The credit creation of private banks

Banks earn their money, among other things, by transferring debts to money capital, i.e. by endowing their solvency with means of payment covered by the legally secured power to incur debts, which in turn arises from the special nature of their capitalization. If, on the one hand, nothing runs in an economy without their monetary transactions, on the other hand, their business activity presupposes precisely this economy, in which the loans granted must prove themselves as monetary capital. The capitalization, which is traded in the legal relationship between credit institutions and “real economy” in such a way as if it had ever already occurred for the banks, must inevitably be realized in future capital accumulation in the entire economy, otherwise, in fact, only the debts grow, while the wealth they promise becomes increasingly illusory.

And this also applies to the question of money creation by private commercial banks (and not just central banks), about which a strange confusion prevails to this day among economists of all stripes. Banks can definitely create money, not out of nothing, as economist Joseph Schumpeter still assumed, but in an extremely productive way, insofar as money creation promotes a steady, future-oriented growth of capital. That is, commercial banks do not create money out of nothing, but in anticipation of future capital valorization.

There is a widespread misconception that banks are pure financial intermediaries that lend out customers’ money and can then lend out exactly only these borrowed sums of money themselves. It is true that banks generate their profits and their growth with other people’s money by buying the power to dispose of it, if possible, from any actor who has it by paying interest. The banks then use this money for their own lending as if it were their own property. Banks thus transfer debts to money capital. What they advance in monetary capital, however, is based only to a small extent on liabilities, on the basis of which they then create loans. After all, commercial banks are not pure money brokers who exploit nothing more than the potency of credit for themselves. They would then be able to grant all the more loans the more savings are made in an economy and, to that extent, the savings of the economic agents also end up in their bank accounts. However, all banks would then not be able to grant more loans in a country as a whole than the savings customers are willing to make available to them. Economist Matthias Binswanger writes: “Banks would then be comparable to a blood bank in a hospital. Just like a blood bank, the bank would then have to tell its customers from time to time: ‘Unfortunately, we have no more savings at the moment, but you can sign up for a waiting list, and we will notify you when we have received more savings.'”

So banks don’t necessarily need those savings to make loans. Rather, their productivity consists in the management of promises to pay or the creation of credits with which they finance and initiate investments and production processes that are as profit-oriented as possible in accordance with their calculation and speculation. Thus, there is no mere redistribution of funds, but the banks themselves operate as an essential growth-generating factor of capital accumulation in an economy.

So how does the process of money creation work? When a commercial bank decides that a customer is creditworthy (can show collateral and the potential to realize capital in the future), it gives him a loan, the amount of which is credited to his account. When the account is credited (demand deposit), it increases the money supply, which today consists to a large extent of deposits in bank accounts. These deposits are called giral or book money, which is written as a number on an account and is mostly used to settle only electronic payments. Once again, with the loan, the bank uses means of payment as a promise of payment and credits them to the customer in his function as debtor on his checking account, thus creating book or giral money (digital amounts on checking accounts), so that on the asset side of its balance sheet, the bank actually has a loan claim against the customer, which is offset on the liability side by the customer’s deposit as a liability. On the liabilities side of the balance sheet, therefore, the liability appears as a deposit from lending, while on the assets side the balance sheet total has increased by an amount roughly equivalent to the loan (minus reserves). In technical jargon, this is called “balance sheet extension.” In this case, the bank’s liability is not offset by any payment, and thus none of its accounts is reduced by any amount of money (a reduction would lead to the reduction of other quantities on the balance sheet). The liability simply appears on the bank’s balance sheet as “customer credit”. The question of whether, when the amount is booked as a credit balance, this amount must be deducted from another account, leading to the reduction of other quantities in the balance sheet – either reserves (fractional reserve theory) or other funds (bank as financial intermediary) can therefore be answered in the negative. Giro money creation means that the limits to lending initially lie in the bank’s risk management.

