Institute ForNew Economic Thinking Credit, Money & Leverage  

Banks create credit, money and purchasing power

Loan to entrepreneur

Bank

100 Credit to entrepreneurs deposit account

100

| 1

Institute ForNew Economic Thinking Credit, Money & Leverage  

Categories of credit

Loans to businesses / “entrepreneurs”

Loans to businesses / speculators / investors

Loans to “impatient” / temporarily cash limited /

poorer households

Mortgage loans to households

… to finance real investment projects  

… to finance purchase of existing assets  

… to bring forward consumption

… to finance residential houses

| 2

Institute ForNew Economic Thinking Credit, Money & Leverage   3

Categories of bank debt: UK, 2009

227

1235

243

232 Primarily productive investment

Some productive investment and some leveraged asset play

Mainly purchase of existing assets

Pure life-cycle consumption smoothing

Other corporate

Commercial real estate

Residential mortgage (including securitizations

and loan transfers)

Unsecured personal

£bn

|    

Institute ForNew Economic Thinking Credit, Money & Leverage   | 4

Credit and asset price cycles

Expectation of future asset price increases

Increased credit extended

Low credit losses: high bank profits •  Confidence reinforced •  Increased capital base

Increased asset prices

Increased lender supply of credit

Favourable assessments of

credit risk

Increased borrower demand for credit

Institute ForNew Economic Thinking Credit, Money & Leverage   | 5

5

Source: McCulley and Pozsar

Private and public leverage cycles

Institute ForNew Economic Thinking Credit, Money & Leverage   6

What the UK banking system did: 1964

Liabilities Assets

Banks & Building Societies’ £ lending/deposits Private non-financial sector as % of GDP

Household lending

Corporate lending Household deposits

Corporate deposits

Source: Bank of England

|  

Institute ForNew Economic Thinking Credit, Money & Leverage  

Household deposits and loans: 1964 – 2009

Source: Bank of England, Tables A4.3, A4.1

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

100%

1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

% o

f GD

P

Securitisations and loan transfers Deposits

Loans

|  7

Institute ForNew Economic Thinking Credit, Money & Leverage   8

Corporate loans by broad sector: 1987 – 2008

Source: ONS, Finstats

Note: Part of the increase in real estate lending may be due to re-categorisation of corporate lending following sale and lease-back of properties and PFI (public finance initiative) lending, but we do not think these elements are large enough to change the overall picture. Break in series from Q1 2008 due to inclusion of building society data. Sterling borrowing only.

|  

Institute ForNew Economic Thinking Credit, Money & Leverage   9

UK bank balance sheets – 2007

2  

UK residents deposits

Non-residents deposits

(including from banks)

Deposits from UK banks

Repos

Other

Capital & reserves Other

Repos

Investments

Market loans to UK banks

Market loans to non-residents (including banks)

Market loans to UK residents

Advances to UK & non-residents

Cash, central bank, T-bills, gilts

Total = 497%

Liabilities Assets

|  

% of GDP

Institute ForNew Economic Thinking Credit, Money & Leverage  

Long-term trends in bank capital & liquidity ratios

| 10

Source: Bank of England and Bank calculations.

Sterling liquid assets

Institute ForNew Economic Thinking Credit, Money & Leverage   | 11

Credit and asset prices: with securitised credit and mark-to-market accounting

Expectation of future asset price rises

Increased new credit extension at

lower spreads

Mark-to-market accounting generates bank profits and capital increase •  High bonuses and motivational

reinforcement •  Increased capital for own account

trading or on balance sheet lending

Increased real asset prices, e.g. real state

Increased on balance sheet lending at low

spreads

Favourable assessments of

credit risk

Increased investor demand for credit securities at lower

spreads

Increased price/reduced spreads of

credit securities

Institute ForNew Economic Thinking Credit, Money & Leverage   12

Velocity of money circulation

Source: Bank of England, Bank of Japan, Datastream

Velocity of Money (Nominal GDP/M4)

Velocity of Money (Nominal G DP/M2)

|