a "criticism of fractional reserve banking" section, but is downright bizarre to place so prominently. In the United States at least, anyone who is paying attention learns how banks work in high school and the fact that people keep accounts well above FDIC insured limits shows the second assertion to be largely false as well. --JayHenry (talk) 00:29, 23 September 2009 (UTC)
I see the article has now been fixed. The bankintroductions.com source, even if it is reliable, doesn't support the assertion of ignorance, nor really the part about the government guarantee (nobody disputes that the guarantee exists, or that it increases comfort with the system, but the implication of the original sentence isn't backed up). Wiley is usually reliable, and the book seems to be a mainstream guide to analyzing a bank's credit, so I'd be surprised if the Wiley reference supported the original wording either. --JayHenry (talk) 00:45, 23 September 2009 (UTC)
I was thinking of trying to incorporate this material into the criticism section as a compromise, but we would need sources actually making the claims. --JayHenry (talk) 00:46, 23 September 2009 (UTC)
the Federal Reserve is a private institution
The article says that the Fed is a government institution, but it is wrong. It is a private institution as Federal as Federal Express. I was shocked to learn the conspiracy theorist were right on this one. In all countries around the world, no central bank belong to the government, they belong to individual investors who are not known by the public (Anonymous societies is a very common way to form companies in most countries). Central banks just play nicely to governments and lend them as much money as they want as long as they agree to pay it back.
The Fed has a license to print money. WOW!
Who owns the Federal Reserve?
The Federal Reserve System is not "owned" by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects.
As the nation's central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. However, the Federal Reserve is subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute. Also, the Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government. Therefore, the Federal Reserve can be more accurately described as "independent within the government."
The twelve regional Federal Reserve Banks, which were established by Congress as the operating arms of the nation's central banking system, are organized much like private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.
Taken from: http://www.federalreserve.gov/generalinfo/faq/faqfrs.htm
Organized as a private entity, but with no owner, monopoly of printing money given by congress, but can't be overruled by any government agency, although the congress can change its charter (the mission of the enterprise), it can't overrule it either. It is even worse than a private bank, because the CEO of a bank must show results to the board, otherwise risking termination. The president of the fed (or any central bank) can go willy nilly and not print money when necessary or print a lot of money when it is necessary to contract the supply. Most central banks behave as good citizens, but I guess the only reason is to avoid loosing their monopoly to government, which may take it back or simply grant it to another cartel.
Furthermore, private banks have stock on the fed, why isn't it traded like all stock? That's unfair. If we could all buy and sell shares of the fed, all our money would grow at least 6% per year. That would be really nice.
Also, if the bank doesn't have any profit, how does it distribute dividends? It has profits, it just doesn't recognize them as such in order to avoid taxation. Why? I understand the motives of the Fed, having an endless money supply is fascinating. I just don't understand the motives of the government to abide such a scam. If they have profits but don't recognize it as such, the government could tax them without calling it a tax. Call it royalties on money generation, or dividend collection probing, I don't care.
Central banks need money to operate. They can print the money directly, or they can obtain it by providing products and services. In the case of the central bank, its services are printing (or loaning) money. Printing a $1000 bill is a as expensive as printing a $100 bill, but the interest obtained in one of them is ten times as much as the other. The cost of printing is below $1. Bills last 5 years on average. The interest rate is between 0% and 10% normally and nominally, but usually considering inflation, it is more like 1% to 3% real annually.
If the cost of printing $1000 is $1 and the return is 1% real, that's $10. That's a 900% profit. Even if they are not careful with money and considering they reprint all bills every year, there are 150 million workers in America and the average American makes $3,000 per month, that's $450 billions only considering the labor side, it can be 10 times that in reality. That money must pay interest, otherwise it wouldn't be printed. Month after month, this money must exist in the economy or otherwise workers wouldn't be paid.
If we consider the fed to play nice, they would charge just a 1% per year of $450 billions, which is $4.5 billions per year. It is almost impossible for one institution to spend all that money every year. —Preceding unsigned comment added by 190.45.14.46 (talk) 11:41, 1 November 2009 (UTC)
FRB does not inflate the money supply without cheques/credit cards
I noticed the sentence "By its nature, the practice of fractional reserve banking expands money supply (cash and demand deposits) beyond what it would otherwise be." This is only true because of the use of cheques or card/computer based equivalents. It would be perfectly possible for FRB to exist in a system in which the only thing you could buy goods with was cash, in which case there can be no expansion of the money supply. So perhaps the sentence should be "By its nature, the practice of fractional reserve banking, combined with the of cheques or card/computer based equivalents, expands money supply (cash and demand deposits) beyond what it would otherwise be."
No, it's the demand deposits that make it possible. --JayHenry (talk) 05:13, 25 November 2009 (UTC)
Let me explain. I have $10 cash. I take it to the bank. They keep $1 cash on reserve and lend Sally $9 cash. Now I have a demand deposit of $10 and Sally has $9 cash for a total of $19 (money supply = Sally's cash + my demand deposit). No checks or card/computer based equivalents are necessary; you have misunderstood what is meant by money supply. --JayHenry (talk) 05:18, 25 November 2009 (UTC)
I think what the OP means is that if the banking system does not have demand deposits (no checks, no instant withdrawals via ATM, no internet based a/c to a/c transfers), instead banks offer only those old type savings passbooks accounts, where you have to queue up for half an hour to get your cash out, then, your bank deposits would not count as money (since you could not use your account balance to pay anyone). Hence, depositing money into such a banking system would actually reduce the money supply rather than increase it. This is true. However, such a banking system (without checks and checking accounts) has never existed anywhere, and there is no serious proposal to introduce it anywhere, as such, it probably shouldn't be mentioned in the article unless there is a reliable source making a similar argument. Even then, it probably shouldn't be mentioned in the lead. LK (talk) 07:11, 25 November 2009 (UTC)
You're just describing full reserve banking there, albeit convolutedly. --JayHenry (talk) 07:17, 25 November 2009 (UTC)
Again, there are no checks, no instant withdrawals via ATM, no internet at all, in the example I gave. M0 = $10. M1 = $19. And yep if I try to withdraw more than $1 before Sally has started to pay back then my bank has a crisis and M1 can collapse. (That's the whole thing that freaks some people about fractional reserve banking.) But checks, ATMs, are irrelevant. Fractional reserve banking can expand the money supply without their existence. Now, the existence of checks and such make the system function better, but they're not themselves what increases the money supply. They are irrelevant. Adding the proposed sentence would not just be confusing, it would make the article incorrect. --JayHenry (talk) 07:23, 25 November 2009 (UTC)
You can have demand deposits with and without the invention of cheques. Without cheques, you can only spend the money in your demand deposit by going to the bank and taking the cash out. With cheques you can spend some or all of your money while the cash stays sat at the bank. You can still have FRB without cheques. For FRB to inflate the money supply, there needs to be a system in place (like cheques or cards) where you can "spend" your cash without taking it out of the bank. I agree with Lawrencekhoo that it need not be mentioned in the lead, but its perhaps worth mentioning somewhere.
Re: "instant withdrawals via ATM" mentioned by Lawrencekhoo. Actually instant withdrawals via ATM not cheque-like behavior. Its just getting cash from your account quickly. So this is not part of how FRB inflates the money supply. —Preceding unsigned comment added by Reissgo (talk • contribs) 12:38, 25 November 2009 (UTC)

