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Why do banks accept deposits?

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May 02, 2013 – Comments (24)

I don't really understand why banks accept deposits. With fractional reserve banking they can lend out far more cash than they take in. I'm not even sure if the banks even have a reserve requirement anymore. So why bother spending all that money paying interest and sending out statements, since the banks can lend out whatever consumers will borrow regardless of te amount of cash in the bank? Is it to legitimize te system? 

24 Comments – Post Your Own

#1) On May 02, 2013 at 2:21 PM, chk999 (99.97) wrote:

Where do you think they get the money to loan out?

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#2) On May 02, 2013 at 2:25 PM, awallejr (81.55) wrote:

You also need customers to lend to.  Depositors tend to borrow from the bank they keep their deposits with.

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#3) On May 02, 2013 at 2:44 PM, Valyooo (99.41) wrote:

@chk999,

They don't lend out cash reserves...they create loans that are 10-40x more cash than they have, and last I read, there are no reserve requirements anymore....why keep cash at all if you can lend an unlimited amount more cash than you have?  Why not just keep $1?  In a normal world for banking, what you said would make sense....but fractional reserve banking is not normal..I'm pretty sure you know all of this already though, you're one of the top 5 most knowledge people on this site in my opinion, which is why I don't quite get your response

 

@awallejr  Yeah depositrs tend to borrow money from where they keep it....but 1) If no banks kept money this would not be an issue  2) if a given bank did not have to deal with all of the expenses of a deposit account, their loans would be cheaper 

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#4) On May 02, 2013 at 2:49 PM, awallejr (81.55) wrote:

Well there will always be a demand for someone to hold people's money.  Personally I don't advise people to keep their cash under the mattress. Or look at it as an "advertising" expense then that creates jobs. 

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#5) On May 02, 2013 at 2:56 PM, L0RDZ (82.15) wrote:

They accept deposits so that they  can  basically  F&CK   people  over...  have  you seen  the fees  they  can  get  away with charging not  to mention these days  they don't  have to pay  interest,  but I hear  you  it  must seem  like  an  annoyance  taking  Jimmy's  deposit and  or  making  change.

They can make a killing  on  just allowing someone access to their  $$$  say  someone  needs  some  money  but  doesn't  qualify  for  not  being  charged  at  the  atm...

Say you need  $100  or  say  you  don't   say you need  $20   the  atm  fees    range  anywhere  from  3 to  whatever they can  get away with charging..

say you  need  20  dollar  and  you get hit with a  3 dollar fee...  thats  a  fast 15%  cut  for  doing  nothing more than providing someone access to their money and heaven  forbid  you  don't  keep enough and  are subject to additional bank fees  or  someone  hits you with a  bogus charge  and  you  are  momentarily  over drawn  at  the bank...

I've once had a  bank piss me off and guess what  they  didn't  have enough  physical  money to  provide me  with  so they had to cut me 2 checks...  unbelievable...

 

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#6) On May 02, 2013 at 3:24 PM, ElCid16 (96.43) wrote:

http://www.federalreserve.gov/monetarypolicy/reservereq.htm#table1

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#7) On May 02, 2013 at 3:29 PM, SkepticalOx (99.44) wrote:

I'm not sure if you fully understand how the fractional reserve banking system works. And banks, traditionally anyway, are suppose to make money on the spread between the interest paid out to depositors and the intereste rate they get from loaning those deposits out.

The banks do have a reserve requirement, in the U.S. anyway, and you can't just lend out money you don't have.

What the reserve requirement is, is regarding how much of the deposits the bank should keep and how much it can lend out. So if the reserve requirement is 20%, then out of the $100 the bank has in deposits, it can lend out $80, and it has to keep $20 in reserve.

The whole deposit multiplication thing in fractional reserve banking happens when that $80 is lent out is deposited into the borrower's account, for which the bank can lend out, up to the amount allowed according to the reserve requirement (in our case, 20%). So:

Bank 1: $100 deposits, lends out $80
Bank 2: $80 deposits, lends out $64

So now in total, the banks have $180 in deposits and $144 in money lent out, all from that initial $100 of customer deposits.  

So... just as chk999 asked, if the banks don't take deposits, where do they get the money to loan out? 

 

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#8) On May 02, 2013 at 3:42 PM, Mega (99.96) wrote:

With fractional reserve banking they can lend out far more cash than they take in.

