In a response to a recent post by Brian Romanchuk, somebody
made the following comment:
"If private banks are ..... allowed to create and lend
out their own money, they can undercut the ..... free market rate of interest,
and for the simple reason that printing money is cheaper than having to borrow
it or earn it."
This seems to suggest a kind of model in which banks choose
whether to finance themselves with someone else's money that they have to pay to
borrow, or money they create for themselves for free. I think the problem is that this confuses two
distinct ideas: that there is a benefit from having monetary liabilities and
that bank lending increases deposits.
The potential benefit that accrues to banks by virtue of
their status as money issuers arises through a reduced rate of
interest on monetary liabilities. If a
particular type of bank deposit, such as a positive current account balance, is
readily available for making payments, then it typically carries a lower rate
of interest than other deposits.
Sometimes the rate of interest on such balances is zero, but
it need not be. The important point is
that there is a benefit to the bank through a reduced funding cost. Set against this is the cost to the bank of providing
current account services in the form of the costs of premises, staff and equipment.
At this point it is worth noting that these costs and benefits
are based on the level of the bank's outstanding monetary liabilities. It is nothing to do with which bank makes the
loan that creates the deposit. It is
quite possible to have banks making lots of loans, but having minimal
liabilities in the form of immediately available deposits, because that bank relies on
different funding techniques. These
banks would be creating new money, but not getting any of the potential benefit
that arises from having monetary liabilities.
On the other hand, it would be possible to have a bank with
very large current account liabilities but which never engaged in deposit
creation. This would happen if the bank
was simply taking deposits through payments received in from other sources and
making all of its loans in cash[1]. The potential benefit of operating current
accounts would be very important to such a bank.
The point here is that it makes no sense to say that it is
cheaper for a bank to print money than borrow it. What the bank does at the point of making a
loan is irrelevant. What matters is how
it chooses to manage its liabilities going forward and in particular the extent
to which it chooses to compete for current account deposits.
The extent of the benefit depends then on how competitive
that market is. Under perfect
competition, banks would have to offer interest rates on current accounts that
would simply leave them with normal profits.
However, it is likely that there is a degree of monopolistic competition
in the provision of banking services, particularly at the retail level, and
this means that there is some supernormal profit that accrues to banks as
providers of monetary liabilities.
It is difficult to assess how profitable it is for banks to have
monetary liabilities, largely because many of the costs are shared with other
activities. Even for the banks
themselves, it is somewhat arbitrary how costs get allocated. However, the point here is that any such
profit is just regular monopolistic profit in the market for current account
services and not something to do with money being created out of thin air.
[1]
Making loans in cash does in fact "create money" in the sense of
increasing the broad money supply, but it is not what people usually have in
mind when they talk of banks "printing money".