I'm sorry, but this is incorrect. Much of bank activity happens with the electronic component of M0. But this is for convenience, not because it's theoretically necessary. Banks are not allowed to increase the electronic component of M0 beyond the levels set by the Federal Reserve. It is possible to disallow electronic banking and require banks to physically move dollar bills. If I write a check from my bank, my bank has to provide that money. In the current system when a bank issues a check they have to draw down some asset to cover that liability. This is exactly the same as if they are actually moving dollar bills.

What does electronic stuff allow? It allows faster clearing than moving physical dollar bills. It allows the Federal Reserve to increase M0 without literally printing new physical currency. The checks are not what allows the money supply to expand. It is the concept of demand deposits in and of itself. The demand deposit system is vulnerable to breakdown with or without cheques. --JayHenry (talk) 14:38, 25 November 2009 (UTC)
Having thought about it more I am beginning to see your point, although it may depend a little on the definition of "money supply". Consider a cash only system. If you had $1000 to your name and kept it under the mattress, then the only time that money can be used for purchasing is when you take some out and spend it. But if you keep the money in the bank and there is an FRB system, then someone else can use your money to buy stuff. This would have the same effect as there being more money in the system, even though the total number of notes is fixed. Whether this counts as an increased "money supply" is another matter - and I'm not sure it does.Reissgo (talk) 17:04, 25 November 2009 (UTC)
I guess we can all agree that it all depends on how money supply is defined. Anyway, all too esoteric for the article I think. If there is a reliable source somewhere that makes the same point we can put it in, but not in the lead I think. It's all moot anyway, as AFAIK there are no serious proposals to eliminate checks and electronic transfers, but keep savings accounts. LK (talk) 17:47, 25 November 2009 (UTC)
added some criticism from the Federal Reserve page
Hi,
Just wanted to say that I added a bit of criticism from the Federal Reserve page that had been written about fractional-reserve banking in general and didn't really belong there. I didn't want to delete it altogether, though, so added it here (in condensed form). I also thought the intro paragraphs were very long, so put the discussion of risk into a separate section.
Afelton 03:19, August 2, 2005 (UTC)
The section of the article that talks about how central banks originated in response to failures of fractional reserve banks is shameful. Anyone remotely conversant with the origins of the Banks of Sweden, England, and France would know that it's a pure concoction. Early central banks were motivated by governments' desire for fiscal aid.
FRB does not cause long term inflation in and of itself
I would like to take issue with the following two excerpts: "Moreover, the existence of fractional-reserve banking allows either the central bank or individual banks (under a free banking regime) to create money at will" and "the inflation brought about by fractional-reserve banking". Both these snippets give the impression that FRB in and of itself is a mechanism for generating long term inflation. This is not true. It is the assorted means by which a government and/or central banks create additional money that causes that. And that could occur under any monetary system, FRB or otherwise. Once the FRB has maxed out the money multiplication process, there is no further scope for increasing the money supply other than "governments creating more money" and "governments creating more money" is not part of the definition of FRB as far as I know.
I suspect what has happened in the article is the conflating of "fractional reserve banking" and "the banking system, as it exists in many countries today". They are not one and the same thing. Sure FRB is a component of today's banking system. But I think it fair to say that today's banking system is FRB plus features X,Y and Z. I think this article should be careful not to attribute the characteristics of X, Y and Z to FRB.
Maybe someone should start a whole new wiki page called "Banking as it is today". Reissgo (talk) 13:32, 28 November 2009 (UTC)
Yeah, I agree here. The two issues have been conflated. It's obvious that Central Banks could also increase the money supply in a full-reserve system, they would just use a different mechanism to do so. An article on the "Modern Financial System" or something like this strikes me as a good idea. The interplay between depository institutions, securities firms, private equity, hedge funds, how the global capital markets work, etc. I haven't fished around but there's possibly an article somewhere that is something along those lines. The Global financial system article could be the beginning of an article that explains "banking as it is today". --JayHenry (talk) 16:24, 28 November 2009 (UTC)
There's a bit of subtlety here. In the early days of the euro-dollar, at least one mainstream newspaper fretted that, because overseas intermediaries were not required to hold reserves for dollar-denominated accounts, they could increase the money supply without limit. Well, if that were true, then fraction-reserve banking without reserve limits could in theory produce long-term trends of increasing prices (though I would think that a high-speed blast towards infinity, followed by a quick crash, would be more likely). But the error underlying that particular fretting was in failing to recognize that the public would have to have zero demand for real cash balances for multiplication to proceed without limit. —SlamDiego_←T 17:42, 6 December 2009 (UTC)
If some rules were made such that new money could be loaned without reserves then it would no longer be fractional reserve banking. So this would not be place to discuss the consequences.Reissgo (talk) 13:50, 7 December 2009 (UTC)
Not quite. It is practice rather than rules which determines whether one has fractional reserve banking. Fractional reserve banking pre-dates and does not itself definitionally entail legal or regulatory reserve requirements. And, so long as banks were in the process of reducing their reserves as a share of deposits, the money supply could (ceteris paribus) continue to expand without an increase on its base. However, contrary to the fretting in that newspaper, this cannot happen without limit so long there is a positive demand for real cash balances. As the banks approached zero reserves, the expansion of the money supply would approach a limit. If there were no demand for real cash balances, however, then maintaining positive-but-diminishing reserves could theoretically sustain a long-term increase in the price level. It's just not particularly plausible that there would be no demand for real cash balances nor that banks would reduce their reserves in such manner. —SlamDiego_←T 23:06, 7 December 2009 (UTC)

