# How much money can banks lend out as multiple of deposit



## mainasia (23 Oct 2008)

Here's another banking question and it's got to do with the cause of the credit crisis.
I've been thinking about money for a while now (who hasn't ), I'm particularly interested in how money is created and tracked down the line as it goes from bank account to bank account.

From some posts I've read here it seems most 'money' in the system is actually on loan from banks, only 10% of it or so is in cash. 
Normally the leveraging was something like 10 times or so, but during the last 10 years with the take up of derivatives this allowed banks to loan out up to 28 times the money on their books.
To me this is the biggest money making scam in history. Since the management and traders work off an annual commission bonus structure they just had to increase the overall money in the system to get rich quick, rather than actually compete for business. They didn't need to worry about pay-back as long as they structured the loans for 5-10 years or could package it and sell it on.

And that brings me to the other point, how does the government control at what leveraging rate (I don't the correct term) an individual bank loans out. Because the temptation is always there to increase it, with deregulation of the markets how did they expect the market to police itself and limit the supply of 'money' in the system? I have been reading comments on the financial regulator in Ireland and in the US and it seems they thought the banking industry would be self-regulating and report honestly to the financial regulators (tee hee hee). I mean that's the biggest joke I've ever heard.

Last question and off the point but perhaps there are some financially astute people out there. What prevents a couple of extra 00s being added electronically to a bank account in one country and putting it into the system (excepting government's printing money and banks loaning out multiples of reserves). For instance a dodgy bank in the Congo adding in a couple of 00s in the bank account and then transferring it to a bank account in Ireland. I guess there is an internationall third party server tracking debits and credits as an auditing system?


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## darag (30 Nov 2009)

No need to get carried away here suggesting there's something fundamentally fraudulent about retail banking.

Retail banking is a relatively straightforward business.

A bank has assets which are divided into different classes depending on how readily they can be turned into cash; having straight cash is at one end of the spectrum, but they also hold high quality bonds (government bonds for example which can readily be sold for cash) followed by different types of loans to other banks, loans to businesses and loans to individuals (mortgages, personal loans, overdrafts).  Mortgages for example may take upto 35 years to turn into cash.  Also loans to businesses and personal loans cannot be readily turned into cash.  All things being equal, holding an asset which can be quickly turned into cash is a more attractive proposition.

On the other hand they have liabilities - they owe money to others. Some are long term borrowings (where the bank can pay back at a predicable rate over 10 years) while at the other end of the spectrum money owed to  depositors is stressful because they it can be demanded back at any time.  In the middle there is money owed to other banks and pension funds and the like - some of which needs to be repaid after terms of between days to a couple of years.  Here the opposite is the case - longer term liabilities (where the bank has lots of time to pay down) are more attractive all things being equal.

Basically retail banking is about juggling all these flows of cash.  Unfortunately because some of them are unpredictable (deposits or the cost of short term borrowing for example), it is impossible for a bank to plan with 100% certainty.  Here is where the risk is involved.  To cover "unforeseen" eventualities banks are required to a certain amount of its assets in a form which can be turned into ready cash immediately - this is called core equity.

When things are going well, everyone is happy; depositors make money for doing nothing, banks make profits and other individuals, business and banks get to do productive things with the borrowed money.  No culture in history has managed to drag itself out of subsistence existence without some form of banking.


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## sunrock (1 Dec 2009)

The OP states that ..the bankers were self regulating and would report honestly to the financial regulator. This was the "biggest Joke" the OP ever heard.
Well I know a bigger joke ...our own financial regulator,who was in bed with the bankers...of course he knew what was going on, but felt his job was not to regulate but to appear in news bulletins talking up the banks even as they were collapsing all around him. His reward was a lotto type resignation package.Actually a VERY BIG SICK JOKE....and the worst thing is that the joke is on all of us!


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## BrianODohert (1 Dec 2009)

Most well managed banks these days--I mean in normal times- might be lending 120% of deposits, the 20% being borrowed, usually short term. Some would argue that they should lend less than 100%, and not be borrowing anything for onward lending. They also should ensure a certain ratio between their own capital and their total loans, and 8% has been considered a benchmark for that. (Now that is to go up, but its a bit more complicated than this, so lets just assume 8% is what Irish banks should be aiming at)

Post NAMA--that is, after the two main banks pass over c. €40 bn. of their loans ("assets") to the State- their ratio of loans to deposits will fall to c. 120% from todays 150% +. That is the main benefit of NAMA to the banks--their Balance Sheets will look less risky. But that will cost them c.€10 bn. in capital losses, which they will have to find. (They have already found c. €3 bn from recent years' profits). On the other hand, because loan totals will have dropped, they will need to show less capital than otherwise, to reach 8% of total assets. In aggregate, they may need to find extra capital now of c. €5 bn., which is probably do-able without asking the State to contribute. (I'm talking only about AIB/BOI). 

However, their capacity to lend extra money will be very limited, if it is available at all, because of the need to keep total loans at no more than, say, 120% of deposits, and given the severe difficulty of raising deposits, especially when many media commentators and politicians are screaming about the risks of putting money into the banks after the State guarantee runs out, etc. Some commentators would even be glad to see control of Irish deposits drifting to outside Ireland, and to be used for funding loans to customers in other countries. We would be rightly banjaxed then, and I would be sure the government would do a lot to prevent that (by avoiding the nationalisation and subsequent resale of these banks). . The other problem impacting on the banks' lending capacity, of course, is that the government itself desperately needs whatever funds the banks can lend, which means the private commercial borrowers will be left behind. At a time when, as now, foreign lenders are generally pulling out of the Irish market, the prospects of current government policies producing any extra loans for Irish industry are dim, at most. Rgds BrianODoherty.ie


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