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Why do we need private banks at all?

by rootless2 Tue Feb 28th, 2012 at 08:37:30 AM EST

Banks make money via statistics. The idea is that 1000 people all deposit $1000 getting say %1 interest, and the bank lends $900,000 to other people getting %8 interest. Over a year, the bank earns $72,000 and pays $10,000 plus its operating expenses. In general, withdrawals will be matched by deposits and borrowers usually don't default so the bank can afford to have 90% of the money deposited with it out on loan. In fact, because many borrowers need credit not a lump sum loan, a bank can lend out more than 100% of its deposits - relying on the borrowers to leave large parts of what they borrowed in the bank between expenses. If the bank is smart, it can ride this statistical advantage by lending to people who keep paying back. However over 700 years or so, societies have learned that this business model always fails in the long run. First, the quality of the banks operation (how good its loans are etc. ) is not visible to depositors until something goes wrong - at which point there is not enough money to cover withdrawals.  Second, and more dangerous, when there are business cycle recessions or panics or other unexpected (but predictable ) events, the model fails: more borrowers default and customers take money out without putting more money in.  So every nation has a complex system of bank regulations to supposedly compensate for the first problem and deposit insurance plus central bank loan programs to compensate for the second problem. Banks can get short term loans from the central bank to keep from sinking under short term imbalances and depositors get their money back from some sort of government insurance if the bank fails. There are three drawback to this model: first, it appears to need regular emergency supplemental bailouts of increasing size,  second it's a ridiculous use of public funds, and third it encourages non-productive investment.


The arguments of the so-called "libertarians" against our system of central bank lending and government insurance are, despite the problems noted above, just stupid. Without some system of public regulation, Marx would have been proved right and capitalism would have collapsed. When a bank fails, not only do depositors lose money, but wreckage is generated throughout the economy. A business can't meet payroll because its payroll money disappears in the bank failure. A supplier can't get paid because the buyer's money disappeared. As each component fails in turn more people are forced to pull savings out of banks and default on loans - spreading a circle of failure. By the late 19th century it was clear that modern market economies are so tightly interconnected that bank failures infect the whole economy with fail. And the world economy is far more tightly connected now than it was 100 years ago. Naked depository banking has been tried and it fails. But the New Deal combination of a strengthened reserve bank plus deposit insurance backed by the government - a method that is now in use worldwide - is not working so well anymore.


Suppose the government provided citizens and businesses with deposit services. Let's say, deposits of up to $100,000 earned 3% plus inflation and deposits over that amount earn nothing. Furthermore, business and individuals can qualify for credit up to a certain amount based on statistical measures.  If you want to borrow more or earn more, then take your chances in the marketplace. But if you want to keep your savings, your cash deposits from your business, your operating funds, somewhere safe and convenient - go to the government bank. The side advantage of this is that the government would not need to borrow money from banks to run. Consider that nations in the EU now are begging banks to buy their bonds - and the banks have money to buy the bonds only because they have deposits which they only have because the government guarantees bank deposits!  This is a scheme that only makes sense to bankers - but they could get real jobs.

(from here )


Display:
'We' don't need private banks. The rich do.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Feb 28th, 2012 at 10:36:14 AM EST
First point, you are reproducing the 'fractional reserve banking' myth: banks do not take in deposits and lend them again.

Banks create credit - as fiat currency look-alikes - which is then spent or lent, creating undated (demand) deposits as reserves or dated (term) loans, respectively.

Private banks are constrained in doing this not by reserve requirements - as is the myth which you repeat - but capital requirements from regulators.

These limit the pyramid of dated loan assets which banks may base upon their capital, and which must at all time be matched by dated (term) deposits, for which increasingly banks rely upon other banks or, these days, central banks.

Second point is that there is no need either for Central Banks or Treasuries to create credit.

The truth of it is that it is our capacity to provide goods and services, and the use value of productive assets such as real property, intellectual property and capital assets, which are the source of credit.

The Internet enables people to interact directly - Peer to Peer - in respect of financing, and 'Peer to Asset' in relation to funding.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Feb 28th, 2012 at 10:48:57 AM EST
"In fact, because many borrowers need credit not a lump sum loan, a bank can lend out more than 100% of its deposits - relying on the borrowers to leave large parts of what they borrowed in the bank between expenses."

That's not what you mean?
I was attempting a short description of things like letters of credit etc.

The main issue I'm addressing is not credit, but deposits.

by rootless2 on Tue Feb 28th, 2012 at 11:18:35 AM EST
[ Parent ]
Deposits are mostly irrelevant - as Chris notes, the real limit to bank balance sheets is their equity, not their liquidity, because liquidity provision is nationalised (as it should be, because liquidity is a public good).

You could, in a modern central banking system, easily separate deposit-taking from lending institutions. In fact, that would probably be a very good start, because that would make it easier to ring-fence the part of the system that absolutely mustn't be allowed to fail from the part that merely shouldn't be allowed to fail repeatedly.

Bill Mitchell has an overview (the five links you find about ten paragraphs down - the text itself is of less relevance to the present discussion). ET has another overview, by yours truly. And you'll find the same description scattered around various BIS and Fed working papers, although these latter tend to bend over backwards to avoid noticing the implications.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Feb 28th, 2012 at 03:52:29 PM EST
[ Parent ]
Forgive me if I mistake your point, but the deposits are not only  a major source of capital, but at least in the US depository banks are the ones with the access to Fed loans. And the justification for the the central bank providing  this loan service is to prevent liquidity failures from causing bank failures that make deposits disappear. So we have a process where repeated bank failures were used to justify both government sponsored deposit insurance and access to government short term loans - because the economic disruption of disappearing deposits caused too much volatility.  So I propose to leave investors on their own and to allow deposits to have a safe haven outside the volatile private bank system.

And what do you think is the source of the equity of, e.g. Citibank ? Their equity consists of loans and other assets that they purchase with retained earning and deposits. No?

 

by rootless2 on Tue Feb 28th, 2012 at 05:30:04 PM EST
[ Parent ]
Deposits are not a bank asset, but a liability. And they are definitely not equity.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 05:32:38 PM EST
[ Parent ]
Yes deposits are a liability - essentially a loan from the depositor. But the bank then converts the deposited funds into an asset. I deposit 1 euro with Santander which then lends the euro to Barracho Brothers Construction at 10% over 10 years which is now magically an asset worth 2 euros or more depending on accounting.
by rootless2 on Tue Feb 28th, 2012 at 05:45:02 PM EST
[ Parent ]
As has been pointed out elsewhere on this thread, lending is not done from deposits.

In fact, lending creates deposits.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 05:48:54 PM EST
[ Parent ]
What do you think Santander does with my euro deposit? Puts it in a mattress?
by rootless2 on Tue Feb 28th, 2012 at 05:55:32 PM EST
[ Parent ]
Why are you talking about Santander, of all banks?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 06:19:29 PM EST
[ Parent ]
random.
by rootless2 on Tue Feb 28th, 2012 at 06:32:06 PM EST
[ Parent ]
It holds it as custodian and pays interest on it.

Now suppose you apply for a loan. When the bank credits your account with the amount of the loan, that increases the deposit base of the bank and increases the amount of your deposit without you actually bringing in any cash or transferring balances from another bank. Therefore, loans create deposits.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 06:24:29 PM EST
[ Parent ]
That would be a very strange business model. Take cash from customers, put the cash in a vault, pay the customer. Seems highly unprofitable. Why in the world would anyone go into such a business?

Why would anyone need deposit insurance in such a case?