Anyway, my principal point was that the association of fractional-reserve banking with long-term (real-world) inflation is in part founded on a failure to appreciate the braking effect of the demand for real cash balances. —SlamDiego_←T 23:31, 7 December 2009 (UTC)
Latest revision made things worse
The revisions made in February took what had been a reasonably good explanation of fractional reserves and made a mess of it--for example: a T-account with 3 columns instead of the usual two, and a long string of transactions trying to show what had been adequately expressed with just two transactions. —Preceding unsigned comment added by 67.49.42.239 (talk • contribs) on 10 February 2007.
I hope everyone realizes "fractional reserve banking" does not really exist. Banks lend neither a fraction of their deposits nor a fraction of their reserves. In fact, a bank theoretically could have zero deposits and lend billions of dollars. From an accounting standpoint, the very act of lending creates reserves. Further, the federal government will lend any bank any amount of money to support loans.
So what limits bank lending? Capital requirements.
Anyone who wishes to discuss this more privately can reach me at rmmadvertising@yahoo.com. Rodger Malcolm Mitchell —Preceding unsigned comment added by 24.1.107.40 (talk) 19:59, 19 March 2010 (UTC)
George Selgin and Austrian Economics
I have been doing some research on Selgin and found that he seems to have very weak ties to Austrians in general and is more involved with CATO, Modern Free Banking School, and other economic organizations. The fact that he was even interviewed by the Federal Reserve makes things a bit strange knowing that Austrians are overwhelmingly anti-Fed. The latest source I found comes from the "Journal of Austrian Economics" with an article aimed at disconnecting Selgin's views from Mises.
My point is, it does not seem credible to include Selgin as a spokesman for Austrians in this article since his position on fractional reserves may only resonate with a very small minority of Austrian economists. Additionally, he doesn't even have any Austrian connections, according to the Wiki article on him. I recommend we remove all references to Selgin in this article. Gaytan (talk) 22:26, 28 January 2010 (UTC)
I will remove any mention of Selgin from this article unless someone says otherwise. Selgin's views on this subject are far from that of the average Austrian economist. Gaytan (talk) 00:00, 2 March 2010 (UTC)
Fractional reserve banking is not universal
I have just removed the sentence: "This practice is universal in modern banking, and can be contrasted with full-reserve banking which is no longer practiced by commercial banks.". The sentence says three things:
1. This practice is universal 2. It can be contrasted with full-reserve banking, for which a wiki reference was given. 3. It is "no longer" practised by commercial banks.
1. is wrong because many types of loan operate without any reserve. 2. Is of no use because the wiki page on full reserve banking does not define what full reserve banking is! 3. The implication is that full-reserve banking *used* to be practised by commercial banks which I believe to be untrue. If someone wants to re-assert this claim then please provide a reference.
If an alternative sentence was required to round off the first paragraph then I think it would be more accurate to have something like "In recent years the reserve requirements have become less and less of a restriction on lending, gradually being replaced by 'capital adequacy' restrictions instead". Modern banking should scarcely be called "fractional reserve banking" any more.
Reissgo (talk) 13:36, 28 April 2010 (UTC)
What you say about the reserve ratio not 'biting' is only true for the US. In most countries the RR is still the most important ratio that banks must adhere to. How about 'FRB is universally practiced by modern commercial banks'? Nice and clean. There currently exists no commercial bank that does not practice FRB. LK (talk) 15:37, 28 April 2010 (UTC)
Your suggested sentence could mislead people into thinking that there were never any loans made without reserve restrictions. I think it would be better to explicitly state that some loans can be made without reserve considerations. Reissgo (talk) 15:44, 28 April 2010 (UTC)
So what about "FRB is universally practived by modern commercial banks, although some individual loans may have different reserve requirements." That said, I think that focusing on individual loans is going too deep. FRB looks at the overall numbers for the bank. Different types of loans will have different reserve requirements (at least, you'd hope!), with riskier loans dictating more caution. A bank that's loaning out more overall than they have in reserve is practicing FRB. From the current wording, I don't think readers will think FRB applies to individual loans, but to the overall numbers for the bank. My first preference would be LK's version. Ravensfire (talk) 18:03, 28 April 2010 (UTC)
It seems that fractional reserves are the exception rather than the rule in modern banking. See this for example: www.prisonplanet.com/fictional-reserve-banking.html, here's two excerpts:

