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Pragmatic Capitalism

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About Bank Runs

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Hi Cullun,

Books on banking I have read almost exclusively teach the Money Multiplier Model to explain how $1000 becomes $1M after issuance of loans upon receiving deposits. But if Banks don’t even need deposits to create loans according to your posts, then why do they have measures to prevent bank runs in the first place?

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Posted by Incognito 7
Posted on 11/06/2016 4:53 PM
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(Apologies my autocorrect changed your name from Cullen to Cullun!)

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Posted by Incognito 7
Answered on 11/06/2016 4:54 PM
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    Hi Incognito,

    A bank run does something nasty to a bank balance sheet. When you withdraw cash from a bank the size of the aggregate banking system’s balance sheet shrinks. If this happens in a widespread fashion the bank could lose enough deposits that it actually can’t meet its reserve requirements. This would force them to borrow from somewhere else or attract liquidity somehow. But the bank that’s undergoing a run probably can’t even do this in the first place because the reason the run is going on is because people are worried that the bank is insolvent. So a run is really caused by solvency concerns. And the run is akin to a leak in a pipe that turn into a flood. The bank has measures in place that try to contain any leaks, but that’s just not always possible.

    So, it’s important to get the causation right here. Banks don’t need deposits to fend off runs. They need deposits to maintain a low cost of liabilities that keep them solvent. That’s the key. If customers get worried about the solvency THEN the bank will lose deposits.

    Make sense?

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    Cullen Roche Posted by Cullen Roche
    Answered on 11/07/2016 2:50 AM
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      Thanks for replying, Cullen.

      But countries like the UK, New Zealand, Australia and Canada do not have reserve requirements that banks have to meet. So why do they have to worry about losing deposits in a bank run? Also I don’t really understand what you mean when you say that deposits are needed to maintain a low cost of liabilities when the deposits are created by the banks in the first place?

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      Posted by Incognito 7
      Answered on 11/07/2016 8:53 AM
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        Hi Incognito7

        Its not the deposits that are an asset , its the reserves that attracting a deposit brings that are the asset.

        And a deposit withdrawal is a withdrawal of reserves.

        UK , NZ AUS and Canada. The bank has to worry about withdrawals as it needs reserves to fund withdrawals.

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        Posted by Dinero
        Answered on 11/07/2016 11:02 AM
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          Aren’t customer deposits liabilites on the bank’s balance sheet? Then having them withdrawn off the balance sheet doesn’t sound like a negative to me? They’re not counting the promissary note as an asset, are they?

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          Posted by MachineGhost
          Answered on 11/09/2016 6:44 PM
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            Yes deposits are liabilities on the bank’s balance sheet and when there is a withdrawal and a corresponding deposit is removed off the balance sheet, a reserve which is an asset on the other side of the balance sheet, is removed from the balance sheet. Its that removal of the reserve that is a negative to the overall value of the balance sheet.

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            Posted by Dinero
            Answered on 11/10/2016 7:25 AM
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              7.25 continued

              To be more precise, its not the value of the balance sheet that is reduced, it the ease of funding claims on deposits that is reduced.

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              Posted by Dinero
              Answered on 11/10/2016 7:32 AM
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                Hi Cullen and all,

                Sorry for bringing up this old thread again, but I still don’t quite understand what you mean by “reserve, capital and liquidity requirements” that Banks have to satisfy in order to avoid bank runs. Going through the thought process of “loans creating deposits”, why then can’t banks simply fund themselves with their own interest free loans in order satisfy their reserve, capital and liquidity requirements? I really can’t seem to get my head around of the contradictory nature of the ex-nihilo money creation by Banks but them still having some sort of limit to it.

                I guess I can understand now why the money multiplier model / loanable funds theory is more appealing….

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                Posted by Incognito 7
                Answered on 11/24/2016 2:39 PM
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                  Because what banks create, deposits, are liabilities to deliver reserves, and those reserves are at he central bank, and they don’t create those reserves without the OK of the central bank.

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                  Posted by Dinero
                  Answered on 11/24/2016 5:24 PM
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                    Reserves are just used to settle interbank payments without moving anything around, i.e. clearing checks and ACH transfers. It really has little relevance to anything other than a legal reserve requirement leftover from the gold standard era (most everyone was paranoid back then about re-causing wildcat banking inflation).

                    Capital is a corporate balance sheet item. Is that a depositor concern as opposed to an investor or acquirer? Probably not since we have deposit insurance or government bailouts.

                    And liquidity which I assume is concern about bank runs, well, that is what the Fed is for via its Discount Window. It certainly didn’t help much during 2008 since nearly everyone got their liquidity needs met via the very short-term repo market, but it could be that the non-banks that were in trouble couldn’t access the window.

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                    Posted by MachineGhost
                    Answered on 11/24/2016 6:02 PM
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                      Yes

                      reserves are a convenience, a trusted asset, in a hypothetical world where each loan contract issued by each bank had the same value agreed by every other bank, and every customer agreed they were transferable, banks could transfer them instead.

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                      Posted by Dinero
                      Answered on 11/24/2016 7:18 PM
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                        >Igocnito7
                        It seems from your question that you need to familiarize yourself with a Bank’s “T account”.
                        What a bank creates is liabilities on itself. The reason this is commonly called “money creation” is because bank deposits are the predominant money.

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                        Posted by Dinero
                        Answered on 11/24/2016 7:27 PM
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