As for the loan, what happens when I spend the money on my new Velocicopter. The  Velocicopter company is not interested in what I have on deposit, they want cash. Where does that cash come from?
 

by rootless2 on Tue Feb 28th, 2012 at 06:31:16 PM EST
[ Parent ]
The velocicopter company also has a bank account. It you pay electronically or by cheque, no cash changes hands, just accounting annotations get made.

In any case you are aware that there isn't enough cash in existence to cash out all deposits? In other words, cash is just a collection of government-certified tokens issued in sufficient amount to cover people's demand for pocket money.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 06:51:31 PM EST
[ Parent ]
an infinite number of turtles all the way down.

That's really not how it works.

by rootless2 on Tue Feb 28th, 2012 at 08:49:20 PM EST
[ Parent ]
That would be a very strange business model. Take cash from customers, put the cash in a vault, pay the customer. Seems highly unprofitable. Why in the world would anyone go into such a business?

Profit comes from giving people loans. Deposits are a way to get people in through the door so you can sell them the loan.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Feb 28th, 2012 at 06:52:47 PM EST
[ Parent ]

Generating 74 percent of total payments related
income, current accounts (known as
DDA in the United States) are the core of
the European payments business. In 2007,
retail current accounts contributed €39 billion
in profit, mainly from interest on balances,
out of total payments-related profit
of €68 billion. Corporate accounts added
another €11 billion.

http://www.mckinsey.com/clientservice/Financial_Services/Knowledge_Highlights/Recent_Reports/~/media /Reports/Financial_Services/FS_Current%20accounts%20in%20Europe_MoP7.ashx

We are currently in a weird situation where banks do not have many places to invest deposits profitably.
http://www.nytimes.com/2011/10/25/business/banks-flooded-with-cash-they-cant-profitably-use.html?pag ewanted=all

But your model of how depository banks work is wrong.

by rootless2 on Tue Feb 28th, 2012 at 07:59:43 PM EST
[ Parent ]
But your model of how depository banks work is wrong.

Not that I expect you to revise that, but anyway, here are two post you could read about it.

Naked Capitalism: Banks are not reserve constrained

Some people still believe in the money multiplier taught in old economic textbooks that fractional reserve banking has banks taking deposits, multiplying them as much as possible, subject to the reserve ratio, and making a much larger amount loans. That is not how it works. In practice, banks don't wait for the reserves to be available to issue loans. They make loans first and then borrow the reserves in the interbank market. The loans come first, not the reserves.

Banks are never constrained by reserves or reserve ratios. Banks are capital constrained. In our fiat money system, the central bank uses reserves in the system to help the it hit a target interest rate. So, the central bank provides the system with enough reserves to meet any reserve ratio at its target rate. The reserves are about helping set interest rates, not about pyramiding money on a reserve base.

Understanding this should also help you understand why QE has been a boon for financial speculation but a bust in the real economy:

Steve Keen's Debtwatch: Dude! Where's My Recovery? (June 11th, 2011)
Lest it be said that I'm parodying neoclassical economics, or relying on what lesser lights believe when the leaders of the profession know better, here are two apposite quotes from Ben Bernanke and Paul Krugman.

...

They are profoundly wrong on this point because neoclassical economists do not understand how money is created by the private banking system--despite decades of empirical research to the contrary, they continue to cling to the textbook vision of banks as mere intermediaries between savers and borrowers.

This is bizarre, since as long as 4 decades ago, the actual situation was put very simply by the then Senior Vice President, Federal Reserve Bank of New York, Alan Holmes. Holmes explained why the then faddish Monetarist policy of controlling inflation by controlling the growth of Base Money had failed, saying that it suffered from "a naive assumption" that:

the banking system only expands loans after the [Federal Reserve] System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt. (Alan R. Holmes, 1969, p. 73; emphasis added)
The empirical fact that "loans create deposits" means that the change in the level of private debt is matched by a change in the level of money, which boosts aggregate demand. The level of private debt therefore cannot be ignored--and the fact that neoclassical economists did ignore it (and, with the likes of Greenspan running the Fed, actively promoted its growth) is why this is no "garden variety" downturn.
Yes, Dorothy, it's turtles all the way down and no, we're not in Kansas any more.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 06:16:15 AM EST
[ Parent ]
But that is addressing a very different point. That bank lending is not limited strictly by deposits does not imply banks don't need any capital or that they do not rely on low cost deposits as a source of capital. Goldman-Sachs is selling CD notes, FDIC insured CD notes, precisely to raise capital.  Those deposits are a source of cash which can then be turned into other assets.

Do you think McKinsey is just making it up? Do you think that Citibank has $1trillion in notes just sitting in a vault?

by rootless2 on Wed Feb 29th, 2012 at 08:14:51 AM EST
[ Parent ]
And again: That is arbitrage against the discount window, not against Goldman's lending.

If Goldman had no solvent customers to lend to, they would still be issuing those. Because they are not issuing them to fund lending, they are issuing them to arbitrage against the discount window (or the interbank market, but that comes to the same thing in the final analysis).

Now, it is certainly possible - in principle - for the central bank to create a high enough spread between the support rate and the main refinancing rate that the absence of solvent customers would disincentivise banks from accepting deposits. But that's not the case today, has not been the case historically, and there is no obvious reason for the central bank to ever do so in the future.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 08:58:04 AM EST
[ Parent ]
Deposits are not "low cost". Especially not now in a "liquidity trap".

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:28:43 AM EST
[ Parent ]
They aren't? Seems my bank is paying a negative real interest rate on my deposits. Seems cheap to me.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Feb 29th, 2012 at 10:09:04 AM EST
[ Parent ]
But the central bank is paying them a negative real interest rate on their excess reserves, and demanding a negative real interest rate on their rediscounts.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 10:23:19 AM EST
[ Parent ]
So why don't they increase lending to reduce excess reserves? Because I suppose that's why those reserves are called "excess"?

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 1st, 2012 at 05:34:58 AM EST
[ Parent ]
Because they prefer to lend the cash to the ECB at 0.25% than to the "real economy".

But I repeat myself

We're in a liquidity crisis and banks want to be in an all-cash asset position.
I wonder what would happen if the ECB set the deposit rate (remuneration on excess reserves) to a negative nominal rate.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 1st, 2012 at 05:41:41 AM EST
[ Parent ]
Wow, that was a real brain freeze on my part. :P

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 1st, 2012 at 06:05:02 AM EST
[ Parent ]
Now you know where the LTRO is ending up: excess reserves.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 1st, 2012 at 08:15:59 AM EST
[ Parent ]
Soooo... why don't the ECB lower their rates on excess reserves to zero? Or even a negative nominal number? Sure, banks might just then have all that borrowed cash sitting in their electronic vaults (instead of in the electronic vaults of the ECB), but they'll have at least some increased incentives to lend.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 1st, 2012 at 10:03:56 AM EST
[ Parent ]
Soooo... why don't the ECB lower their rates on excess reserves to zero?

For all practical purposes they have.

They don't do it permanently, because the remuneration rate for excess reserves sets the floor under the interbank rate. Which the CB wants to do if it wants to conduct active interest rate policy. It shouldn't do that IMO (I favour a zero interest rate policy and conducting monetary policy at the exchange rate and margin requirements instead), but that's a subject for another time.

Or even a negative nominal number?