Not true. Fractional reserve banking means they lend out far more than their equity capital. It doesn't mean they can print cash and lend out more cash than they have.

I'm not even sure if the banks even have a reserve requirement anymore.

They do.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm
http://en.wikipedia.org/wiki/Basel_III

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#9) On May 02, 2013 at 3:45 PM, Mega (99.96) wrote:

Perhaps I should have read #6 and #7 before responding.

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#10) On May 02, 2013 at 3:53 PM, Schmacko (55.25) wrote:

There's still a reserve requirement on the banks.  They just don't have to check reserve levels before making a loan.  The reserve levels are squared up at the end of the day and if the bank is short they borrow money from another bank with a surplus (fed fund rate) or directly from the fed (discount window).

Major banks pay squat out in interest and most are moving to electronic statements so the costs associated with those two items isn't significant.  Plus taking deposits means the banks can charge those depositers fees and fees are a major source of bank income.

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#11) On May 02, 2013 at 4:06 PM, somrh (86.39) wrote:

Well, when banks create money  they don't "print money" or anything of the sort. The loan actually creates a deposit, an addition to an account. So the deposit system is necessary for the whole process. 

Regarding some other comments regarding "money multipliers" and such see The Myth of the Money Multipliler.

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#12) On May 02, 2013 at 8:13 PM, Valyooo (99.41) wrote:

Megashort,

 

Look at cash vs loans on a balance sheet of a big bank.  I never said they could print cash.  I said they could create bank credit 

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#13) On May 03, 2013 at 9:52 AM, Mega (99.96) wrote:

I never said they could print cash.  I said they could create bank credit 

There's nothing special about how banks create credit. They are just trading cash for a loan asset, the same way you would do it if you were making a personal loan to a friend.

Once a bank runs out of excess cash, they have to sell other assets or issue new liabilities in order to make new loans.

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#14) On May 03, 2013 at 1:08 PM, Valyooo (99.41) wrote:

But I mean, if my friend needed a loan, I could only loan him the cash I actually have...there is no money multiplier for a friend to friend loan.  Banks can lend way more than they have...thats why I dont get the point of having any cash at all

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#15) On May 03, 2013 at 2:30 PM, Mega (99.96) wrote:

Money multiplier is a macroeconomic concept. It doesn't even mean anything in terms of corporate finance.

When you say "Banks can lend way more than they have", that's not a precise statement at all. They can only make the limited amount of loans that their equity base AND their liquidity position support. And making loans consumes their liquidity position.

Here is a great resource if you want to understand banks better: http://csinvesting.org/wp-content/uploads/2012/07/analyzing_and_investing_in_community_bank_stocks.pdf

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#16) On May 03, 2013 at 2:30 PM, Valyooo (99.41) wrote:

There's no reserve requirement in Canada...so what about there? Why the need for any cash?

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#17) On May 03, 2013 at 2:36 PM, Valyooo (99.41) wrote:

What I am saying is look at the Cash (not equity base or deposits) and compare it to the outstanding loans. There's clearly a huge difference 

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#18) On May 03, 2013 at 2:37 PM, Valyooo (99.41) wrote:

Thanks for the link though

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#19) On May 03, 2013 at 2:53 PM, Mega (99.96) wrote:

What I am saying is look at the Cash (not equity base or deposits) and compare it to the outstanding loans. There's clearly a huge difference

Because they had to pay out cash in order to create or acquire all those loans.

You never see a lot of cash on a bank balance sheet, because it's like inventory in a manufacturing business. You try to only keep enough around, in case it's required.

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#20) On May 03, 2013 at 2:59 PM, Mega (99.96) wrote:

Reserve requirements are a subset of capital requirements. Canadian banks still have equity capital requirements.

http://www.cbc.ca/news/business/story/2013/03/26/osfi-banks-capital.html

The banks will need to have a common equity tier 1 ratio of eight per cent as compared with seven per cent for smaller, less important financial institutions as of Jan. 1, 2016.

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#21) On May 03, 2013 at 5:27 PM, Valyooo (99.41) wrote:

By cash, I mean paper currency deposited into the bank

 

I know I must be missing something, because in my head it looks like this:

 

Jason deposits 100k of paper cash into BAC

BAC lends out 80k to Frank in the form of bank credit

Frank deposits that back into BAC.  BAC now has 180k in deposits.

