Creation of money: Danger by private banks?

Frankfurt – Only the central banks have the license to print money. However, some commercial banks create their own money through their lending. This is calling critics to see the dangers to the financial system. According to the Bundesbank, however, the criticism goes in the wrong direction.


Image: Euro coins as gears 

What is money creation by commercial banks?

Borrowing a customer, for example, 1000 euros at a commercial bank, this writes him the amount in his account well and raises in return claims on interest and repayment. Only if the customer actually withdraws the amount in his account as cash or transfers it to an account of another bank, the bank must get money from the central bank. However, only a small part of the bank balance is actually withdrawn and transfers between banks largely offset each other. So it happens that commercial banks create money almost “out of nothing”. They do not have to spend as much central bank money as they credit their clients.

What problem do critics see about money creation by banks?

Banks could become vulnerable to “bank runs,” a widespread fear. During the financial crisis, doubts arose about the solvency of many financial institutions. The savers were afraid that they would not get their savings back, which is why many of them wanted to withdraw their money at the same time. So they demanded more central bank money than the banks had in stock – many banks could not pay anymore.

What does the Bundesbank counter criticism?

It is not justified from the point of view of the monetary authorities. A commercial bank could spontaneously get central bank money in case of cases. To do this, it must deposit collateral, such as securities, with the Central Bank. Only when she does not have enough of it, it gets really tight. But this can not be prevented by the fact that the bank has more central bank money ready, so the argument. It is rather the result of losses, for example with securities transactions. In the financial crisis many banks had lost large sums of money with dubious US home loans.

Can banks draw unlimited money?

Critics warn that the creation of money leads to excessive lending and the formation of financial bubbles, followed by drastic slumps. These financial cycles can then also plunge the real economy into crisis. According to the Bundesbank, however, lending is limited by the demand of companies and private individuals on the one hand and by the weighing of risks and costs by commercial banks on the other hand. Both are also influenced by the key interest rates. How much central bank money the commercial banks have in stock, however, is not decisive. This is also illustrated by the current situation: Since the financial crisis, the amount of central bank money has increased more than sevenfold, most recently due to the multi-billion dollar purchases of securities by the European Central Bank (ECB). At the same time, lending has increased only moderately.

Are profits of commercial banks justified by the lending of self-created money?

From the point of view of the Bundesbank, yes, because this is a compensation for services. On the one hand, banks offer their clients long-term loans and, on the other hand, the possibility of short-term investments. Due to their size, they can also shoulder default risks. However, this requires a functioning regulation, warns the Bundesbank. During the financial crisis, states with billions of taxpayers were responsible for bank losses.

What alternative do critics think about money creation by banks?

The best known proposal is the so-called “full money”. The idea behind this is that in the future, banks should actually have one euro cash for each euro that savers have deposited with them, or keep them in an account with the central bank. Currently, they only have a fraction of them in stock – the so-called minimum reserve is one percent. The full money would mean raising the reserve to 100 percent. Even after the Great Depression, this idea was discussed in the 1930s. Her most famous advocate was the US economist Irving Fisher, who had previously lost almost all of his private wealth as a result of the deep economic crisis.

What does the Bundesbank think of the proposal of the full money?

Not much. It was “very questionable whether this avoids financial cycles on their own,” it says in the monthly report. In addition, this could limit important functions of the banks. For a more stable financial system, other means are needed, such as strengthening the equity of the banks. An important step in the right direction was also the launch of the European banking union combined with a joint European banking supervision under the auspices of the ECB.



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