Then the banks would go all-cash. As in, demand a big pile of € 100 bills that they could actually lock in their physical vault. Unless you go full Geselian currency, you can't beat the zero bound on nominal interest rates.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Mar 2nd, 2012 at 04:58:31 AM EST
[ Parent ]
You know, I think I've learnt as much or more reading the ET comment threads than I have my text books.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 1st, 2012 at 10:05:41 AM EST
[ Parent ]
Though I suppose there is one more place LTRO money is going beside excess reserves: Spanish banks buying Spanish sovereign debt, Portuguese banks buying Portuguese sovereign debt, Italian banks buying Italian sovereign debt, and so on. They'll all go down anyway if their sovereign defaults, as they already hold so much domestic sovereign debt. So they might as well double down and buy more, especially as the ECB is printing money for them to do it. A little upside, no downside.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 1st, 2012 at 10:11:15 AM EST
[ Parent ]
And then they are repoing the bonds for cash at the LTRO and putting the cash in excess reserves.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 1st, 2012 at 11:19:43 AM EST
[ Parent ]
Can they use that cash to buy even more periphery sovereign bonds, and then repo those bonds for even more cash, and then use that cash... and so on and so on?

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Fri Mar 2nd, 2012 at 06:34:09 AM EST
[ Parent ]
Yes.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Fri Mar 2nd, 2012 at 06:46:50 AM EST
[ Parent ]
Wow. That's brilliant. There really are turtles all the way down.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Fri Mar 2nd, 2012 at 07:27:43 AM EST
[ Parent ]
No, it's called central bank monetization of sovereign debt is illegal but not if it's mediated by private banks. Also known as transsubstantiation religious bollocks.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Fri Mar 2nd, 2012 at 07:30:16 AM EST
[ Parent ]
Shhhh! Someone Serious might hear you!

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Fri Mar 2nd, 2012 at 07:32:45 AM EST
[ Parent ]
Transsubstantiation stands on not a few outsize turtles...
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Mar 2nd, 2012 at 08:09:17 AM EST
[ Parent ]
Or canards, me duck.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Fri Mar 2nd, 2012 at 08:56:29 AM EST
[ Parent ]
Draghi's comments on the press conference today got me thinking a bit more.

14. 23 Some fascinating comments from Draghi -- delivered with obvious relish -- on what he sees as the real potential benefits of the LTRO to the real economy. He stresses that the number of banks tapping the cheap three year finance jumped from some 500 in December to 800 this time. Many of the new takers were small banks in Germany and elsewhere.

    I would love to read you the places, the towns, the villages where these banks are but often they would be the only bank in towns so they could be identified. But this tells me one thing - this money is now closer to the small and medium-sized businesses than it was before. I'm not saying this money will necessarily go to SMEs but it is certainly closer. We have this in mind because 80 per cent of eurozone employment is SMEs.


Isn't Draghi right here, that LTRO money could actually end up in real investment?

Imagine a fundamentally solvent European bank, ie a bank without periphery sovereign debt all over its balance sheet. Imaging that this bank has a number of customers who want to borrow money for certain projects, say a mine or a wind power project. Given the risk for the bank inherent in the project, the bank want the money bank back in three years, and a margin of at least 10 %. The bank can currently raise money at a cost of 4 %, and hence demand an interest rate of 14 % on the loan to issue it. This rate of interest turns the net present value of the project negative, so no loan is made and the project doesn't happen.

Imagine instead that the bank pledges some of its quality assets to the ECB and gets to borrow at 1 %. Hence, they only demand 11 % interest from the developer, which turns the NPV positive, the money is lent, the project happens and demand increases.

Or am I missing something here?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Thu Mar 8th, 2012 at 11:47:36 AM EST
[ Parent ]
Isn't Draghi right here, that LTRO money could actually end up in real investment?

It's not really the LTRO money. The key here is 8 December 2011 - ECB announces measures to support bank lending and money market activity

The NCBs are allowed, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use. Details of the criteria for the use of credit claims will be announced in due course.
I.e., banks could potentially give loans and use those loans as collateral for liquidity directly with their national central bank, not just at the LTROs but at the weekly liquidity auctions.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 8th, 2012 at 12:05:26 PM EST
[ Parent ]
Well, shouldn't that work in some cases, and give lower interest rate costs to companies, and hence make more projects NPV-positive?

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Mar 8th, 2012 at 12:09:30 PM EST
[ Parent ]
No reason why it shouldn't. See my Rediscovering Minsky's wheel, one pundit at a time (May 9th, 2011) and JakeS' The trouble with [talking about] banking (May 13th, 2011) for more on that.

Also, Steve Keen's Dude! Where's My Recovery?

This is bizarre, since as long as 4 decades ago, the actual situation was put very simply by the then Senior Vice President, Federal Reserve Bank of New York, Alan Holmes. Holmes explained why the then faddish Monetarist policy of controlling inflation by controlling the growth of Base Money had failed, saying that it suffered from "a naive assumption" that:
The banking system only expands loans after the [Federal Reserve] System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt. (Alan R. Holmes, 1969, p. 73; emphasis added)
The empirical fact that "loans create deposits" means that the change in the level of private debt is matched by a change in the level of money, which boosts aggregate demand. The level of private debt therefore cannot be ignored--and the fact that neoclassical economists did ignore it (and, with the likes of Greenspan running the Fed, actively promoted its growth) is why this is no "garden variety" downturn.

In all the post-WWII recessions on which Lazear's regression was based, the downturn ended when the growth of private debt turned positive again and boosted aggregate demand. This of itself is not a bad thing: as Schumpeter argued decades ago, in a well-functioning capitalist system, the main recipients of credit are entrepreneurs who have an idea, but not the money needed to put it into action:

[I]n so far as credit cannot be given out of the results of past enterprise ... it can only consist of credit means of payment created ad hoc, which can be backed neither by money in the strict sense nor by products already in existence...

It provides us with the connection between lending and credit means of payment, and leads us to what I regard as the nature of the credit phenomenon... credit is essentially the creation of purchasing power for the purpose of transferring it to the entrepreneur, but not simply the transfer of existing purchasing power." (Joseph Alois Schumpeter, 1934, pp. 106-107)



There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 8th, 2012 at 03:42:54 PM EST
[ Parent ]
But there is an important point insofar as the ECBuBa keeps pretending that it's going to yank away the unlimited tender weekly liquidity before the interbank market has completely unfrozen. And some of the members are crazy enough to actually do it, so it's a threat that has to be taken seriously.

This ensures that the liquidity for a mid-term project won't suddenly disappear in a poof of neo-Hayekian idiocy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 8th, 2012 at 05:33:50 PM EST
[ Parent ]
Well, can they call in the cash at anytime? The repo is over three years, isn't it? That is, ECB only has the right to demand the cash back after three years, not earlier than that.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Fri Mar 9th, 2012 at 10:31:21 AM EST
[ Parent ]
Precisely.

Mig argued that they had already done what you said they were doing when they expanded the eligibility for the MRO.

I agree with you that this has a greater scope, precisely because it can not be revoked with a week's notice. But I also agree with Mig that the scope is not as much greater as the BuBa (wants to) believe.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Mar 9th, 2012 at 11:54:14 AM EST
[ Parent ]
Eurointelligence Daily Briefing: Weidmann says Target 2 imbalances a major concern - calls on Draghi to change collateral rules (01.03.2012)
Angelo Baglioni

Writing in Lavoce, Angelo Baglioni writes that very little of trillion euro LTRO shows is likely to end up with the real economy (a point also made by Fitch Ratings yesterday). He said the sole effect of this  operation is to support government bonds. If the ECB were to assume the role of lender of last resort, it would favour a policy to strengthen the traditional banking lending channel. As it stands, however, the economy continues to be weighed down by credit constrains, which will exacerbate the recession.