The US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only to deposits by individuals; banks have no reserve requirement at all for deposits by companies.

And – according to Steve Keen – about 6 OECD countries have already done away with reserve requirements altogether (Keen confirmed that Australia requires no reserves; I know that Mexico doesn’t require reserves; and Canad, New Zealand, Sweden and the UK supposedly require no reserves as well).

I think that the sentence we write should reflect this fact.
Having a reserve requirement isn't related to FRB. If a bank loans out more than it has in reserve, it's FRB. It's that simple. Ravensfire (talk) 14:19, 29 April 2010 (UTC)
If you want to allow a "capital requirement" based banking system to be labelled as a fractional reserve system, then half of the main article will have to be re-written to reflect that fact. All the talk of reserve requirements and the theoretical maximum money multipliers would have to be heavily edited. Reissgo (talk) 15:49, 29 April 2010 (UTC)
Just because a bank does not have a reserve requirement does not mean that it is not practicing FRB. In the early days of banking, there were no reserve requirements, and banks kept reserves based on prudence and estimates of what cash they would need. Since they loaned out their deposits, they were still practicing FRB. Back to the point, all modern banks practice FRB. I would like to note this in the lead, unless there is a direct objection to this statement? LK (talk) 16:35, 29 April 2010 (UTC)
I now concede that all banks practice FRB in that catch-all sense. But it is a shame that the main article falsely gives the impression that the mechanism by which the banks practice FRB is almost universally via minimum reserve requirements. The current wording gives the impression that reserve requirements are the main mechanism and capital adequacy might be used sometimes whereas I think the opposite emphasis is more true.
I suspect that the concept of a maximum money multiplier is scarcely meaningful in any western country today. Reissgo (talk) 17:20, 29 April 2010 (UTC)
This is a common stance among Post-Keynesians, and is known as endogenous money. However, this is a heterodox view that is not well accepted within the mainstream economics profession. LK (talk) 01:33, 30 April 2010 (UTC)
The main article states "The money multiplier, m, is the inverse of the reserve requirement". But if the reserve requirement is zero then m is infinite. Reissgo (talk) 06:50, 30 April 2010 (UTC)
It's an economic model and there are simplifications made to make it easier to understand. Obviously, infinite money creation doesn't happen as other limits will 'bite'. For example, banks will hold some cash even when not required to, for prudential purposes. LK (talk) 08:31, 30 April 2010 (UTC)
Money multiplier confusion
The section on the "money multiplier" needs editing to reflect the fact that there are several money multipliers. Some referring to ratios of the different "M's", M0,M1 etc, while still other multipliers are ratios of *changes* in the amount of "M's".Reissgo (talk) 17:19, 29 April 2010 (UTC)
Infinite lending?
I note the following sentence from the main article "When there are no mandatory reserve requirements, the capital requirement ratio acts to prevent an infinite amount of bank lending.". Does anyone have a reference for this? I ask because I have seen an unpublished paper which shows that there is no such limit in place: http://arxiv.org/PS_cache/arxiv/pdf/0904/0904.1426v2.pdf Reissgo (talk) 17:18, 29 April 2010 (UTC)
Infinite money creation doesn't happen as banks hold reserves even when not required to, which puts a limit on money creation. LK (talk) 08:26, 30 April 2010 (UTC)
I am going to do some more research before coming back to this issue. But the original claim still needs a reference. Reissgo (talk) 17:11, 30 April 2010 (UTC)
The capital requirement ratio limits lending by individual banks. What i'm attempting to show in the paper is that with the current implementation of the reserve banking rules, it is not adequate as a limit on lending and money supply growth within the larger banking system as money flows around the fractional reserve system. The two best examples of this at the moment are what happened in Iceland, where money was deliberately borrowed to increase equity capital holdings, and probably China. China is particularly interesting since they currently have a real estate credit bubble, rapidly increasing money supply, and they have aggressively tried to control this by increasing the reserve holdings - currently at 17%.
Since i'm actively researching in this area i don't feel it appropriate to edit the main article. It might help to consider that there are and have been many different ways of of implementing this system, and each has its own quirks. In particular, the current textbook description is based on gold standard era understanding of it, which was quite a different set of conditions to those being used currently, and i think this is one of the causes of a lot of the confusion in this area. Mischling (talk) 10:37, 14 May 2010 (UTC)
Disingenuous statement by the federal reserve
I noticed that in the quote from the federal reserve it says: "depositors might have to pay banks to provide safekeeping services for their money". But this is completely disingenuous because of course customers do pay for safekeeping. Just because it is not charged explicitly, it is never the less an expense that must be paid for. Its like buying a car and being told that the wheels are free. Sure a salesman can say those words, but we all know that its not really true. I note that the quote is taken from a document which is not peer reviewed. Reissgo (talk) 19:27, 5 May 2010 (UTC)
Unbelievabe
How could someone write this and keep a straight face, the system described is unbelieveably criminal. I was especially surpised at the frankness of the 'History' section. There is a word for what the goldsmiths were doing, it's called EMBEZZLING! They should have been thrown in jail. This article is a perfect example of something which is "hidden in plain sight" Why doesn't the public know about this?? We should be outraged! —Preceding unsigned comment added by 99.198.32.36 (talk) 05:57, 5 June 2010 (UTC)
Regarding the section "How it works"
The paragraph is quoted bellow:
"However, there have been some recent bank runs: the Northern Rock crisis of 2007 in the United Kingdom is an example. The collapse of Washington Mutual bank in September 2008, the largest bank failure in history, was preceded by a "silent run" on the bank, where depositors removed vast sums of money from the bank through electronic transfer.[citation needed] However, in these cases, the banks proved to have been insolvent at the time of the run. Thus, these bank runs merely precipitated failures that were inevitable in any case."
Why were the run of these banks inevitable? In the paragraph that preceded this one it is said that central banks have an obligation to stop these bank runs and do this by being the lender of last resort. Why doesn't this apply to these brief exceptions? —Preceding unsigned comment added by 195.67.20.5 (talk) 12:04, 27 July 2010 (UTC)
U.S. centric
Hi, I tried to remove some of the more confusing references to the Fed in the opening example, as if this is meant to introduce the situation by example it really doesn't work at the moment (being both Americo-centric in stand point and confusing by adding all the Fed information). Any chance of moving the Fed stuff out of the opening example?
— Preceding unsigned comment added by 86.151.152.146 (talk • contribs) 09:56, 26 September 2007 (UTC)
Money supply contraction
The quote here: "The expansion and contraction of the money supply occurs through this money creation process. When loans are given out, the process moves from the top down and the money supply expands. When currency is withdrawn from the commercial banks, causing loans to be called back, the process moves from the bottom to the top and the money supply contracts" suggests a number of things that are confusing. One - is the causality right? How is currency withdrawn from commercial banks when they are loaned out to the hilt? Second - when people repay debt, does the repayment not go to the reserve accounts of the banks? Aren't these repaid amounts now bank capital? In other words is it not the case that when deleveraging takes place, money accumulates in the banks, and so the money 'supply' remains constant? —Preceding unsigned comment added by 83.208.165.249 (talk) 19:29, 29 September 2010 (UTC)
Deposit Multiplication
This is misleading, people don't borrow from a bank to put the money into another bank. This would be stupid as the interest you pay a bank for borrowing money is more than you get in interest by depositing it. To look at it in this way is a total fiction. Fraction Reserve Banking (FRB) allows the bank to invest the majority of the money placed in it by usually by lending it to customers at a higher rate of interest than it is paying the customers who deposited the money. This section of the article is misleading and people have the idea that FRB creates money. What would the alternative be? That a bank should not loan out money to other people but pay people interest for it storing the money in its safe? Ridiculous! —Preceding unsigned comment added by Caparn (talk • contribs) 14:17, 17 July 2010 (UTC)
>> I think that the receiving bank is getting money from the supplier of goods/services that the lendee bought with the loan that the previous bank lent out. Omitting that process makes the table simpler. 99.62.29.93 (talk) 01:03, 9 September 2010 (UTC)
Modern Money Mechanics is by no means modern
I feel that the reference to Modern Money Mechanics should come with some kind of health warning because it is now seriously out of date (1992? 93?). Doing a quick search reveals the document does not contain the phrases "Basel" or "Capital adequacy". The name of the document in itself implies that it is up to date but clearly it is not. Reissgo (talk) 07:27, 14 September 2010 (UTC)
In the last 20 years or so, there has been a change in most jurisdictions on exactly which regulation is binding on the amount of bank lending (and hence the money multiplier). Traditionally, the reserve requirement was the binding constraint, and most textbooks still treat it as such. Under Basel II, capital requirements are now the binding constraint in most jurisdictions (but not all, in some jurisdictions reserve requirements are still binding). However, I am unaware of any textbook that discusses the money multiplier implications of Basel II. This is because such a discussion would be difficult to understand, as Basel II contains many capital classes requiring different capital adequacy ratios, and the resulting money multiplier would be different depending on exactly what classes of assets a commercial bank actually held. Hence, textbooks continue to use reserve requirements to discuss money multipliers, as the formula is simple, and easily understood.

