By the Publisher: David E. Robinson
Professor Werner brilliantly explains how the banking system and the financial sector really work.
Many people think that banks collect deposits from savers and relend the deposits to borrowers to earn interest. This is, of course, what we hear, and a lot is written up in the newspapers, or even in financial and economic textbooks. But this is not actually what banks do.
A New deposit of say 100 dollars — with reserve requirements of around 1% — textbooks say this requires the banks to send 1% — or 1 dollar — to the Central Bank as reserves, which allows the bank to lend out the remaining 99 dollars as loans.
But even this is not what banks do, according to Professor Richard A. Werner, Chair in International Banking at the University of Southhampton and the Director of its Centre for Banking, Finance, and Sustainable Development, who says:
In reality, the bank will take the entire 100 dollars deposit and send it to the Central Bank saying that this is a 1% reserve out of 10,000 dollars, which, minus the 100 dollars, leaves 9,900 dollars that the bank is allowed to lend out, so the 100 dollars deposit leads to a 9,900 dollars asset for the bank in what is called “new loans”. This is more realistic as an explanation of what banks get to do.
In other words: 1. 100 dollars is deposited into the bank. 2. The bank gives the 100 dollars to the Central Bank as the bank’s required 1% fractional reserve. 3. the bank loans out the remaining 9,900 dollars in securitized loans.
A 100 dollars deposit is equal to 9,900 dollars in allowable interest-bearing securitized bank loans. A ratio of 1/99, or 99/1, however way you see it.
This is a legal construct. The bank is allowed to do this. And this means actually that the bank is creating its 9,900 dollars asset out of nothing.
This is money creation.
This adds to the money supply.
It is not bank lending. It is bank-credit creation.
(Banks do this out of the value of your signature)