Pretending the reserve requirement is 80% for a second, can BAC now lend out 80% of 180k (total deposits, so they can lend 144k)? 

If so, then they can lend out 144k to Edward, who can deposit that money back into BAC, who then has 324k in deposits and 224k in loans....so their deposits and loans can keep growing exponentially


Or, is it that they have to keep 20% of the first loan (20k), 20% of the second loan, and then they can only lend 80% of 80k ?

Either way it seems that the banks can be leveraged at a ratio of triple digits to 1....in which case it hardly seems like having any cash at all matters because a slight change in defaults will equate to way more than the cash they have...it seems that you could just make 100% of bank equity be "deposits made from prior loans", without any actual cash.

 

Are there any books that explain like the inner workings of fractional reserve banking? 

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#22) On May 04, 2013 at 1:24 PM, Mega (99.96) wrote:

OK, after Jason and Frank's transactions, BAC has 180k in deposits, 80k in loans and 100k in cash.

Assets
100k cash (100k in, 80k out, 80k back in)
80k loan to Frank
Total: 180k

Liabilities
100k deposit for Jason
80k deposit for Frank
Total: 180k

Shareholders equity = Assets - Liabilities = 0 

But the problem with this balance sheet is it's missing the equity. Let's say BAC had raised 30k cash from local businessmen before starting up.

Assets
130k cash (30k equity, 100k in, 80k out, 80k back in)
80k loan to Frank
Total: 210k

Liabilities
100k deposit for Jason
80k deposit for Frank
Total: 180k

Shareholders equity = 30k
Equity Ratio = 30k / 220k = 14.3%

The bank is well capitalized right now and very liquid.  But what would happen if they tried to lend out 144k to Edward? 

They only have 130k cash on hand, and some of that needs to be held as reserves. They would come up several thousand dollars short, and would need to borrow or take in more deposits in order to make the loan. 

And if they are successful in taking in more deposits and loaning out more money, they are required to stop leveraging up once they hit the minimum capital ratios. If leverage gets too high, the regulators will take over the bank.

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#23) On May 06, 2013 at 12:34 AM, Valyooo (99.41) wrote:

I knew that already, and somehow when going through my own example got confused...cleared my head, now I remember how this works.  I appreciate you taking the time to clear this up for me though.

The one thing that still confuses me in FRB though, is the concept of federal reserve notes....they are an obligation of the government to produce something of equal value in dollar terms equal to the dollar...seems like a crazy loop 

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#24) On May 06, 2013 at 1:55 PM, justaluckyfool (< 20) wrote:

"Why do banks accept deposits?" The primary reason is because they are "Private For Profit Banks" (PFPB).Their public purpose is to help "to circulate and exchange the currency of the nation.Since modern money requires a means of recording and transfering, banks are used for this purpose. They take possession of the fiat currency issued by the government (US issues Dollars): record the amount and await demand for transfer by the depositor. For this service they charge a fee, and fees that could "help them do what they were created to do; make profits for their owners. This is a simple transaction. 100% in goes out as 100% payments and fees.....But the banks discovered that 90% of the currency they had in storage just sat there idle in the bank. Knowing that their purpose in life was to maximize profits, they decided 'to lend this currency they didn't even own to other people, regardless of where they banked. So they print bank money ,"checks" in US Dollars for 90% of what they have in "Other People Money" and without withdrawing that money, issue a check (new money) to fund the loan. Then the magic of banking: they must record the transfer. The bank has an asset of $90M (the loan amount) which the borrower of $90M has a liability to pay back.This creates on the balance sheets the folowing entries : Total Assets:= Deposits ($100M) + Assets (loans) $90M for a total of $190 M on the plus side. On the minus side we have  deposits money in storage $100M + $90 M temporarily given to borrower. ****$190Million = $190Million. How long would it take you to become a member of the 1% if you could issue $90 trillion in loans at 2% for 36 years, meaning that you would receive $180 trillion in repayment? OK, you would have to cancell the asset on your books of $90 trillion, but damn what could YOU DO with the $90 trillion "in maxamized profits"? You do this and you go to jail,charged with conterfeiting and stupidity. Why stupidity, because all you had to do to make it legal was "to own a PFPB" (GOOGLE- "JUSTALUCKYFOOL"

 

 

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