An interview with Professor Richard Werner (who has worked on our proposals)

It is also an accounting fact that no other asset class increases when an advance is paid off, as would be the case when a conventional asset is sold (disposal of a loan book via securitisation -does- increase the bank’s cash assets, but that is not the same thing as loan repayment). Neither is the attrition of advances through loan repayments reflected in the profit and loss account, as would be the case with the depreciation or revaluation of other assets. The only attribute that advances share with conventional assets is that they generate a source of revenue. But so do staff, and so does the application of knowhow, and so does the administration of methods and procedures, yet none of these are capitalised as assets on the balance sheet.

Advances resemble loans, but loan assets are acquired by non-bank lenders through the expenditure of money, the transfer of money owned by and in the possession of the lender to the borrower. Advances may look like a loan, but they don’t behave like a loan and they shouldn’t be classed as a loan.

Similarly with current account deposits. Account holders acquire these normally by transfer from those of other account holders. But when an account holder receives an advance, augmenting their deposit, no other deposit is diminished. It is simply not true to say that banks lend out 90%, 95%, 99% or whatever, of the new deposits received by their customers. It doesn’t happen. Nothing leaves these accounts when advances are extended. The total balance on all accounts increases when an advance is made, by the amount of the advance. This isn’t a view: it’s an accounting fact.

Now what -is- a view is the interpretation that what happens when an advance is made is “as if” the bank lends out a proportion of new deposits received, which is the view propogated by economics textbooks. But this is only a way of looking at things, a viewpoint. It is not an explanation of the mechanism by which the process actually happens. Similarly, to say that a bank leverages its capital is to apply a metaphor to describe the appearance of what is happening, not an explanation of how its happens. Because the creation of bank deposits through advances is effortless and costless, prudential managers and officious regulators have to devise restraints on the process, and because economists have failed to address the subject and develop theoretical groundings for such constraints, resort has to be made to rules of thumb. Two measurable quantities seemingly independent of the levels of advances have been adopted for this purpose: the levels of customer deposits (which are not, in fact independent) and the level of the bank’s capital, and these have been pressed into service to set rule-of-thumb constraints. Levels of deposits inform “fractional reserve” banking constraints, levels of capital inform “capital adequacy ratio” banking constraints. But these views of banking are directed at reigning in the process by which money is created, not explaining it.