Bank Loans Do Not Work This Way In Inventing Money

We have yet another attempt to tell us that banks just invent money and there’s no limit:

Instead what the bank does is a conjuring trick. To make it easier to understand presume that you have asked a bank you have not dealt with before for this loan. When they agree to the loan they open two accounts for you. One is a current account. The other is a loan account. If you borrow £10,000 they mark your current account as having £10,000 in it. You’re now free to spend that however you like.

They also mark your loan account as having £10,000 in it. You now owe that to the bank.

Add the two together and they add up to nothing. One you apparently own (the current account) and one you apparently owe (the loan account). But if you decided to cancel the deal you could straight away repay the loan using the current account and there would, literally, be nothing left. Which is why I mean they add up to nothing. There was no money before the loan was agreed. There is none when it is repaid. In the meantime the loan created money. And repaying it destroyed it.

Note there’s no cash involved in this process at all. It’s just an accounting trick. Nothing more.

And no one else’s money is involved in the process.

Or any existing money, at all.

This loan creates entirely new money, from nowhere.

That stops working at 4.30 pm each and every afternoon. At which point the bank has to balance its books.

Assume – as is logical – that you’re going to go spend your new loan. Banks being remarkably short in the supply of things you want to buy. Your money therefore leaves the bank. At which point the bank has to go and borrow the money it has just lent you.

Sure, other bank customers might deposit into the bank. But from the bank’s point of view that is the bank borrowing money. Or it could borrow the money from other banks, or issue bonds or, or…..but the bank must finance that loan.

No, there is no cute way out of this. Think on it for a little bit. If there was a cute way then no bank would ever be illiquid, would it? No bank would ever fail for being illiquid either. But banks do become illiquid, it’s a feature of the system. And banks fail because they’ve become illiquid. The most usual form of this being that they cannot continue to finance, with short term borrowings, the long term loans they’ve made.

So, if a bank can fail because it cannot finance loans then it must be true that a bank must finance loans in order not to fail.

Banks do not, therefore, simply invent loans and money out of nothing, for they must finance them.