Fractional Reserve Banking And Fiat Money Questions

[Banana]

Because I'm deaf.

 

[Deborah K]

Because I'm deaf.

I'm sorry, I didn't know that. :o

 

[Banana]

No need to apologize. How would you have known?

 

[AceNZ]

I have $1,000 FRNs. I make a deposit in the bank.

Bank records this as a vault cash. This doesn't count toward reserve and isn't available for loan (not yet.

Vault cash and the bank's reserve account, taken together, hold all of the bank's reserves. So the vault cash is part of reserves.

The bank decide it wants more reserve.

The only way a bank can actively get more reserves is by borrowing them from another bank or from the Fed.

So it exchanges with Fed FRNs into reserve money (digital). It now has $1,000 in reserve and $0 in vault.

It can now make a loan of $900, keeping $100 in reserve. This is deducted from the reserve account. The vault is still $0.

Loans are not made from reserves. A new loan doesn't change the amount of reserves. It does change the amount of "excess" reserves. With an initial $1000 deposit, the bank would start with $900 in excess reserves. After making a $900 loan, the excess reserves would go down by $90 to $810.

The borrower takes the loan and cash it to his bank. Bank then converts the loan into FRNs by transferring the first bank's $900 in reserve to the second bank's vault cash.

The borrower would deposit a check drawn on the first bank into the second bank. The Fed would process the check by reducing the balance in the first bank's reserve account and increasing the balance of the second bank's reserve account. The second bank can then ask the Fed to exchange their reserve account balance for FRNs, which can be given to the borrower in exchange for the checkbook money they just deposited.

If the above example is correct, what happens to the initial $1000 in FRNs? If they become digital, what happens to the physical notes?

They're held by the Fed until they're needed by another bank.

If a bank can only add to its reserve by sending actual FRNs to the fed, then it seems to me that when they exchange their reserve back to FRNs, the fed can just give them the same notes that they sent earlier. Unless checkbook/digital money can also be used as reserve. Is this right?

No. If a bank sends FRNs to the Fed, it does increase the balance in their reserve account. But that's not the only way it can add to it. Incoming checks from other banks, Fed Funds borrowing and Discount Window use also increase the reserve balance.

Checkbook money is the main kind of money that's used as reserves (its the main kind of money, period). FRNs really play a very small role in the money system.

 

[Banana]

Vault cash and the bank's reserve account, taken together, hold all of the bank's reserves. So the vault cash is part of reserves.

Oh, okay. I got confused bac there, thinking they were separate somehow.

The only way a bank can actively get more reserves is by borrowing them from another bank or from the Fed.

Loans are not made from reserves. A new loan doesn't change the amount of reserves. It does change the amount of "excess" reserves.

This is probably was what I got confused on.

With an initial $1000 deposit, the bank would start with $900 in excess reserves. After making a $900 loan, the excess reserves would go down by $90 to $810.

Why $810? Are we still talking about same bank or the banking system in whole?

The borrower would deposit a check drawn on the first bank into the second bank. The Fed would process the check by reducing the balance in the first bank's reserve account and increasing the balance of the second bank's reserve account. The second bank can then ask the Fed to exchange their reserve account balance for FRNs, which can be given to the borrower in exchange for the checkbook money they just deposited.

And in the end, the "excess reserve" is unchanged, right?

 

[AceNZ]

A bank initially has the following in his vault/reserve:

BANK:
- $1000 (cash)

It lends 90% and it gets deposited back. Now it looks like this:

BANK:
- $1000 (cash)
- $900 (digital)

Then it lends 90% and it gets deposited back. Now it looks like this:

BANK:
- $1000 (cash)
- $900 (digital)
- $810 (digital)

Are you saying that when it comes time for the bank to pay, for example, $1900, it will ask the Fed to exchange the $900 digital into FRNs??

If a request was made to withdraw $1900 (by cash or check), that would be a run on the bank. The bank would be unable to fulfill such a request, because it only has $1000 in reserves.

 

[bluepelican]

I posted about this in another thread, but anyway. . .

Ellen Hodgson Brown's "Web of Debt" is another great book on this subject. It was first published in 2007, so it is a lot more up to date than "Jekyll Island" and provides a more comprehensive view of our current situation.