This is not to say that the discussion of the money multiplier process as it stands in the article is incorrect. The fundamental process itself remains unchanged, what has changed is the exact proportion of new deposits that can be lent out. Under Basel II, this proportion varies from bank to bank depending on the types of assets that they hold. Personally, I feel some mention of this would improve the article, but a full treatment would probably be best reserved for the Basel II page, as the subject of fractional-reserve banking and money multiplication is difficult enough as it is, and we should avoid further muddying the waters here. LK (talk) 07:55, 14 September 2010 (UTC)
Whilst everything you've said may be true, it is not really an argument against what I have said. Sure its all very complicated and a full explanation on a wiki page may bee too much detail. But all I am asking for is a health warning. The name of the fed's document implies that it is up to date, which it is not. Reissgo (talk) 09:46, 14 September 2010 (UTC)
How about including "(from 1993, does not include a discussion of Basel II)" to the link? Frankly, I think this is unnecessary, as the fundamental money creation mechanism described in the paper remain unchanged, only the particular regulation limiting lending has changed (from reserve requirements to capital adequacy requirements). But feel free to add a 'health warning' if you think it necessary. LK (talk) 15:06, 14 September 2010 (UTC)
The fact that the gist of the money creation mechanism is approximately correct in that document, does not mean that it should be referenced without a health warning because the information it contains about the limits on money creation are horribly wrong and out of date. That's an incredibly important feature of FRB - not just some minor technical detail. I shall make an edit to the article. Reissgo (talk) 10:00, 15 September 2010 (UTC)
Besides any caveats that article deserves, I'm uncomfortable with its hosting. That makes it hard to verify that it is indeed what it claims to be. Is there a more authoritative link we can use? CRETOG8(t/c) 13:46, 15 September 2010 (UTC)
I think the whole book has been copied to that Wiki project that keeps full-text sources. (WikiSource?) BigK HeX (talk) 13:49, 15 September 2010 (UTC)
It does seem to be, but it's not clear the origin of it there, either. Oof. CRETOG8(t/c) 19:39, 19 September 2010 (UTC)
New article: Limits on money creation
An essential feature of fractional reserve banking was to place certain limits on money creation. However in the real world today fractional reserve banking in its pure form is rarely (if ever?) practised. The rules controlling the limits on money creation vary from country to country. I propose a new page about the rules *as practised in reality today* governing lending limits in a variety of countries. I have crated a very rough outline of how I see the page in my userspace here: http://en.wikipedia.org/wiki/User:Reissgo/Limits_on_money_creation_around_the_world while it is being prepared. If anyone cares to help out, it would be much appreciated.
What you have on that page currently could (except for the graphs) possibly be fit into a table and added to this article. It would need good references for everything. CRETOG8(t/c) 19:40, 19 September 2010 (UTC)
I suspect that it would grow to become too large. Also, in countries with no reserve requirement it would be misleading to describe their monetary system as a fractional reserve one. It should instead be described as perhaps a credit-money system. Steve Keen says: "We are therefore not in a 'fractional reserve banking system', but in a credit-money one" See http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/.Reissgo (talk) 20:11, 19 September 2010 (UTC)
I think that would be a good offshoot article, but there probably isn't space in this article for it. Also, both full reserve and no reserve banking is a subset of fractional reserve banking (where the fraction is 100% and 0% respectively). So its not really misleading/incorrect. Fresheneesz (talk) 18:32, 5 November 2010 (UTC)
Why accept the Fed's own output as reliable sources on this page?
Surely hundred of academics have written articles in peer reviewed journals about fractional reserve banking and the actions of the fed. The fed is a semi-private company. Their publications are hardly likely to be unbiased and they certainly won't be peer reviewed.
Some academics do question the Fed as an institution, whether it behaves correctly, whose interests it serves, etc. However, I'm not aware of any serious doubt among economists that the Fed's publications are factually true, and they generally use the Fed's publications as reliable sources. CRETOG8(t/c) 17:53, 3 October 2010 (UTC)
Ok, lets explore this a little. How about this: "If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money" - this sentence is farcical. This sentence implies that people don't pay for the safekeeping of their money. The payment for the for the safekeeping simply is simply included as part of other types of charges and fees. Its analogous to the following. Imagine a shop that sells cars. Outside the shop is a sign that says "Bay a car and get the tyres free!". This is quite clearly just advertising guff. If an academic was to write a paper on the economics of the shop for a peer reviewed journal, he would not conclude that people buying the cars were genuinely getting the tyres free. Reissgo (talk) 19:06, 3 October 2010 (UTC)
Any time an academic selects some of the Fed's output to quote in a paper, then that quote will itself be peer reviewed. Just because some of the feds output has passed peer review, it does not follow that everything they output is automatically gospel.Reissgo (talk) 19:45, 3 October 2010 (UTC)