There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 1st, 2012 at 05:58:40 AM EST
[ Parent ]
McKinsey is saying the opposite of what you want to imply:
Current accounts are the cornerstone of the European payments business.
Consumer deposits are part of the payments and clearing system, as JakeS has pointed out.
They provide a stable and inexpensive source of funding for banks,
They're talking about current account, not savings accounts or time deposits. Current accounts don't generally pay interest, therefore they are a cheap source of liquidity ("funding" - see also JakeS's comments) in the amount of their average balance. In the US, checking accounts generally have quite stiff maintenance fees unless minimum balances are maintained. But savings accounts or time deposits pay higher interests and are therefore more expensive. Also, some banks aggressively advertise demand deposits (current accounts) paying high interest rates. Those are an expensive source of funding.
and interest on balances provides the major portion of payments-related income in Europe.
If that's bank income, it must refer to interest charged on negative balances.
As banks' stickiest product, current accounts are an excellent basis for selling other products and building a broad relationship with a customer.
Also mentioned in mine and others' comments
Important challenges loom, however. Even as overall payments revenue is projected to grow from 30 to 35 percent of total banking revenues in Europe between 2007 and 2012, income from current accounts is under attack.
This [bank] income from current accounts must be from charges and fees.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:50:01 AM EST
[ Parent ]
So your claim is that banks in Europe generate 30% of their revenue from charges and fees on current accounts?
by rootless2 on Wed Feb 29th, 2012 at 10:49:38 AM EST
[ Parent ]
What is your mechanism for banks to generate revenue from deposits?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 10:52:24 AM EST
[ Parent ]
They lend it.

0% current account deposit of 100 zlotys
5% mortgage for 100 zlotys

Profit!

by rootless2 on Wed Feb 29th, 2012 at 11:12:05 AM EST
[ Parent ]
The revenue is from the loan, not from the deposit.

And as we've pointed out repeatedly loans don't require deposit. They create deposits.

If I have 100 of your zloty and I lend 100 zloty to Jake, I credit 100 zloty to Jake's account so now you still have your 100 zloty deposit and Jake has a spanking new 100 zloty deposit. So my loan to Jake doubles my deposits from 100 to 200. I am not loaning to Jake from your 100. Your 100 are still available to you, as are Jake's 100.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:15:50 AM EST
[ Parent ]
In order to lend the money to Jake I must meet a reserve cash requirement. Where does that cash come from?
by rootless2 on Wed Feb 29th, 2012 at 11:51:43 AM EST
[ Parent ]
You can borrow it from another bank. Or you can pledge the loan to Jake as collateral at the central bank in exchange for cash with which to satisfy the reserve requirements. Or you can take deposits.

But you only have to satisfy the reserve requirement after Jake already has his loan. In extremis you will borrow the reserves from the central bank at a penalty rate.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:58:39 AM EST
[ Parent ]
No, you have up to a month to find those regulatory reserves, because regulatory compliance only requires that your average position over the month in question is in excess of the requirement.

But that's actually incidental, because you make the loan to me, and turn around and rediscount the note with the CB on the very same day.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:02:19 PM EST
[ Parent ]
rootless2:
Why in the world would anyone go into such a business?

Well, for one I am not certain that I did get more in interest last year then they nicked in fees, but anyhow there are a couple of possible reasons:

  1. That the government demands it for access to the lucrative borrow from central bank and lend to customers business.

  2. That borrowing from customers is cheaper then borrowing form the central bank when it comes to liquidity demands of the government.

  3. That it brings customers in.

On the third, I do have an account with the bank of my local supermarket chain that did pay interest and have no fees. But then again once I have put money in that bank I am probably more likely to shop at their stores anyway. And with a banking license they can fund their own loans from their own bank, even though they do not appear to lend to anyone else.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
by A swedish kind of death on Wed Feb 29th, 2012 at 04:14:45 AM EST
[ Parent ]
1. and 3. are correct. 2. is correct under normal circumstances, but since the Global Financial Clusterfuck there are plenty of deposits being advertised by banks which pay more than the central bank demands for its lending.

The difference is that central bank lending to banks is collateralised quite stringently, whereas customer deposits are not collateralised. In fact, they are guaranteed by the government and the cost to banks of taking part in deposit insurance schemes is rather low.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 06:00:47 AM EST
[ Parent ]
2. <- is the issue under discussion.
by rootless2 on Wed Feb 29th, 2012 at 08:15:45 AM EST
[ Parent ]
You need to view this in terms of opportunity costs.

If the bank lends you money, the opportunity cost of that money is the Fed funds rate. This, along with legal limits on how much lending it may pile on top of its equity, is the operational constraint on bank lending. This is irrespective of the rate it pays on deposits, or the volume of deposits.

Yes, it can use deposits to defray that expense, if it can obtain them at less than the Fed funds rate. But if it can obtain deposits at less than the Fed funds rate, it could also just place them in the interbank market or at the discount window to make the Fed funds rate on them. If the bank made no loans at all, it would still be trying to attract those deposits. And if the bank had no depositors, it would not alter one whit the quantity or interest rate of its lending.

OK, in Goldman's case this is not true. Goldman doesn't take deposits because of a business case for taking deposits. Goldman takes deposits so it can hold them hostage if the federal government decides that Goldman needs to go away. But Goldman is special.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 09:14:17 AM EST
[ Parent ]
Discuss: Government bids to bring halt to banks' deposit war (13 April 2011)
Much to the displeasure of the Bank of Spain, the sector has been engaging in a deposit war now for several months in order to improve liquidity after the debt crisis in the euro zone cut off traditional wholesale funding sources for many lenders.

Some banks are offering annual deposit rates of 4 percent, thereby, narrowing their margins and restricting their ability to lend. The practice also ends up increasing the borrowing costs of households and companies.

The decree move follows repeated calls by the central bank to put an end to what it feels is a self-defeating practice.



There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:24:50 AM EST
[ Parent ]
So why do they need "liquidity" if they can just create money as needed?

What does the bank get out of having that cash there?

by rootless2 on Wed Feb 29th, 2012 at 10:42:21 AM EST
[ Parent ]
Only the central bank can create money as needed.

The other banks can only create the money they lend. When they have to make an actual payment to another bank, they need actual money (i.e., liquidity).

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 10:47:49 AM EST
[ Parent ]
But previously, you said that what the bank does with my deposit is

"It holds it as custodian and pays interest on it."

So now it is used for interbank payments too?

by rootless2 on Wed Feb 29th, 2012 at 11:13:16 AM EST
[ Parent ]

The other banks can only create the money they lend. .

Not so, they create money when they spend as well, except that this spent money becomes the object of an (undated) demand deposit in the recipient's current account.

What happens with the (dated) loan is that the money is created, deposited and then instantaneously lent via what is essentially a repo of virtual (fiat 'look-alike') cash.

I find it useful to distinguish between dated and undated deposits.

Banks must always balance - in aggregate - dated (term-even overnight) deposits and dated (loan) assets.

Undated demand deposits (reserves) which are held by banks at the Central Bank are reflected in the balance sheet by:

(a) the (undated) ownership claim of the banks equity capital; and

(b) the (undated) claim of demand depositors in respect of their current account balances.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Feb 29th, 2012 at 11:59:58 AM EST
[ Parent ]
The central bank pays them interest on the pile of cash. Or the Treasury does, if the CB enforces its target rate by open market operations. Comes to the same thing, though, unless your central bank believes that Treasury notes have cooties, like the ECB does.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 10:53:34 AM EST
[ Parent ]
So your theory is that they borrow from depositors at 4% and lend to the reserve bank at 1% (actually less).

No wonder they are in trouble.

by rootless2 on Wed Feb 29th, 2012 at 11:01:20 AM EST
[ Parent ]
No, they borrow (uncollateralised) from depositors at 4% and borrow (collateralised) from the central bank at 1%.