 

[AceNZ]

Why $810? Are we still talking about same bank or the banking system in whole?

Either for this bank or for the whole system, a new loan consumes excess reserves.

$1000 initial deposit becomes reserves. Required reserves = 10% ($100), excess reserves = 90% ($900).

A new loan is made up to the amount of excess reserves; this is new money. $900 loan. The reserve requirement is 10%, so 10% of $900 = $90 in reserves are required. So now there would be $100 (from above) + $90 in required reserves = $190, and $900 (from above) - $90 = $810 in excess reserves.

And in the end, the "excess reserve" is unchanged, right?

FRNs (vault cash) are reserves. So a cash withdrawal lowers both reserves and excess reserves for the bank they were withdrawn from and from the banking system as a whole.

 

[Banana]

Why do we need a reserve requirement for the loan itself? Where does that goes (bank can't have that as that has been borrowed out, no?)?

Wait, does the reserve requirement increase everytime a new loan is made (because new money is made, which shows up on bank's book as... more?)

 

[SilentBull]

Ok. Let me try again to see if I understand when FRNs are actually printed...

A bank's reserves can be made up of both FRNs and digital money that was loaned out to it by other banks from their reserves or by the Fed. This borrowed money is actually digital. Since that digital money is now considered reserves, the bank can order FRNs from those.

So basically, when a bank borrows money from the Fed, the Fed doesn't just directly give FRNs to the bank, but it does give the bank digital money that they can then turn around and order FRNs on.

So FRNs are printed (indirectly) when banks borrow from the Fed or from another bank's reserves. But they are only printed if the bank actually needs the paper. Then, when the bank pays the Fed back, that money is "destroyed" meaning it does not go into any bank's reserves. The Fed could then use those FRNs next time some other bank needs actual paper. Or can the bank pay the Fed digitally and that way the printed paper still stays in circulation?

Am I close?

 

[shocker315]

Why do we need a reserve requirement for the loan itself? Where does that goes (bank can't have that as that has been borrowed out, no?)?

Wait, does the reserve requirement increase everytime a new loan is made (because new money is made, which shows up on bank's book as... more?)

You may find the answers you looking for in the link below...from the FED itself. Of course is more technical than it probably needs to be. But if your really interested in the topic you my take the time to decipher it. One interesting note ...about half way down this website the FED clearly states the process I described a few posts back. ( Bold emphasis added by me)


QUOTE:

Reserve Requirements and Money Creation


"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity."

http://www.ny.frb.org/aboutthefed/fedpoint/fed45.html

 

[Tom228]

Banana: In one word, "No" Reserve Ratio Stays the same regardless of how much money is created. It can be changed but it isn't done very often. And no it is not needed to make loans, it's a response to the Bank Runs during the Depression I believe.

 

[AceNZ]

Why do we need a reserve requirement for the loan itself? Where does that goes (bank can't have that as that has been borrowed out, no?)?

That's why it's called "fractional reserve banking". All loans have to be backed by reserves.

Wait, does the reserve requirement increase everytime a new loan is made (because new money is made, which shows up on bank's book as... more?)

Yes.

A bank's reserves can be made up of both FRNs and digital money that was loaned out to it by other banks from their reserves or by the Fed. This borrowed money is actually digital. Since that digital money is now considered reserves, the bank can order FRNs from those.

So basically, when a bank borrows money from the Fed, the Fed doesn't just directly give FRNs to the bank, but it does give the bank digital money that they can then turn around and order FRNs on.

A bank's "digital" reserves are not always borrowed from other banks or from the Fed. They can also be obtained (or lost) through checking transactions with other banks or the Fed.

So FRNs are printed (indirectly) when banks borrow from the Fed or from another bank's reserves. But they are only printed if the bank actually needs the paper. Then, when the bank pays the Fed back, that money is "destroyed" meaning it does not go into any bank's reserves. The Fed could then use those FRNs next time some other bank needs actual paper.

Close. I would say it this way:

FRNs are printed (indirectly) when banks order them from the Fed, which they do when they need the paper. They are paid for using digital money in the bank's reserve account at the Fed. When the bank has more cash than they need, the FRNs are bought back by the Fed by adding digital money to the bank's reserve account. The Fed can then use those FRNs the next time some other bank needs actual paper.