Positive Money UK
‘The trick to understanding how banks create money is to remember that they still have a balance sheet that reflects both sides of any loan or borrowing they make. When we say ‘create money’, what we mean is that they can grow their balance sheet. By placing ‘money’ in a customer’s account (a liability to the bank), they also register the customer’s debt to them for the same amount at some future date (an asset to the bank).
However, there is a stock of real money (e.g. people’s cash deposits) that they draw on when someone comes along to withdraw the ‘money’ in their account. The system works provided that people who hold accounts at the bank don’t try to withdraw cash all at once. If they did, the fact that the banks had created money in their accounts that it can’t back with cash would cause the system to collapse, as happened to some extent in 2007-8. Don’t confuse ‘creating money’ with actually growing the stock of central bank reserves or cash (the resources banks need to pay back customers who want to redeem their deposit at the bank)!
In this process of juggling money around on their balance sheets, banks also interact with the central bank (Bank of England). The TFS is one such interaction: commercial banks receive assets (central bank reserves) on favourable terms – i.e. the liabilities that go on their balance sheets are not as heavy as they might otherwise be if they borrowed from elsewhere. The Bank of England does this to try to give banks space to pass through actual money (reserves) to consumers and businesses. However, it also lets those banks make higher profits, and does nothing to fix the faulty mechanism whereby banks don’t have enough reserves to pay their creditors all at once.’
Positive Money UK
Positive Money UK With mortgages, too, its easy to get confused between the actual value of the house and the number on the banks’ balance sheet. When they create a loan to a customer who then buys a house, the loan is the asset on the bank’s balance sheet. When they repossess it, that loan is replaced by the house itself. A house is not great for the bank to have on its asset sheet – it would rather have cash, and moreover there is a legal obligation to the customer and former homeowner to cover any shortfall! So low auctioned prices will be in the bank’s interest. That the money created to buy the house isn’t backed by reserves doesn’t matter during this process; the point of our argument is that so many of the transactions that take place in our economy, and seem to shift value around, aren’t backed by real cash or value.