>the justification for this is something about investment and risk taking. Which are supposed to involve your own funds, not money you printed out of thin air.

Money is socially constructed. If we agree, societally and legally, that banks can lend out most of the money that their depositors place with them (fractional reserve), then the money the bank lends out is no less real, no more "printed out of thin air," than any other money. And we do agree to that statement, legally and (for the vast majority) societally.

> risks are supposed to be (and are) handled by insurances.

Which is exactly how banks handle interest rates on loans. This is why we have credit scores: so that the underwriter at the bank can assess how risky your proposed loan is, and how much interest (i.e. premium) to charge you. Exactly like an insurance underwriter assesses how risky your proposed insurance policy is and how much premium to charge you. Both insurance and banking largely automate these decisions these days, but there are still human underwriters who can override the automated decisions.

A few years ago I briefly worked in the credit risk department of a bank, and as part of my orientation I spent an afternoon sitting with one of these underwriters watching and listening as they dealt with clients who wanted to appeal the automated credit decisions.

> And then there's the paperwork and checking and all that that most likely should involve a flat rate

This also already exists, it's called an origination fee.

> This should be much more ethical than charging interest over money that didn't even exist to begin with.

In summary, this is completely wrong. The money does exist, just as much as any other money exists, and if it's not repaid the lender is on the hook for it[1], just like any other money. And the way you think lending should work is indistinguishable from the way it already works.

[1] Or, in many cases, the person who bought the loans from the originating bank.

With one crucial difference: right now the main criterion is whether the bank will get reimbursed or not. Whether it will make money off of the credit. And credits are so important to our lives right now that I don’t believe such an important decision should be left to that kind of invisible hand.

I mean, it’s as important, perhaps more important, than the state’s budget. This suggests, if not a democratic oversight, at the very least a clear set of democratically chosen rules over what kind of loans should be given.

I'd flip that around: whether it will lose money off the credit, not whether it will make money. Based on my time in credit risk this is more accurate to how banks actually think about loans. The upside for each individual loan is much smaller than the downside, so the threat of loss dominates the discussion.

Once you flip it around like that it becomes much less attractive to think of forcing banks to make loans that they expect to lose money on.

> if not a democratic oversight, at the very least a clear set of democratically chosen rules over what kind of loans should be given.

Which, again, we already have. There are many rules and regulations about what information banks may and may not take into account when deciding which loans to approve, and what interest rate to charge. Rules put in place and enforced by the democratically elected government.

That's not what I'm proposing, though. I'm proposing that each loan would come with the creation of central money, such that any that falls through results in nothing more than a little bit of inflation. And the people who issue the loans would effectively be government workers. Or contractors or whatever, but they would do all this on behalf of the state.

> Which, again, we already have.

I have to confess ignorance here. Do we have rules that forbid specific industries from contracting loans? (Industries that are otherwise legal, I mean.)

There's no difference between "central" money and other money, though. It's all just money.

> Do we have rules that forbid specific industries from contracting loans?

Regulations differ by jurisdiction, but generally you can't do any kind of banking business without being licensed specifically as a bank. For example, if you get a car loan "from the dealership" it's not actually the dealership giving you the loan, but a bank that they partner with.

So I've googled and read upon it every time I hear this almost exact same sentence (and I see it every now and then), and I don't get it at a basic level. I have little to none awareness of high level finance, but my understanding of 'fractional reserve banking' is thus:

1. 100 people deposit $1 each to a bank. It has $100 of deposits

2. Without fractional reserve banking, bank would basically have to keep $100 in its vaults. It would be useless money going nowhere doing nothing.

3. With fractional reserve banking, bank basically has to (say) keep $10 in its vaults (digital as they may be), but can loan $90 to other entities (and do more complicated things with it). There are risks and benefits to this, and it is basically a full time job of many people at the bank and regulator to find various balances of risk and benefit, to bank and society, based on the policy and goal.

I don't understand where, in this simple math, does a regular bank "create money out of thin air". I'd love to understand when and how this may be the case (but NOT via angry youtubers, please:).

I do understand that central banks and/or the government control circulation and "create money" through various mechanisms, but I never get the feeling that is what we're talking about when people say "fractional reserve banking means private banks get to make money up".

Through rinse & repeat.

When the bank has loaned those $90, the deposits still show $100, and are still available to their respective owners. Just not all at once, but we don’t care as long as the illusion is maintained — and it is.

Where those $90 go? to other deposits. So where we had $100, we now have $190. Only $100 of those are central money, but again, as long as the illusion is maintained (and it is), everything works exactly as if we had $190. And since money is but a convention, a good enough illusion is actually real. $90 really have been created.

And those $90 that have been added to deposits can also be used to lend money. $81 in the current example. So now we have $271. Rinse & repeat indefinitely, eventually you end up with up to $1000 total, with $900 created out of thin air. As long as the illusion works at least. And it does.

Sure, sometimes it breaks down. Sometimes we get a bank run. But in practice the illusion is so important that the state steps it an make it real: by creating actual central money to compensate for the bank run. Heck, often just the promise of doing so is enough to prevent the bank run in the first place, and maintain the illusion.