This article's talk page is probably too narrow a venue for this as a general discussion. If you really want to pursue the question, you could go to the reliable sources noticeboard or WikiProject Economics talk page. I feel the burden of evidence would fall on you to show that the Fed is not a reliable source. As a general rule, I very much doubt that the peer reviewers of those academic papers are questioning the Fed's material included in the papers, but are in fact taking it as reliable (which is a lower standard than "gospel" I think) and looking at other parts of the papers. CRETOG8(t/c) 20:17, 3 October 2010 (UTC)
Done. Here. Reissgo (talk) 21:36, 3 October 2010 (UTC)
Is there a particular citation which is in question? "Reliable source" isn't boolean, it'll depend on context &c. As a closely observed national financial institution whose effectiveness depends on maintaining a sober reputation, I would personally consider the Fed a reliable source in most of the circumstances they're likely to be cited, but... bobrayner (talk) 21:57, 3 October 2010 (UTC)
Yes, the one starting "If banks did not lend out their available funds..." the link given as a reference no longer works. Information in Wikipedia must be verifiable. If the reference link is not repaired/replaced in the next few days I will remove the quote altogether. Reissgo (talk) 23:59, 3 October 2010 (UTC)
I've fixed the link via a quick google search. Note that it's better to try to fix a reference rather than to remove it when there is a broken link. Also, best practice is to keep broken links so that others may try to fix it in the future. LK (talk) 04:17, 4 October 2010 (UTC)
If it is a published document available offline there is no reason to remove it as a source even if a link to it does not work. See WP:Linkrot. Lambanog (talk) 05:02, 4 October 2010 (UTC)
So, I gather if we're talking specifics, we're talking about the blockquote at the beginning of this section, referenced to this document from the Philidelphia Fed. I think that Federal reserve bank official publications should be treated as reliable sources for explaining the basics of fractional reserve banking. For that particular quote, the only thing I see which could possibly be contentious (I leave open the possibility I'm missing something) is the word "important", which is strictly true, but could be interpreted as "good" as well. I think that small possibly implication isn't enough to want to remove the quote, which is clear and attributed to the Fed. CRETOG8(t/c) 15:54, 4 October 2010 (UTC)
I was asked to refer this matter to get some independenet editors (not regular contributorsd to this page) to give their opinion on http://en.wikipedia.org/wiki/Wikipedia:Reliable_sources/Noticeboard#Is_the_Fed_a_reliable_source. Looking at the comments of Itsmejudith , Blueboar and Wehwalt it seems that the consensus is that this particular children's educational document is not a reliable source or that an alternative source should be found. Reissgo (talk) 06:54, 5 October 2010 (UTC)
In answer to Cretog8's last comment. The sentence I object to most is: "If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money." I do not believe you can find a peer reviewed document to support that assertion. Reissgo (talk) 12:06, 5 October 2010 (UTC)
I agree. While self-published documents may be used for descriptions of how things currently work, they are not considered reliable as source for information about other entities or speculation. The statement called out is speculation. Yworo (talk) 13:11, 5 October 2010 (UTC)
OK, some total OR and personal (expert) opinion on my part. I hope everyone is aware that commercial banks make their profits by lending out our deposits? That's why they pay us for keeping our money safe. If they can't lend it out, we'ld have to pay banks to hold our money. This isn't pure speculation, consider safety deposit boxes, and the history of full-reserve banks. This is basic and totally uncontentious, and can be cited to some intro macro textbook, but I'ld have to look. Please don't make me go though the bookshelf full of intro macro books behind me. LK (talk) 10:51, 6 October 2010 (UTC)
I would agree with LK's position. I just checked the two textbooks within reach of my desk and they were pretty direct on the point that "Banks make their profits by lending the money that others have deposited with them..."; however, neither textbook specifically addressed the alternative (that if banks couldn't earn money this way, depositors would have to pay for their services) presumably because there's no point exploring such a fruitless scenario in any depth, but I wouldn't worry too much about OR when including what appears to be an obvious conclusion - how else would the running costs of banks be paid? Alternatively, I'd be happy to rephrase; perhaps a simple sentence explaining that banks earn profits by lending out money, and that in cases where the bank can't lend out something deposited with them (ie. the contents of a deposit box), customers generally have to pay for the service instead. bobrayner (talk) 11:43, 6 October 2010 (UTC)
I also find the assertion non-contentious. I'm fairly baffled as to why it seems to have be the source of so much consternation. Actually, I've been largely tempted to restore the statement.... BigK HeX (talk) 12:32, 6 October 2010 (UTC)
Why has the quote been chopped up like that?[5] What is so contentious about that section of the quote that it must be excised and replaced with an ellipsis? Personally, I'd rather keep the whole quote. If somebody feels that part of the quote is factually incorrect, it may be more appropriate to contrast with whichever other reliable source disagrees. bobrayner (talk) 13:44, 6 October 2010 (UTC)