Digital money tokens are lent, which are inscribed in checking accounts and inherit a claim to (government) cash (giro money). Although the customer now has the credited sum of money at his or her free disposal, at the same time there is a corresponding debt to the bank. During the term of the loan, there is usually no cash payment to the customer, so that the issue of the means of payment remains a promise of payment by the bank, which is cancelled again installment by installment as the loan is repaid. The bank realizes profits during the term of the loan, known in technical jargon as “seigniorage,” the source of which is the interest payments made by the debtor. Banks are therefore primarily profit-oriented money producers and not simply money brokers. In this context, the bank’s granting of the loan to a capitalist enterprise, including the contractually secured repayment and interest payment over a certain period of time, presupposes that the debtor will increase the money borrowed. This precondition is absolute, i.e. independent of the debtor’s success, and accordingly takes precedence over the debtor’s initially only promising business, with the bank attempting to calculate its uncertainty and pricing it into the amount of interest. The more precarious the debtor’s performance in realizing the loan or the potency of money in monetary capital, the higher the interest.

If a loan is now repaid installment by installment, then the money supply is reduced again by the corresponding amounts. Crucial to the question of the increase in the money supply is net lending: If the commercial banks of a national economy issue more new loans than loans are repaid to them, then the money supply increases and, at best, so does growth, insofar as more loans are used to finance investment.

So far, only the internal money flows of a bank have been dealt with. If a bank A grants a loan to a customer, which is credited to the customer’s account, and the customer initiates a non-cash payment from his account to the account of another commercial bank B, then bank A records an outgoing payment and bank B records an incoming payment. The commercial banks settle these payment flows in special interbank accounts, and the differences tend to balance out. Through money-creating writing processes, the giro money is initially created at the level of the public, but this always results in payment flows between the banks, which are measured on interbank accounts and differences are shown as respective results. Now, if the practice of lending between banks differs greatly, for example, if one bank has more claims on customers than another bank, then there are unequal payment flows, which affect the interbank loan accounts and thus also the respective profits of the banks. It is now no longer the entries for claims/liabilities vis-à-vis customers but the entries for claims/liabilities vis-à-vis banks that indicate the changes in banks’ assets.

With their money creation, banks do not limit themselves to demand deposits, but their power of disposal extends to deposits of all kinds, to savings deposits with longer and shorter notice periods. They handle their credit creation in accounting terms with credit entries for which it does not matter at all that they do not denote money that already exists but money oriented to the future, which represents nothing but promises of payment by the bank. As far as the borrower does not withdraw the amount in cash, the credit operates as a non-cash payment transaction. It is therefore not true that the granting of credit and the subsequent disbursement must always be countered in total by a plus, a deposit, a credit note or the payment obligation of a business partner, own money or own debts of the financial institution, as the Gegenpunkt writes. And he goes on to write, “In this respect, they can indeed lend only what is reflected in their available solvency.” Not entirely wrong, but not entirely right either, as we have seen. Banks have ongoing operational costs and they need capital, which means that lending and interest rates cannot be based solely on expectations either. The Counterpoint itself qualifies its position when it writes that banks, as managers of the social circulation of money, have the means “to use whatever is on their books as a plus for payments.” This plus results, among other things, from the creation of money, the anticipation of utilization in the future. However, banks cannot create money without limits because, for example, companies tend to reduce their debts rather than take out loans during a recession, or the banks themselves are reluctant to lend because of the lack of profit prospects of their potential borrowers. The banks’ money creation always remains tied to the mechanisms of capital accumulation. This, of course, would need further elaboration.

By means of money creation by the banks, more and more investments can be financed in an economy without having been saved beforehand, i.e. capital accumulation is stimulated and economic growth is advanced, as far as the credits are used productively. In this case, they are used either to finance machinery and equipment with investments, which increases the production capacity of a company. If, on the other hand, additional investment had to be financed by more savings, this would not allow economic growth, since higher savings would at least lead to a corresponding decline in consumption and be counterproductive for growth. Savings and consumption are related, and consumption is proportional to the income generated in production. Finally, it is production that must be equalized to bring savings into line with investment. This was Keynes’ answer to Says` law.