Strictly speaking money hasn’t been created. It’s just an accounting trick. But the trick works. Those $900 may be fake money, but if people are using it (and they are), it’s also real money. It’s not real real money, but it’s close enough.

> as long as the illusion is maintained (and it is)

> a good enough illusion is actually real.

> As long as the illusion works at least.

> But in practice the illusion

> maintain the illusion.

You sure like that word.

It's not an illusion. The money is real. It's real real. It's real real. There is nothing fake or illusory about it. It is just as equally real as a $100 bill straight from the Bureau of Engraving and Printing.

Stop pretending that it's not.

> But in practice the illusion is so important that the state steps it an make it real: by creating actual central money to compensate for the bank run. Heck, often just the promise of doing so is enough to prevent the bank run in the first place, and maintain the illusion.

This is false. FDIC is insurance. The money that is used to step in and rescue a bank is real money that comes from banks that pay insurance premiums to have their depositors' money insured. It's not "central money" created by the state. It's exactly the same kind of money that banks lend out to you and me. Banks pay insurance premiums to the FDIC and when a bank fails the FDIC uses those insurance premiums to step in and insure the deposits.

> Strictly speaking money hasn’t been created.

This is also false. Money really is created when banks give out loans based on fractional reserves. This is called the money multiplier effect, and it's a really important economic factor. But it's not fake money, it's real money. Real real money.

And there's still is one way the money isn't real: if everyone runs to the bank to retrieve their money they can't. Not all at the same time. But they never do, so the money is real.

> This is false. FDIC is insurance. The money that is used to step in and rescue a bank is real money that comes from banks that pay insurance premiums to have their depositors' money insured.

Oh, I see. A tad more complicated than I though, but the effect is the same, so my central point remains.

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My step dad used to work in banks, and you, he, and I agree on how this all works. Interestingly though he didn't want to see it as "creating" money. He didn't quite accept the connotation, and I suspect the full consequences of fractional reserve. His exact word was that banks are authorised to transform money (which I suspect is a legal term in France).

So the banks charge a 5.75% “risk premium” and we’re back where we started.

And just because some cultures and religions are anti-usuary doesn’t invalidate it’s value. All interest does is price the value of money (ignoring all the shenanigans the central banks get up to). Money today is worth more than money tomorrow so you have to pay a premium to both access it and compensate the owner for the lost utility.

Yeah, fractional reserve lending is fraud but it’s legal fraud so what are you going to do?

I don't understand how it's fraud. Banks could not lend at all if they must retain 100% of deposits.

On the lending side, it would hurt everyday people and the economy if banks could not lend. Loans are important for homeowners (mortgages) and for businesses of all sizes (research and development).

On the savings side, your community bank provides incredible guarantees with your deposit that are difficult to find elsewhere: deposits are very liquid, principle is virtually guaranteed, and convenience in routing the money wherever you direct it.

What would a better system look like?

More democracy.

Yes, banks couldn’t lend as much money if they couldn’t create it, and the way we’re making the economy work needs money to be created for those loans. So they definitely fill a need. However they are printing money and decide who can borrow and who cannot, without democratic oversight.

We tend to reduce democracy down to restrictive laws & regulations. Whether we want guns or not. Whether we want to allow abortion or not. How heavy the penalties are for murder or theft. How a given industry should be regulated. But resource allocation is arguably even more important.

How we allocate our resources determine pretty much everything in our lives. It’s the choice between more roads or new train tracks, which industry should be prioritised, basically what direction our whole economy should take. And that, instead of being subjected to democratic oversight, is currently left to private interests, with a vague hope that it will somehow be okay, because "invisible hand" or something.

Damn, I’m just asking for more democracy, and there we are, way outside the Overton window.

I feel there's shifty language and moving posts all the time.

Fractional reserve banking, to my limited understanding and your previous post, is lending some of the money that got deposited to. Where is this "creating money" (for non central banks) coming from? The phrase comes in and out of various conversations about banking system and it's the most slippery thing I've ever seen. Can you please elaborate on your understanding of how "banks create money" so we can have a discussion from same basic understanding and principles?

And it's not "banks couldn't lend as much money". If we didn't have fractional reserve banking, it feels banks could not lend AT ALL. This is not shades of gray, it feels like a basic principle. If a bank gets deposits, and can't do anything with deposits, and has to keep all the deposits in a vault, then it cannot do any loans. SImplified and all, but again, I want to see if our basic understanding is in line.

Also, what does "more democracy" concretely mean here, as nice as the phrase is? Aren't regulations by government the spear of the democracy, in practical sense?

More or less. Long story short, when money is lent in a bank, it’s then deposited elsewhere, and then it can be lent again, such that with a fractional reserve of 10% you can ultimately multiply the amount of money in all deposited accounts by 10. In other words, a whole bunch of money just got created. It’s not central money, but it’s still money.

You could maybe try to counter with "but but but bank runs", but if this happens the state tend to print central money to compensate, thus actualising the money creation that happened with fractional reserve banking alone.

> If we didn't have fractional reserve banking, it feels banks could not lend AT ALL.

They could lend their own money.

> Also, what does "more democracy" concretely mean here, as nice as the phrase is?