They lend to each other, and to customers, at whatever the respective markets will bear.

And it's not my theory. It is a fact Competition for deposits in 2010-11 got insane and they were offering up to 4% for demand deposits (not time deposits!) which did squeeze margins as they were not increasing what they were charging for their lending in a commensurate way. And so the Central Bank got worried, especially as competition for deposits is a zero-sum game among banks and does not improve the overall health of the banking system.

However, what deposits (as liabilities) do is allow banks to book cash as assets. At a minimum they can park this cash as central bank reserves making a measly 0.25%. And, as assets, central bank reserves and cash don't count as risk weighted assets and therefore don't count in capital adequacy requirements (i.e., they don't imply regulatory or market needs for additional equity) whereas a loan which may collect 7% or upwards as interest income is a risky asset which does count as risk-weighted assets for capital adequacy purposes and does lead to additional equity requirements.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:12:16 AM EST
[ Parent ]
I must be dumb indeed, because here's what I understand Jake to be saying:

  1. the banks borrow from customers at 4%
  2. the banks deposit that money in the central bank at nearly zero interest.

That would make no sense.

At a minimum they can park this cash as central bank reserves making a measly 0.25%. And, as assets, central bank reserves and cash don't count as risk weighted assets and therefore don't count in capital adequacy requirements

So they put some of it in the central bank, which increases their cash asset base which allows them to lend and buy more profitable assets - in theory. But suddenly, the deposit taking doesn't seem like a service business, it seems like a vital part of bank capital management. In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!

To me you are taking a true observation: that with access to central bank reserves and fancy accounting, bank lending is not constrained to be a fraction of deposits, and then extending it over the cliff as an argument that deposits don't have any effect on bank lending capability - something you contradict in the quoted sentence above.

by rootless2 on Wed Feb 29th, 2012 at 11:21:06 AM EST
[ Parent ]
Look, before the Global Financial Clusterfuck it was a perfectly viable banking model to fund your lending by borrowing in the interbank market instead of and in preference to deposit-taking.

Then the interbank maket seized and it took with it Northern Rock and Lehman Brothers.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:25:34 AM EST
[ Parent ]
I agree with that, sort of, before the crisis one would read all sorts of snotty comments about the business of retail banking which was so passe and boring. BUT before the boom deposits were the prized and since the bust, suddenly all those juicy deposits look valuable again.  They are NOT a service business but a much sought after source of cash which banks obtain at a low rate because of the government subsidy in form of the guarantee. My argument is that there is little public gain in the resulting complex system and guaranteed deposits could simply be provided for by a postal bank or flexible treasury bond system.
by rootless2 on Wed Feb 29th, 2012 at 11:43:48 AM EST
[ Parent ]
Your conclusion - that the depository function could be handled by a postal bank, or direct participation by the CB - is true.

Everything leading up to it is false, and it won't have the effect on the financial system you think it will. But it's still a good idea for other reasons.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:05:17 PM EST
[ Parent ]
I think the reason deposits are wanted now - and even more so a year or so ago - is that we are living through a continous financial crisis.

US embassy cables: Mervyn King says in March 2008 bailout fund needed | Business | guardian.co.uk

The problem is now not liquidity in the system but rather a question of systemic solvency, Bank of England (BOE) Governor Mervyn King said at a lunch meeting with Treasury Deputy Secretary Robert Kimmitt and Ambassador Tuttle. King said there are two imperatives. First to find ways for banks to avoid the stigma of selling unwanted paper at distressed prices or going to a central bank for assistance.

I understand this to mean that banking as a whole since 2008 is in permanent crisis. This causing stuff like temporarily panics for deposits to short-term meet requirements that would otherwise send them into receivership or to government help centrals.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Feb 29th, 2012 at 02:17:37 PM EST
[ Parent ]
I think the reason deposits are wanted now - and even more so a year or so ago - is that we are living through a continous financial crisis.

We're in a liquidity crisis and banks want to be in an all-cash asset position.

This is what the ECB's LTRO is about: allowing banks to get into an all-cash position for up to 3 years to weather the coming storm. Draghi to banks: winter is coming and it's going to last at least a year.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 04:59:09 PM EST
[ Parent ]
I must be dumb indeed, because here's what I understand Jake to be saying:

  • the banks borrow from customers at 4%
  • the banks deposit that money in the central bank at nearly zero interest.

That would make no sense.

If you can find a bank that'll pay you 4 % on a demand deposit, you should run away very fast because they're most likely desperately papering over their insolvency.

But suddenly, the deposit taking doesn't seem like a service business, it seems like a vital part of bank capital management.

"Large" != "vital."

In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!

Not so.

Having extended a loan, they must obtain some cash reserves. They can always do this (so long as they are solvent and the central bank defends a policy rate) by rediscounting the loan with the central bank.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:29:53 AM EST
[ Parent ]
In order to lend, they must have some cash reserves. And one big source of cash reserves is - deposits!
Not so.

Having extended a loan, they must obtain some cash reserves. They can always do this (so long as they are solvent and the central bank defends a policy rate) by rediscounting the loan with the central bank.

ECB: 8 December 2011 - ECB announces measures to support bank lending and money market activity
The NCBs are allowed, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use. Details of the criteria for the use of credit claims will be announced in due course.


There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:32:08 AM EST
[ Parent ]
It's very easy to find a bank offering 4% on short fixed term deposits - I simply look up the article migeru linked to 3 comments above.
by rootless2 on Wed Feb 29th, 2012 at 11:46:24 AM EST
[ Parent ]
No, not any more. But it was possible a year ago.

And, again, your point is?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:47:30 AM EST
[ Parent ]
That would make no sense.

I have called it insane. The Spanish Central Bank called it self-defeating and after a year of asking pretty please it issued a directive banning the practice.

So, your point is?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:36:27 AM EST
[ Parent ]
So what was the bank motivation? Just crazy?
by rootless2 on Wed Feb 29th, 2012 at 11:52:31 AM EST
[ Parent ]
Interbank lending dried up and borrowing from the Central Bank carried a stigma. So the banks started a price war. You are familiar with the concept of a price war, and why it's not necessarily a good thing for firms to engage in it, are you not?
In the short term, price wars are good for consumers, who can take advantage of lower prices. Often they are not good for the companies involved. The lower prices reduce profit margins and can threaten their survival.

In the medium to long term, they can be good for the dominant firms in the industry. Typically, the smaller, more marginal, firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.



There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:56:26 AM EST
[ Parent ]
This is what you claimed banks did with deposits

"It holds it as custodian and pays interest on it."

So the motivation for this price war is somewhat elusive. The prestige of being a custodian and paying interest?

I'm more used to looking businesses that try make profits or at least revenue. This concept of borrowing money from depositors as a beneficent service has me befuddled.

by rootless2 on Wed Feb 29th, 2012 at 12:26:03 PM EST
[ Parent ]
Having a customer's deposits means the bank becomes involved in all the payments activity of that customer and collects all kinds of service provider fees from it.

Also it brings the customer in the door so they can be sold loans.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 12:28:19 PM EST
[ Parent ]
Yes.1

But more importantly, depositors don't ask for collateral. The discount window does. So when your balance sheet is full of shit, you are willing to pay your depositors for the privilege of not being asked questions.

If your balance sheet is not full of shit, however, there is no particular reason to prefer creditors who do not ask questions over ones who do.

