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Monetary reform
What is money?
What is money?
What is money?
What is money?
What is money?
What is money?
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
Bank owes Zane:
£2,100
- This is added to Zane’s current account at Barclays
How banks ‘create’ money
Barclays owes Zane:
£2,100
- This is added to Zane’s current account at Barclays
Zane owes Barclays:
£2,100 + interest
- Bank adds this to its list of assets
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
Barclays increases amount it owes Cyclelab by:
£1,000
- This is added to Cyclelab’s current account at Barclays
How banks ‘create’ money
How banks ‘create’ money
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
Barclays reduces amount of deposits it has at Bank of England by:
£1,000
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
Barclays reduces amount of deposits it has at Bank of England by:
£1,000
Cooperative Bank increases amount of deposits it has at Bank of England by:
£1,000
How banks ‘create’ money
Barclays reduces amount it owes Zane by:
£1,000
- This is taken away from Zane’s current account at Barclays
Barclays reduces amount of deposits it has at Bank of England by:
£1,000
Cooperative Bank increases amount of deposits it has at Bank of England by:
£1,000
Cooperative Bank increases amount it owes Look Mum No Hands by:
£1,000
- This is added to Look Mum No Hands current account at the Cooperative
How banks ‘create’ money
In reality:
How banks ‘create’ money
In reality:
•Banks cancel out transactions between each other at the end of the day
How banks ‘create’ money
In reality:
•Banks cancel out transactions between each other at the end of the day
•Then work out how much in Bank of England reserve deposits they need to transfer to each other
How banks ‘create’ money
In reality:
•Banks cancel out transactions between each other at the end of the day
•Then work out how much in Bank of England reserve deposits they need to transfer to each other
•The larger the bank, the fewer reserves it needs in comparison to its lending, because more transactions take place within it
What are central bank reserves?
What are central bank reserves?
They are created by the Bank of England to enable banks to complete transactions with each other.
What are central bank reserves?
They are created by the Bank of England to enable banks to complete transactions with each other.
They originally enter the system by banks borrowing them from the Central Bank.
What are central bank reserves?
They are created by the Bank of England to enable banks to complete transactions with each other.
They originally enter the system by banks borrowing them from the Central Bank.
Banks can borrow from the Bank of England ‘overnight’, at the interest rate set by the Monetary Policy Committee.
What are central bank reserves?
They are created by the Bank of England to enable banks to complete transactions with each other.
They originally enter the system by banks borrowing them from the Central Bank.
Banks can borrow from the Bank of England ‘overnight’, at the interest rate set by the Monetary Policy Committee.
To do so, banks must have UK government bonds as collateral.
What about cash?
The Bank of England will swap central bank reserves for cash, and cash for central bank reserves, with banks.
Banks need to hold cash in order to meet demands on it from depositors – ie, to pay debts that they owe.
What about cash?
Barclays reduces amount it owes Zane by:
£100
- This is taken away from Zane’s current account at Barclays
Barclays gives Zane
£100 in cash
Barclays replaces £100 cash by:
-Taking £100 in deposits from businesses it is spent in
-Turning central bank reserves into cash
- If needed, it may need to borrow more central bank reserves from other banks, or Bank of England
Can banks ‘create’ money?
They can create deposits in accounts of customers
They cannot create reserve bank deposits or cash
But they need reserve bank deposits or cash whenever their customers want to buy things
What happens when Zane repays loan?
Barclays gets:
£2,100 + £400 interest in reserve bank money
- Bank removes this from its list of assets
Barclays gets:
Most of this reserve bank money always existed somewhere in system
But deposit which was created no longer exists.
Money has been deleted.
How much money is there in the UK?
0
500
1000
1500
2000
2500
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
Year
£ b
illi
on M0
M4 - M0
M4
What if Zane does not repay the loan?
But he has:
Barclays has to remove £2,100 from its list of assets
But Barclays has lost £2,100 in central bank reserves
If Zane hasn’t spent the money:
No problem.
How do banks go bust?1) Owing more than they are owed
If a bank has more liabilities than assets, it is bankrupt
Banks are not allowed to trade in the UK if they are bankrupt
How do banks go bust?2) Not being able to make debt
payments when they come due
Eg, a cash withdrawal, repayment of central bank reserve loan, not having enough central bank reserves to move a deposit to another bank
In reality, the Central Bank can provide new loans to ensure bank can do all these things, but not if the bank is bankrupt
How do banks go bust?
0
20
40
60
80
100
120
140
Assets Liabilities
Equity
Interest
Debt
How do banks go bust?
0
20
40
60
80
100
120
Assets Liabilities
Equity
Interest
Debt
How do banks go bust?
0
20
40
60
80
100
120
Assets Liabilities
Equity
Interest
Debt
What limits how much banks lend?
1) Likelihood of being repaid
Banks risk being bankrupt if too many of their loans are not repaid (in UK, in reality managers of banks lost little, and lenders to banks nothing. Shareholders did lose out)
2) Having enough central bank reserves and cash to meet payments and cash withdrawals
Regulations
1) Reserve requirements (apply to how deposits are used)
These say that banks need to hold a percentage of deposits in reserve rather than lending it out, say 10%
None exist in the UK
Therefore, fractional reserve banking does not exist in the UK
They do exist elsewhere, including the US and China
Regulations
2) Capital adequacy requirements (apply when loans are given)
Money set-aside in order to pay for defaults on loans – ie, to ensure assets are more than liabilities
Come from equity investments, and retained profits (money which has not been lent to the bank)
International agreement first introduced in 1988, Basel I. Basel III recently agreed.
Regulations
2) Capital adequacy requirements (apply when loans are given)
Loans given a risk weighting. Business loans 100% risk. Mortgage loans 35% risk (because bank owns the house if a default – there is collateral)
So, if capital adequacy ratio of 8%
- For £100,000 business loan, need £8,000 of capital in reserve
- For £100,000 mortgage loan, need £2,800 of capital in reserve
Regulations
2) Capital adequacy requirements (apply when loans are given)
Exist to prevent banks becoming bankrupt (!), not to control lending
1) Positive money: Full reserve banking
• Money in current accounts cannot be lent to anyone else. It sits as electronic cash at the Bank of England.
• Money for lending is put in an ‘investment accounts’. Savers choose how long they are willing to be without their money – say two years. The money is then lent to someone for two years. The lender can’t access the money in the meantime, the borrower has to repay after two years.
• If loan not repaid, saver loses money (two year loans could be pooled, so lose a proportion depending on how many not repaid).
1) Positive money: Full reserve banking
• Money is created by adding it to the government’s account at the Bank of England
• The government chooses how this is spent
• The amount of money created is decided by the Monetary Policy Committee of the Bank of England, independent from all political interference.
• Full reserve banking has never existed (except maybe Amsterdam for a bit in 17th Century)
• There would no longer be banks as a particular class of regulated company. Anybody could be a bank – eg, pay day lenders, credit unions.
2) Credit controls• UK 1950s and 1960s, quantitative limits
on how much lending banks could make each year, and qualitative limits on what they could lend for (eg, only 20% for mortgages)
• Widespread use historically, including in US
• Japan, Korea and Taiwan used during development. Quantitative limits targeted nominal GDP. Qualitative forced most lending to be for new production, not speculation, asset-buying or consumer purchases
3) Bank nationalisation• Own the banks, then can decide what
they lend for
• Would be similar impact to credit controls
• Difference would be in determining where profit goes, and how much level of political decision over lending
What have we not mentioned?
What have we not mentioned?