Edited to add: Is there actually another source that disagrees? That would be a good basis for for concerns about the reliability of an existing source. However, one wikipedian's disagreement with a banking regulator's comments about the basic mechanisms of banking would not be a good basis for removing anything sourced from that institution. bobrayner (talk) 13:52, 6 October 2010 (UTC)
The assertion about fees/whatever seems pretty straightforward to me. There is history to support the notion that un-lent deposits of currency required fees [goldsmiths of "ye olden days"], and LK also has the modern example of safety-deposit boxes, so it's not really speculation. I'll probably restore the assertion pretty soon, though I'll allow more time for input here. BigK HeX (talk) 14:20, 6 October 2010 (UTC)
If the fees issue is uncontentious, then there must be a flaw in my "Bay a car and get the tyres free!" argument near the start of this thread. Please tell me the flaw. Reissgo (talk) 15:04, 6 October 2010 (UTC)
I feel that your analogy is flawed because it isn't actually analogous to the economics of banking; it alludes to bundling without actually saying what is bundled. However, argument by analogy is not a particularly strong argument anyway. If you would like to overturn the Fed's comments, do you have anything stronger than a simplistic analogy? A reliable source, perhaps? bobrayner (talk) 15:16, 6 October 2010 (UTC)
It's less like "buy car, get tires free" and more like "rent this storage space, and get tires free in addition to a full refund of all your rental fees".

