Accepting that banks create money out of nothing when they make a loan. What happens to the repayments on the loan?



Now part of the repayment will be covering the interest and so clearly that is profit for the bank (just like mark-up in a shop). However I'm unclear as to what happens to the part of the repayment that reduces the outstanding amount of the loan. Is part of the money which the bank created then destroyed so all of the repayment profit for the bank? Or does the repayment money cancel out the bank created money in some way?

I think the answer to your question is nothing. The bank could use the money to lend it out again. Once the money has been created it doesn't disappear and the money supply has been increased. The only way the money "disappears" is if the money supply contracts.



There is a thing called the "money multiplier" which is a ratio of how much money is created by bank lending based on how much the central bank deposits with the commercial banks and what percentage of that they must keep in reserve. If the commercial banks lend the money on then in theory it could increase the amount of money in the economy (the money supply) up to whatever the "money multiplier" says.



So if the aim is to decrease the money supply - destroy money if you like then the government and/or the BoE can do several things. It can increase how much the banks have to hold in reserve (so the money multiplier falls), sell government securities (so money flows back to the government) or put up the interest rates the B of E charges to banks who borrow from it.

I thought I'd already explained in very basic terms that the talk of banks "creating money out of nothing" is just not true.



I'll have another go.



I have just set up Bank of FA (quite a fitting moniker, I thought)

You are my first customer



You want to borrow £10K from my bank, so I lend you it. All this means is your loan account is credited with 10K. BUT, and this is the point that most people miss, no money has been "created" - because whereas previously you had no money, now you have got MINUS 10K. You owe it to my bank! the two cancel out. No money has been created.



In due course you repay your loan. You, your bank, and the total sum of money are now squits, nothing created, nothing lost, except that the bank has made you pay a fee (interest and bank charges) for the privilege, so to that extent, they are in front, but that is money for services rendered, paid out of your income, again it is not money that has been "created".

So the repayments are profit? As an example say I borrow £10,000 for 12 months at a rate of 6.7%. The bank creates that money. At the end of the 12 months the total amount I will have paid the bank will be £10,355.76. This £10,355.76 is the profit (ignoring any admin/staff costs etc.) the bank has made on the loan? This money is now sat there in the bank's reserves for it to do with as it pleases?

No, they "gave" you 10K, you've returned it. The two cancel out, obviously.

Do the bank get chicks for free though?

It's a well accepted principle that fractional reserve banking increases the money supply and this is often referred to by economists as money creation.







There are two things missing from your example. Where the bank got that £10K from in the first place and what happens to it after it lends it.



If this is the first bank in the chain it will have got it from the central bank who will have taken it out of the money supply or created the money sometimes by printing it. It will have had to stash some money it got from them on reserve and it can lend the rest on.



To keep it simple lets say it got 10K from the central bank and it must keep 10% on reserve. That means it can lend £9K on.



It lends £9K to another bank and they do the same thing. £900 is put on reserve and £8100 is lent on.



So the amount lent out is £17,100 (£9K+£8.1K). But we only had £10K to start with. [uSo the lending process has created £7,100[/u.



The deposits (the £10K and the £9K) represent each banks liability, the loans its assets. So for example given the second bank has liabilities of £9K but reserves of £900 plus assets of £8.1K its balance sheet is sound.







The interesting question is where does the money to pay the interest come from? Out of thin air?

I agree with your explanation of fractional reserve banking but the OP doesnt, he (because he has misunderstood things he has read and heard) thinks that they need no money at all in their reserves in order to lend money, he thinks they literally lend as much money as they want because it all compeletely comes from nowhere.

I agree with Charlie Sheen, that ain't working.

As FA says, the loan capital cancels out. Only the interest is added to the net worth of the bank.

In my case it comes from my employer in the form of wages.

It's no wonder we got into bother if bankers use faulty maths like that.