- Jake

1A lot of bankers (and, unfortunately, regulators) are witch doctors who target cutesy rules of thumb like "lending/deposit ratio," Taylor rules or "even banks around the rediscount rate." Most of these rules of thumb are bullshit, but pass for plausible under ordinary conditions, because they basically amount to "do the same thing you did yesterday."

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:00:16 PM EST
[ Parent ]
If you can find a bank that'll pay 4 % on a demand deposit anywhere in the world today, I wanna know where it is, so I can run as fast as possible in some other direction.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:30:25 AM EST
[ Parent ]
Forgive me if I mistake your point, but the deposits are not only  a major source of capital,

They are a source of liquidity. If depositors woke up one fine morning and decided that they would rather hold cash than FDIC-insured deposits, then the Fed would provide the cash. It must, if it wishes to defend its interest rate policy.

The reason banks like deposits is that they come with fewer strings attached than interbank or central bank loans, they are generally cheaper and, as you note, in some systems accepting deposits is a prerequisite for gaining access to interbank and central bank funding or other perks.

But operationally, you might as well split the deposit-taking bank into two: One that takes deposits and deposits them at the central bank, where the CB pays its policy rate on them, and one that originates loans, which it then rediscounts with the central bank, or - what comes to the same thing - in the interbank liquidity market.

This, incidentally, is the answer to your question elsewhere in the thread about what banks do with deposits: They put them in the central bank, and the central bank pays them its policy rate for that (give or take the CB's own bid-ask spread). They make money on the spread between the policy rate and the rate they pay their depositors, and their costs include servicing those deposits with ATMs, branch offices and so on.

And the justification for the the central bank providing  this loan service is to prevent liquidity failures from causing bank failures that make deposits disappear.

That's the depositor guarantee, no the discount window.

The reason the Fed lends to banks is that by the combination of setting an interest rate for such loans and demanding that banks maintain a certain liquidity reserve, the Fed sets an interest rate floor under the loans extended by the bank - if the bank must secure funding at 3 % from the Fed, on peril of being shut down, then it cannot very well charge less than 3 % for the loans it makes to other businesses.

And what do you think is the source of the equity of, e.g. Citibank ? Their equity consists of loans and other assets that they purchase with retained earning and deposits. No?

Their equity is the difference between assets and liabilities. This is unchanged when you deposit $100 at Citi. And because Citi can borrow from the CB or the interbank market at the policy rate, and place your deposit there at the same rate, the opportunity cost of creating a new loan is also unchanged by your deposit.

Essentially, deposit-taking institutions are service providers who manage the everyday payment clearing system. Which, incidentally, is the reason they IMO shouldn't be allowed to touch the lending business.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 06:24:07 AM EST
[ Parent ]
deposit-taking institutions ... IMO shouldn't be allowed to touch the lending business.


There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 06:25:55 AM EST
[ Parent ]
It follows logically from wanting banks to fund from the discount window rather than the interbank market. If all funding is from the discount window and all deposits end up at the discount window, there is no longer any operational reason for the co-habitation between banking and the routine operation of the clearing infrastructure.

And I see no particular reason to expect expertise in one of those areas to translate into competence in the other: One is an infrastructure servicing function, the other is an industrial planning function. I would expect deposit-handling to have more in common with supermarket logistics or cell phone networks than with credit analysis and due diligence.

Also, I want the regulator to be able to burn the investment banks down without waking up to the ATMs not working.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 06:34:43 AM EST
[ Parent ]
Could one of these operations be set up under current legislation?

Could it be something we interest a cell-phone company in?
(There's a lot of reasons for them to get into the wider payment transactions business, this could complement...)

by Metatone (metatone [a|t] gmail (dot) com) on Wed Feb 29th, 2012 at 10:49:24 AM EST
[ Parent ]
And no, I don't know how to make this happen straight away, but following Sven's theory of consumer power, if someone could set up a "deposits bank" that can advertise that it does no lending, so it's incredibly safe in these troubled times... that might make some waves...
by Metatone (metatone [a|t] gmail (dot) com) on Wed Feb 29th, 2012 at 10:52:46 AM EST
[ Parent ]
The thing is, deposits are perfectly safe in any country with a depositor guarantee (Iceland was special). So you don't get to make that selling point.

It's also a very low-margin business, which means you need to piggy-back on some other activity to be able to make payroll, nevermind turn a profit. That activity has to (a) cover a wide geographic area, and (b) be accustomed to handling substantial amounts of cash or cash-equivalent.

That means you'll be piggybacking on banks, supermarkets or post offices. And the last one is going away, so banks or supermarkets.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:07:20 AM EST
[ Parent ]
I'm thinking mobile phone operator... because I may be able to seed the idea with one...

But yes, supermarkets are the ones already trying to get into banking.

And at least in the UK, deposits are perfectly safe, but plenty of people don't believe that they are safe...

by Metatone (metatone [a|t] gmail (dot) com) on Wed Feb 29th, 2012 at 11:36:06 AM EST
[ Parent ]
Well, it's gonna be a loss-leader at least until we get out of the current clusterfuck and central banks start hiking their policy rates back up.

But on the upside, if they can make a safe and convenient "cash app" for phones, they will be able to automate some of the drudgery (and hence cost) associated with handling deposits, because they won't have to shift as much physical cash around.

The latter point might actually be the main business venture for a cell phone operator, at least initially. In Denmark alone (5 million people), it's estimated that firms and banks spend on the order of a billion € a year on handling petty cash. So there should be an R&D grant or two in that project. And a couple of hundred million Euro in licensing revenues if they can get people to switch to it wholesale.

And at least in the UK, deposits are perfectly safe, but plenty of people don't believe that they are safe...

OK, point. But I'd be careful about trying to play on that. Because the BoE and Chancellor might, eh, take exception to people starting bank runs for fun and profit.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:49:04 AM EST
[ Parent ]
We can learn from Africa in this area.

No need for research grants.

Now what ?

by pi (etrib@opsec.eu) on Sat Mar 3rd, 2012 at 01:16:33 PM EST
[ Parent ]
In principle you can do it tomorrow.

'You' being a trustworthy entity with equity on the order of € 10 million.

As askod notes, several supermarket chains already do that (though I believe that this is mostly about funding their inventory at the policy rate rather than the retail rate, and not so much about handling deposits).

I would think that cell phone operators would be both too small and too unstable to be plausible depository institutions. I would go with supermarkets if I were to push something like that.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 10:59:16 AM EST
[ Parent ]
You are correct on all these dimensions.

The mobile operator is big and red... worth a try I suspect...

by Metatone (metatone [a|t] gmail (dot) com) on Wed Feb 29th, 2012 at 11:37:57 AM EST
[ Parent ]
What I think the superrmarket is really doing is using deposits as a way to take advantage of the psychology of sunk costs. Since I have already set off a sum on their account as my food budget - payable with their card in their stores - I am more likely to treat shopping at their store as lower cost because it comes out of my already set aside food budget instead out of my general budget. Plus they offer discounts for having the card, for paying with the card, for using the card a lot and so on. And of course they are going to collect data from purchases to tailor offerings and see who pays what with what.

So the point with the deposits is not really to make money of them directly, but to use it as part of building customer loyalty around a payment/discount card.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Feb 29th, 2012 at 02:01:58 PM EST
[ Parent ]
The two are not mutually exclusive. But just looking at the size of an ordinary supermarket inventory compared to its markups, shaving a percentage point or two off their funding cost by tapping directly into the interbank market would easily exceed any possible revenue increase from the effects you're talking about.

Doesn't mean the supermarket in question won't happily accept the extra customers. But that's not the biggest incentive at work here.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 1st, 2012 at 02:45:01 AM EST
[ Parent ]
I'm not so sure. Supermarkets typically pay for the goods they sell over 6 months after acquring them. Very, very little of their inventory will need to be funded -on the other hand, they will play with the colossal amount of liquidity they have at hand.

