The Fractional Reserve System and the Current Debt Crisis

[Conza88]

I am relatively new to economics and after reading a significant amount of information on the net I have some probably pretty basic questions:

1. A bank gets money either from a central bank, depositors or other banks (or all three).
Under the fractional reserve system the bank then lends out 10x the money it recieves.
The profit of the bank is determined by the amount of interest it receives from these loans.
If 90% of these loans no longer pay interest (default) the bank still has the same amount of money it had to begin with.
Does this mean than the bank needs more than 90% of its loans to default for the bank to actually LOSE money?

2. Why did the government need to purchase the toxic debt that these banks owned when these banks had just created the money to issue these loans?

1. There's a difference between the reserves and loanable assets. Banks can lose money if they don't get paid back, period.

2. It didn't; it purchased the toxic debt as payment for support in funding the government. Cronyism.

 

[McLovin]

The banks could in theory stop lending and stop getting deposits and still be very profitable, they only NEED to make more loans cause people are making deposits and because they want to increase their profits

In theory yes, but it would be fraught with very real danger of making themselves insolvent (it wouldn't surprise me if there is a regulation somewhere that compels banks to accept deposits). You also have to remember that if the stop accepting deposits they will soon run out of money. Also, if they stop extending credit or accepting deposits then the security backing their loan books (houses) will probably fall off pretty sharply (no money available to buy houses) which will put their borrowers in default and so on and so forth. Either that or someone else will start another bank to take up the slack.

 

[tothemax6]

Skating101,

Firstly, the 'money as debt' videos, whilst entertaining, are fraught with bias and misunderstanding. One day I intend to post a rebuttal on youtube, but alas I lack Pauls Grignons animation skills .

Banks are credit intermediaries. That is, they take money from creditors and lend it to borrowers. Most of the credit banks receive is in the form of deposits, and most of the credit they give is long maturity loans. Now a deposit, is not 'my money in the bank', as most people believe. A deposit is a loan to the bank - the bank then owns that money and promises to repay it to the depositor on demand (indeed this is what banknotes used to have written on them).

Because only so much of these 'deposits' will be withdrawn at any time, the bank need only hold enough money on reserve to meet any daily payments. This works fine, unless for some reason there is a sudden increase in withdrawals.

The amount of money is rigid, either because it is gold (traditionally) or created in limited supply by a central bank (fiat money). The amount of total credit, i.e. the amount of deposits (credit to the bank) and amount of loans the bank makes (credit from the bank) is flexible and varies somewhat according to peoples demand for credit. However it is tied to the amount of money by a ratio - the average reserve ratio of the banks.

Banks cannot simply extend as much credit as they want. The reasons are as follows. A large amount of inter-bank transactions occur every day. This is due to people having to pay people who use a different bank. At the end of each day, the banks will then demand settlement of these payments from each other - in money. If a bank extends too much credit relative to its competitors, it will find that (since it has more customers paying customers in the other banks) money will start to leave its vaults - eventually causing bankruptcy (in this situation the bank typically tries to contract its credit like mad to save itself).

Hope this was helpful.