On the other hand, if credit is used unproductively, that is, to buy goods and services that already exist, then money creation can lead to rising prices and inflation. If money creation leads to the purchase of securities or derivatives, then this, most economists assume, should be subsumed under unproductive use of money. It is true that money creation can lead to inflation in financial markets and speculative bubbles, which are particularly common in the stock market or the real estate market. Nevertheless, the trading of fictitious capital does have a productive component. We find a doubling of capital when trading fictitious capital. This happens quite concretely when a money owner buys property titles such as stocks, bonds or securities, and this purely with the aim of making more out of his money. Quite contrary to the purchase of standard goods from industrial production, which serve either consumption or industrial use, the purchase of a property title implies the specific use of the secondary use value of the money capital, i.e., the buyer of the property title uses the secondary or meta-use value of his sold sum of money to generate returns in the future, while the seller of the share, bond, etc. is by no means excluded from the capitalization of the money capital, because, as in the case of the sale of ordinary goods, the issuers of shares or bonds, for example, dispose in real terms of the money which the sale of the property title earns them. Depending on the economic situation, this has positive or negative consequences for the economic activities of a country as a whole.

However, the realization of advanced money takes place only if, in the long run, productivity increases either through technological innovation or through the increase in labor intensity (and thus growth) in such a way that the mass of loans (and fictitious capital) used remains justified. The borrower has to make the lender’s money productive, that is, his realized proceeds have to justify the anticipation in the loan, have to yield the wealth anticipated in the interest claim, thus making the lent money pay off for the lender as well.

In this context, let us briefly address the question of the relationship between central banks and commercial banks. If a lending bank has sufficient funds on a given disbursement date, it pays the sums drawn down from its holdings; if they are negative, it usually asks for the money on the interbank market. The balances between commercial banks resulting from these account movements are settled in central bank money. It is still possible to speak of the qualitative dominance of central bank money, but today the money created by commercial banks is much more important in quantitative terms than central bank money, so that here, too, we must begin to think about the significance of the changeover from quantity to quality. Thus, in the second half of the 20th century, an essential area of competence of central banks, which consisted in quasi-autonomous monetary policy, was increasingly transferred to financial capital itself. Book money has long since ceased to be only what the central bank issues as its money, but also what private commercial banks create as credit. As a result, central banks no longer have precise information about the quantities of money currently in circulation – and about the risks that are circulating on the financial markets. However, it must be conceded that after the financial crisis of 2008, money creation has once again passed more strongly to the central banks, whether by granting loans at low interest rates to private banks or by purchasing securities with a lower credit rating (from banks, governments and companies). In the process, the balance sheet totals of the leading central banks have increased massively. However, this process must not be considered irreversible.

Thus, central banks no longer exercise the function of a “lender of last resort” without being challenged, because a high share of national and transnational operations of financial capital (of commercial, investment and shadow banks) is executed independently of the central bank, whereas, on the other hand, the governmental intervention power of central banks always remains dependent on the price movements of derivative monetary capital. However, it is precisely in times of economic crisis that the use of the security device “central bank” is then called upon again by endangered financial capital units themselves. Central banks constantly link their operations such as minimum reserve formation, liquidity protection and interest rate policy with the strategies of private financial capital. Moreover, it is precisely the establishment of central banks as the “fourth estate in the state,” the legal disengagement from the executive and legislative branches, and the transformation of the central bank toward a quasi-autonomous government practice that confirms the alignment of central banks with the dynamics and necessities of financial capital accumulation.

The term “quantitative easing” describes central bank measures such as the permanent purchase of commercial banks’ securities, the aim being to increase their reserves at interest rates that are already at zero and to continue to pursue an expansionary monetary policy. In the course of the financial crisis of 2008, a large part of the bad mortgage-backed securities (MBS) was deposited with the central banks and replaced by first-class reserves on the balance sheets of the commercial banks. By 2009, commercial banks were already saturated with reserves, so that active monetary policy by central banks qua repo (sale and repurchase agreement) was hardly necessary and lost its influence on money creation by commercial banks. At present, short-term interest rate changes no longer have a cyclical influence on corporate business activities due to the policy of QE, because commercial banks simply leave reserves lying around in a recession due to a lack of profitable investment opportunities, or companies deleverage rather than borrow, with the result that the key interest rate at least gradually loses its steering and allocation function for (industrial) capital accumulation. (Central banks actually pay interest to commercial banks for holding reserves).

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