But maybe, getting the option of funding at the target rate, they could tell their supplier that they would be open to paying earlier in return for a nice 10% off the price.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Sat Mar 3rd, 2012 at 02:20:39 AM EST
[ Parent ]
This, incidentally, is the answer to your question elsewhere in the thread about what banks do with deposits: They put them in the central bank, and the central bank pays them its policy rate for that (give or take the CB's own bid-ask spread). They make money on the spread between the policy rate and the rate they pay their depositors, and their costs include servicing those deposits with ATMs, branch offices and so on.

Well the McKinsey report I cite below describes profits banks had from interbank lending on deposits. And this report from the Fed shows that prior to the financial crisis, excess reserves were near zero

http://www.newyorkfed.org/research/staff_reports/sr380.pdf

by rootless2 on Wed Feb 29th, 2012 at 08:27:48 AM EST
[ Parent ]
Well the McKinsey report I cite below describes profits banks had from interbank lending on deposits.

Yes. That's what I'm saying. They put them with the central bank. Or in the interbank liquidity market, but that comes to the same thing, since the central bank puts in or withdraws liquidity from that market in precise lockstep with demand, resp. supply. Because if it does not do so, it cannot defend its target rate.

And this report from the Fed shows that prior to the financial crisis, excess reserves were near zero

Uh, yes. That's my point. That's not an accident. It works out like that because the Fed uses open market operations to withdraw liquidity from the interbank market. The liquidity in question still ends up with the Fed, even though it passes through a couple of private bank balance sheets first.

The reason excess reserves have risen is that the Fed is at the zero bound (or near enough as makes no matter). The moment the Fed decides that it wants the Fed Funds Rate to be, say, 2 %, that excess liquidity will disappear overnight, or at least before the next bank day.

Now riddle me this: What, in your view, is the difference between the Fed selling a one-week Treasury note (pretend for the moment that such a maturity is issued in the first place) at a yield to maturity of 1 % and the Fed offering a one-week liquidity deposit at 1 %?

Because unless you have a really great answer to that question, you need to rethink your view of where deposits go after you put them in the bank.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 08:52:08 AM EST
[ Parent ]
Well the McKinsey report I cite below describes profits banks had from interbank lending on deposits.

That's "interbank deposits". A "deposit" in that case is short-term lending to another bank. Banks make money on that.

You're conflating that with "retail deposits".

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:21:21 AM EST
[ Parent ]
The mckinsey report is about retail and corporate deposits.
by rootless2 on Wed Feb 29th, 2012 at 10:44:59 AM EST
[ Parent ]
If you were correct about what banks do with deposits, it would contradict Migeru's argument.

But in fact, it's not true
http://www.kc.frb.org/publicat/fip/prs01-4.pdf

by rootless2 on Wed Feb 29th, 2012 at 08:33:27 AM EST
[ Parent ]
No, I'm making the same argument Mig is.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 08:53:39 AM EST
[ Parent ]
Nice try.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 09:20:09 AM EST
[ Parent ]
Growth in traditional deposit funding sources
has stagnated at many banks in recent years and has
largely failed to keep up with the growth in bank
assets. In response to these trends, banks have had
to supplement traditional funding sources with a
variety of new, but potentially less stable and more
expensive, funding instruments

from the fed article i cited.
that was in 2001 - before the current crisis. But the point is clear, I hope.

by rootless2 on Wed Feb 29th, 2012 at 10:36:53 AM EST
[ Parent ]
Perhaps my understanding of accounting is poor, but to me it looks like this

the deposit is entered as both a
Debit - of 100
and
Asset - of 100

The bank, which intends to make a profit, will not be motivated to put the money in a reserve account from which it can borrow at the same rate - unless it has serious liquidity or reserve issues or cannot find a more attractive place to invest. If the bank can lend the money out with interest, the accounting then shows the bank with an increased asset. That is the normal business of banks.

by rootless2 on Wed Feb 29th, 2012 at 11:00:03 AM EST
[ Parent ]
Under no ordinary circumstance will the bank pay the full policy rate on demand deposits. They only pay at or above the policy rate when they want to borrow with absolutely no questions asked. Which is not the usual state of affairs for solvent banks, who are perfectly happy to entertain questions pertaining to the use of their loans when doing so knocks 50-75 basis points off their funding cost.

So, you put € 100 in the bank. The bank pays you 1 % pr year. The bank turns right around and puts the money in the central bank. Which pays, say, 1.5 % pr yr.

This is a poor business model because?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:17:36 AM EST
[ Parent ]
so when you wrote

But the central bank is paying them a negative real interest rate on their excess reserves, and demanding a negative real interest rate on their rediscounts.

how does this square with 1.5% ? Can you point me to some indication that the central banks are paying at such a rate?  What I see for both US Fed and ECB is significantly less.

by rootless2 on Wed Feb 29th, 2012 at 11:30:45 AM EST
[ Parent ]
The ECB pays the Repo Rate on required reserves. This is currently 1% but was 1.5% three months ago.

It also pays 0.25% for excess reserves. This was 0.75% when the repo rate was 1.5% because the ECB likes cutesy rules of thumb like constant-width bands around its repo rate.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 11:33:52 AM EST
[ Parent ]
so when you wrote
But the central bank is paying them a negative real interest rate on their excess reserves, and demanding a negative real interest rate on their rediscounts.

how does this square with 1.5%

1.5 % is a negative real rate under currently prevailing consumer price inflation.

Reading the posts you quote tends to be good for your argument.

The policy rate is [inflation] - [("cyclical") unemployment] for central banks operating under a Taylor/Mankiw Rule (which includes the Fed and the ECBuBa). Which averages to the inflation target. So most of the time the policy rate will be in excess of 1.5 % nominal.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 11:38:53 AM EST
[ Parent ]
So their business model is to borrow from depositors and pay them 1% and then deposit that with the reserve bank at below inflation (at 1.5% although they really only get 0.25%). So they net 0.5% which means they might as well set the money on fire.

Ok.

by rootless2 on Wed Feb 29th, 2012 at 12:21:07 PM EST
[ Parent ]
Which part of deposit-taking is not a profic center for banks don't you get?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 12:24:48 PM EST
[ Parent ]
I understand that to be your assertion.
by rootless2 on Wed Feb 29th, 2012 at 12:44:44 PM EST
[ Parent ]
So their business model is to borrow from depositors and pay them 1% and then deposit that with the reserve bank at below inflation (at 1.5% although they really only get 0.25%). So they net 0.5% which means they might as well set the money on fire.

Wait, what?

In what fictional alternative universe does it not make sense for a bank to get paid 50 BP of its customers' money per year?

You lend me a million. I put the million with the CB. The CB pays me € 500 more than I pay you. Who cares if it's below inflation? The inflation eats the customers' money, not the spread (OK, technically it does eat the spread, but it eats less than half a basis point in this case).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 12:36:19 PM EST
[ Parent ]
"Deposits are not "low cost". Especially not now in a "liquidity trap". "
by rootless2 on Wed Feb 29th, 2012 at 12:56:42 PM EST
[ Parent ]
Well, yes.

When you're in at the zero bound, it means the central bank stops paying you to handle deposits.