In this particular instance I’m thinking of full reserve banking (deposit banks turn back into glorified vaults), print central money for mortgages (and burn that money when it’s paid back), and democratically (with congress, referendum, whatever) define clear criteria about who can contract mortgages, and what for. Criteria which would then be enforced by mortgage clerk, on behalf of the state.

The point here is that instead of letting private interests that want to make money decide, the people decide (possibly through elected officials) of the applicable criteria.

This is an interesting idea. The problem with a single lender is that it removes incentives for good customer service and (sometimes) good products. Monopolies, whether public (DMV) or private (your local cable company) are universally hated. It would be difficult to design the right incentives for the government to provide a good product.

I think the main disconnect is that deposit banks never operated as a glorified vault. Lending against deposits is supposed to be understood by anyone entering that agreement. I understand why it may be a surprise when you first learn about fractional reserves because it may not fit an existing mental model. Instead, it seems unfair that a bank can create money. But it's not. Money supply and money velocity is a term used by economists to describe how much and how quickly money exchanges hands. The world's accounting books, with all debits and credits, always sum to the same total: however much money the central bank has printed.

There are a lot of benefits of the current system (liquidity, virtual guarantee of withdrawal, conveniences). Your proposal would replace a system where you receive a small income from your deposits to a system that steadily decreases the size of your deposits; I think that would be a hard sell.

I believe that's mostly a US thing. Here in France we love state monopoly on tap water, energy, and trains and snail mail service… Privatising those and opening them to competition generally caused more problems than it solved.

> Lending against deposits is supposed to be understood by anyone entering that agreement.

The only agreement most people understand, at the most basic level, is that money they deposit can be retrieved at any time. The idea that a bank run could even be a thing nowadays feels outlandish (I don't know the particular, but I understand that we have put various mechanims in place to make bank runs very unlikely, if at all possible).

> Your proposal would replace a system where you receive a small income from your deposits

I don't receive any income from my regular bank account. I even pay a small fee for the privilege of having that account. The things that pay interest back are special accounts, some of which I don't have immediate access to. For those the bank is very clear that it will use that money to invest in stuff, justifying why there's a return on interest at all.

Now if we went all the way to forbidding investment accounts, sure, every bit of inflation means your money is evaporating over time. I'm actually okay with that. It's a form of tax, with a flat rate, that rich people with a ton of money will pay more than the small folks. But yeah, it sure would be a hard sell to those rich people.

How could a bank lend _any_ money if it must reserve 100% of deposits as cash?

> they are printing money and decide who can borrow and who cannot, without democratic oversight

I do not understand how regulations are equivalent to democracy. Either way, banks are heavily regulated in the G7 countries. Such regulation was thought to exacerbate the mortgage crisis of 2008 because regulations created incentives to offer mortgages to people who should not have qualified.

Supply and demand of deposits and loans creates a competitive market - banks operate with razor thin margins.

I still do not know how you would improve upon the current system.

That’s the thing though, they could lend out and pay interest on “savings” with the understanding that the money might not be immediately available for withdrawal as it’s “in the wild”.

And a different class of banking, we’ll call it “checking”, would allow for immediate withdrawal as it’s backed by 100% reserves and doesn’t pay interest because it doesn’t make any money for the bank. Heck, they might even charge for the convenience of warehousing your money and being able to transfer it to any other economic actor you chose through a novel intra-bank clearinghouse.

What this doesn’t allow is for banks to lend out 90% of every dollar they take in — even ones available for immediate withdrawal.

As we’ve seen from the recent SVB[0] catastrophe if people assume their money is immediately available and it isn’t there’s big problems because everyone rushes to get their money right now instead of maybe getting their money at a later date. Big problem…

This is all stuff they figured out centuries ago, the main problem is it cuts into the banks’ profits so it isn’t done this way.

[0] as an illustration of the problem, they didn’t seem to get in trouble due to fractional reserve lending but from the liquidity of their assets.

Those are Certificates of Deposit.

> they didn’t seem to get in trouble due to fractional reserve lending but from the liquidity of their assets.

It was the opposite. SVB had over-invested in long-term US treasuries, which are extremely liquid, but were falling in price due to the rapid increase of interest rates. If not for withdrawals squeezing their reserve, SVB could hold onto those treasuries until maturity and get back 100% of their principle.

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I think the disconnect is that savings accounts are not popularly well understood. People are shocked when they understand that the money they deposited is not sitting in a big vault.

You could tweak fractional reserves to be 20% (or 80%) of deposits, but that comes at a cost too. For example, it would create scarcity of money available for lending, which in turn would make loans more expensive (e.g., higher interest rate mortgages could double the cost of home ownership.)

The current system prevents the worst of bank runs by covering a good chunk of assets with insurance (FDIC in the US). It's a system that allows banks to fail and protect customer deposits.

The collapse of SVB was not a "catastrophe" because the banking system is intended to let banks fail. The alternative is far worse.

Isn’t that obvious? We’re living in an increasingly oppressive regime, and fractional reserve banking is but one of its many symptoms. So we’re going to do whatever people do under oppressive regimes.

First step though is awareness.