If an editor's personal misunderstanding of the assertion about fees is the only basis for the objection (as opposed to a reliable source), then the text really should be restored. BigK HeX (talk) 15:16, 6 October 2010 (UTC)
The "Buy a car and get the tyres free!" argument is flawed, although I think I can see where it comes from. You appear to believe that banks primarily make their money off fees, charges, and the like instead of interest on loans. According to my fuzzy recollection of popular press accounts, this view is more correct than it was 30 years ago, but is still wrong. Depository banks make their money primarily off loans. CRETOG8(t/c) 17:00, 6 October 2010 (UTC)

Back to the general discussion--I think that the source is fine, and I like it because it's well-sourced and well-phrased. I think the particular line in question is also uncontentious. I also read the lack-of-consensus on the RS noticeboard to read less as, "this is not a reliable source" and more as a "hmm, maybe you can do better". Since I think Reissgo is mistaken, but is acting in good faith, I'm willing to try to do better. One of us must have an intro money & banking text around which we can use. CRETOG8(t/c) 17:00, 6 October 2010 (UTC)

got one, coming up... CRETOG8(t/c) 17:40, 6 October 2010 (UTC)

How about, "...the only way that banks could cover their expenses and make a profit under 100% reserve banking would be to charge depositors a fee for holding their money (that is, to pay negative interest on deposits)." ^[1] Intermediate college macroeconomics text as the source, says pretty much the same thing. I'd rather go with the bit from the Fed, but there's a quote if it's needed. CRETOG8(t/c) 17:50, 6 October 2010 (UTC)
Seriously confused
Referring to the example: how is $180 out of $100? I just don't understand this. I deposit $100. $80 is loaned out to other people, $20 goes into the figurative vaults,... but where does the other $80 come from? I still do not understand, how is money created here? The loans are always less than the deposits, a difference equal to that original deposit by the Fed. I certainly understand how money is created by the Feds, but I don't get how it is created by the commercial banks. Someone please make this clearer for me. 99.62.29.93 (talk) 01:03, 9 September 2010 (UTC)
It's unclear how you can understand how the Fed creates money, if you're asking this question ... but anyways, if the bank loans out $80 in your scenario, then there's now 1 person who has the $80 loan in his bank account, and the original person who had the deposit totaling $100 in his account. This is $180, which includes bank credit. The bank created money (as bank credit) when it made a loan. BigK HeX (talk) 02:09, 9 September 2010 (UTC)
I understand that the Fed simply prints up money to buy treasury bonds with. That's a completely different process than writing a note which has earned money paid as principal. So as you explain it, the money supply in the economy doesn't expand at all, the debt still equals the deposits. $180 is just the addition of debt and money together, when in actuality it is subtracted. 99.62.29.93 (talk) 04:48, 9 September 2010 (UTC)
There are different measures of a "money supply". But, no, the amount of currency within your scenario did not change, but bank credit in the form of checking account balances is usually counted in money supply measures, so people likely would say that the money supply increased. Deposit Guy has a bank receipt showing that he has $100 available, and Loan Recipient Guy has a bank receipt showing that his account now has the $80 loan in it. Together the two have $180 to spend.

The bottom line is that Banks Can Create Money. It's not a difficult concept, per se, although some people do just find it hard to believe. BigK HeX (talk) 04:57, 9 September 2010 (UTC)
It seems misleading to me to say that they create money. Since every loan is backed by deposits (and some reserves), it's really just a perception of inflation. It would not be any worse than if an individual loaned another individual. The lender would not consider his loan to be the same as cash. People perceive deposits to be like cash in their hands, but it's really a debt owed to them. They cannot spend the money without making a withdrawal (which reduces the amount of debt lent out by the bank). 99.62.29.93 (talk) 05:30, 9 September 2010 (UTC)
It's not misleading to say that banks create money. It's an astounding literal truth. [see: here under "Who Creates Money"]. Also, it is not the same as an individual lending money, because that individual then does not have claim to the money; when a bank loans money, no one loses claim to any money (because it is newly created money). BigK HeX (talk) 05:39, 9 September 2010 (UTC)
That is simply untrue in any common law nation. The basic concept of a contract is consideration, both parties trading something of comparable value. When I lend money to someone, I certainly have a claim to recover it! The only difference is the liquidity. I probably won't be able to get it back as quickly as using a debit card. In the same spectrum, many corporate loans are unable to be called, some might be callable on certain dates, or require premiums to be called, etc.. These call options have an effect on the value of the bond. When a bank lends money, it usually collects the principal back over time. The contract stipulates how much money it gets back (on top of interest). In most cases, the bank will get back all of its principal eventually, they just do not call the loan early. If claims to principal did not exist, there would be no defaults, no risk of runs on the bank and interest rate spreads would be incredibly small.

Addition: I found within your article the contended money creation process.

"Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time."

This is similar to the current system but still does not create money as long as the loans do not exceed the reserves. Creating a note is just another form of currency for the same money in this case. In the current system, loans exceed reserves, but not deposits. When a note (loan) is created, the reserves are reduced. This still preserves the same quantity of money. In the old system, when a bank wrote a note, they kept the gold in the vault! 99.62.29.93 (talk) 06:12, 9 September 2010 (UTC)
Yes ... if you lend money to a neighbor, you retain a legal claim to recover the money, but that doesn't change much about the money itself obviously being out of your hands once you've lent it. BigK HeX (talk) 07:42, 9 September 2010 (UTC)
I agree that it is misleading (or perhaps confusing is the right word) to say that banks create money. Certainly it isn't the same thing as printing money. Its more subtle than that, and saying banks "create" money, while being certain said a lot, isn't a very helpful statement when trying to explain the system to people. In my opinion of course. Fresheneesz (talk) 02:23, 12 November 2010 (UTC)

^ Abel, Andrew B.; Bernanke, Ben S. (2001), Macroeconomics (4th ed.), Addison Wesley, p. 523, ISBN 0-201-4413-0 {{citation}}: Check |isbn= value: length (help)

[AbelBernankeMacroeconomics4thEdition-1] Abel, Andrew B.; Bernanke, Ben S. (2001), Macroeconomics (4th ed.), Addison Wesley, p. 523, ISBN 0-201-4413-0 {{citation}}: Check |isbn= value: length (help)

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