1 of 15 Henric kindly points out that banks create most of the money supply. But... That money is issued as loans, which with interest, must be repaid, any profit from productive loans is a result of State money spending. Buckle up, a long thread.
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2 of 15 Commercial banks create the QUANTITY of money (deposits) through lending, the QUALITY & finality of that money depends on central bank. **
3 of 15 The central bank provides the universal settlement medium (reserves and cash) that makes the banking system’s diverse IOUs interoperable and trustworthy as national money supply. **
4 of 15 Commercial banks exist by virtue of their licence, granted by the…
1 of 15 Henric kindly points out that banks create most of the money supply. But... That money is issued as loans, which with interest, must be repaid, any profit from productive loans is a result of State money spending. Buckle up, a long thread.
**
2 of 15 Commercial banks create the QUANTITY of money (deposits) through lending, the QUALITY & finality of that money depends on central bank. **
3 of 15 The central bank provides the universal settlement medium (reserves and cash) that makes the banking system’s diverse IOUs interoperable and trustworthy as national money supply. **
4 of 15 Commercial banks exist by virtue of their licence, granted by their governments through Prudential Regulation Authority(PRA), part of the Bank of England in the UK, or Office of the Comptroller of the Currency(OCC) for federal banks or the State for State banks in the US. **
5 of 15 They fall under eye of the Financial Conduct Authority(FCA) UK. In US, Fed Deposit Insurance Corporation(FDIC) deposit insurance is mandatory for almost all banks. Fed Reserve approval required if company controls bank or if state-chartered bank joins Fed Reserve System. **
6 of 15 Smaller UK banks, must have Short-Term Repo(STR) facility at BoE a weekly auction - eligible firms borrow reserves for 1 wk against quality collateral. To manage daily liquidity shocks by lending/depositing reserves overnight they need Operational Standing Facility(OSF). **
7 of 15 Smaller US Banks hold reserves indirectly via accounts with larger correspondent banks, which have direct Fed accounts, these are called Pass-through (Correspondent) Accounts. Short-term liquidity needs are addressed by the Discount Window at the Fed. **
8 of 15 Banks create loans. When commercial bank approves a loan, it simultaneously creates a new asset (the loan contract) and a new liability (a customer deposit) on its balance sheet. **
9 of 15 The borrower’s account is credited with a deposit, and the bank records a promise of repayment. This new deposit is "bank money." **
10 of 15 It exists only as digital entry in THAT bank’s ledger - can be used seamlessly for any transaction where both payer and payee use the same bank. Within that closed system, it functions perfectly as money. **
11 of 15 When depositor wants to use this money outside their bank’s ecosystem—to pay a mortgage held at different bank/buy from seller who banks elsewhere/withdraw cash. This requires converting the bank’s IOU into a more universal form of money that the other party will accept. **
12 of 15 To send a payment to someone at another bank, your bank instructs the central bank to transfer central bank reserves from its own reserve account to the recipient bank’s reserve account. **
13 of 15 Reserves are ultimate settlement money, created by central bank and held only by commercial banks at central bank. They are universal final means of settlement between banks. The process extinguishes your bank’s liability to you & fulfils obligation to the other bank. **
14 of 15 When you take cash from ATM, your bank converts its digital IOU (deposit) into central bank’s physical IOU (cash/notes). Bank gives you cash, and its liability to you decreases by the same amount. Cash is a direct liability of the central bank, not the commercial bank. **
15 of 15 To paraphrase @RichardJMurphy - Every pound, dollar, euro or yen in circulation exists because governments run deficits that create reserves. They also issue bank notes and coin - cash, the currency we all use & the means through which banks can conduct their operations. **
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