This does not in any way, shape or form make deposits more necessary for lending. At all. Really, riddle me this: How the fuck does being able to borrow at nearly 0 % from the CB against toilet paper collateral make deposits in any way relevant to the lending operations of the banks?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 29th, 2012 at 01:52:24 PM EST
[ Parent ]
Can you clarify for me whether in your understanding  in the normal course of events, deposits are sources of profit for banks or just a tiresome service provided to lure borrowers into the shop?
by rootless2 on Wed Feb 29th, 2012 at 04:36:11 PM EST
[ Parent ]
In the ordinary course of events, taking deposits makes the bank money, because the government - by way of the central bank - subsidises the handling of deposits through maintaining a non-zero interbank rate.

Were the government to run a zero interest rate policy -which it could and, in my opinion, should- taking deposits would become a loss-leader for other activities (or simply go away) unless deposit handling were explicitly rather than implicitly subsidised.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 1st, 2012 at 02:41:16 AM EST
[ Parent ]
You bring up a good observation that banking is essentially a function of governance, not of producing something for which going to market makes much sense.

However, that does necessarily mean that private, for-profit organizations should be excluded from providing those banking functions or that such organizations cannot provide those functions better than organizations directly related to public institutions of governance.

Also, I don't think I agree that we have any real problem at all today with deposit-taking institutions.  The problem seems to be instead with lending, not with savings at all, so I don't know that any solution oriented toward savings will do anything to resolve problems of credit, such as defaults or lack of credit extensions.  

by santiago on Tue Feb 28th, 2012 at 02:04:26 PM EST
One problem is that the deposits are not allocated well. Banks have enormous amounts of capital to manage, thanks to government guarantees, and extract a lot of fees from those deposits and then lend in destructive ways. If German and US can't think of anything better to do with capital than speculate on bonds of nations that obviously will not be able to pay back or US mortgages, then perhaps there should be alternatives.

I'm not proposing outlawing private banking, just providing a baseline safe government alternative.

by rootless2 on Tue Feb 28th, 2012 at 02:26:23 PM EST
[ Parent ]
There is some truth to that, but deposits from savers make up a really insignificant part of the capital from which banks are able to extend credit. Deposits are really now effectively divorced from lending and banks provide for deposits mostly just as a service to customers who want to preserve liquid savings, hence the higher fees for providing that service today.  

The capital that supports lending comes from large capital market operations, such as selling bank stock, bonds, or other securities to finance lending.  In modern capital markets, banks don't need depositors at all, because they can get all the capital they need from very large investors.  The only reason banks have depositors is because governments force them to do so to gain some of the legal and regulatory advantages of being a bank.  For example, Goldman Sachs became a deposit-taking bank in order to benefit from Fed bailout funds during this past crisis.

by santiago on Tue Feb 28th, 2012 at 03:01:00 PM EST
[ Parent ]
Goldman Sachs became a depository bank in order to get access to the Fed Credit window and to get a base of insured deposits that would shore up its equity.

Goldman Sachs said that over the past several weeks it began discussions with the Fed regarding the possibility of becoming a bank holding company. "We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness," the company said in a statement.

http://www.npr.org/templates/story/story.php?storyId=94894707

So now, with access to the Fed loans in hand and ability to offer government insured deposits GS moves to increase its deposit base.


Unlike most of its competitors, Goldman Sachs (GS) does not have a deposit base or retail branches, making it vulnerable to liquidity risk. JPMorgan (JPM) for example has a vast pool of overnight and term deposits (both retail and institutional) they can access during tight liquidity periods. Goldman however tends to rely on capital markets for funding, forcing it not only pay higher financing rates, but making its funding costs extremely volatile, translating into unstable earnings and high stock volatility.

http://seekingalpha.com/article/313522-goldman-taps-the-wholesale-funding-market

So what is it doing? Selling insured Certificates of Deposit.

by rootless2 on Tue Feb 28th, 2012 at 05:40:27 PM EST
[ Parent ]
A rough picture: Here's the total loans and investments of commercial banks in the US vs some measures and parameters of deposits:
http://research.stlouisfed.org/fred2/graph/?g=5nE

Although there is correlation on a broad level between savings amounts and loan amounts, there is actually very little, if any, apparent correlation between changes in total savings levels at banks in the US and changes in total loans provided by those banks in the US. This picture is consistent with deposit functions of banks and lending functions of banks being independent services and not having much to do with one another.  Deposits have increased since Great Recession started in the US, while loans have stagnated.  The problem with banks is not in their deposit taking functions, but in their lending functions. Namely, it makes little sense for banks to lend money when default risks are high and when they can make more certain income by just taking fees from providing the service that people really want in a crisis -- saving their wealth.  

by santiago on Wed Feb 29th, 2012 at 05:31:57 PM EST
[ Parent ]
Many of the large investors are managers of OPM who aggregate many small deposits and/or retirement accounts. The purchasers of the worst CDOs included a lot of German banks who took the money from the deposits of their savings and corporate depositors and invested them in trash marked by GS or, worse, in the case of DB, their own subsidiaries.

I think it would also be useful of those accounts could find a safe home outside the banking system.

by rootless2 on Tue Feb 28th, 2012 at 06:08:42 PM EST
[ Parent ]
Following santiago's comment, it is not totally obvious to me why you want to nationalise deposit-taking. That is usually not the part of the financial system that creates novel and interesting catastrophes. And TBH, I don't see much benefit from nationalising ATMs over, say, requiring interoperability at regulated rates, like we do for phones.

Also, inflation-indexed instruments are evil, and need to be purged with fire. Because they are liable to explode in your face in the event of a serious supply-side shock. In fact, inflation-indexed bonds is one of the few ways in which you can create hyperinflation in an otherwise healthy economy. Don't go there.

If you want to index, index to nominal GDP rather than inflation.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Feb 28th, 2012 at 04:06:23 PM EST
by rootless2 on Tue Feb 28th, 2012 at 05:53:29 PM EST
[ Parent ]
i want to reduce the size of the private financial sector.
by rootless2 on Tue Feb 28th, 2012 at 06:12:25 PM EST
[ Parent ]
I think the deposits - as they are not necessary for loans except by government regulation - should mainly be seen as a system for payments. That needs to be regulated and international payment systems other then american is needed so that legal transactions between country A and B is not nicked by US banks and regulators, but I am not so sure it neads to be public.

rootless2:

i want to reduce the size of the private financial sector.

That is all good, but I think it is loans - the creation of and allocation of credit - that is the power issue.

Then again all concentration becomes a concentration of power. Perhaps savings and loans should be regulated as mandated seperate businesses.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Feb 29th, 2012 at 06:28:55 AM EST
[ Parent ]
Perhaps savings and loans should be regulated as mandated seperate businesses.
Now that's two in a row in a few minutes... Are we ready for a new issue od "Socratic Economics"?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Feb 29th, 2012 at 06:30:48 AM EST
[ Parent ]
We need private banks because public banks tend to blow up even more spectacularily than private banks, as they are even more exposed to moral hazard.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Feb 29th, 2012 at 10:02:23 AM EST
Suppose that one could open a treasuries account and use it as a deposit account. Suppose furthermore that the Treasury added electronic payment feature so you could transfer to other treasury accounts and private bank accounts. Now let's limit this to say 100K or something reasonable. Maybe deposits only earn interest in 4 month blocks so if you do a lot of transactions, you don't earn.
by rootless2 on Wed Feb 29th, 2012 at 12:53:00 PM EST
[ Parent ]
Uh-huh. What would this change?

At least in Sweden, you can already deposit your cash with the National Debt Office, which is more or less a wing of the central bank (their job is to manage the national debt and borrowing money for the sovereign). They also make it possible for private individuals to buy Swedish sovereign bonds and bills.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Thu Mar 1st, 2012 at 05:42:32 AM EST
[ Parent ]


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