Credit Creation

8 Key excerpts on "Credit Creation"

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  eBook - ePub

  Leading Issues in Islamic Economics and Finance

  Critical Evaluations

  • Zubair Hasan(Author)
  • 2020(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  We deal here with an aspect of monetary policy in a dual financial system where Islamic and mainstream banking institutions operate side by side in a competitive setting. This policy addresses a number of objectives, including the mobilization of resources for development, promotion of distributional equity, and maintaining stability in the internal and external value of domestic currency. This we discussed in the preceding chapter. Presently we shall be looking at monetary policy contextual to the Credit Creation process and the control measures a central bank employs to mitigate volatility in macroeconomic variables. Such volatility often promotes proclivity to crises that snowball to inflict severe damage on national economies across the globe. The 2007–2010 turmoil is a recent example. In this process, the credit money that banks generate plays a crucial role.

  In the following section, we briefly explain the process of credit money creation. In Sect. 9.3 we explain how Islam rewards capital in the absence of interest payments. How the profit sharing operates between the parties. Section 9.4 proposes a new instrument for controlling Credit Creation, explains and illustrates its operation as well as its linkage with the rate of interest and its relationship with other measures in the following section. Section 9.5 elaborates on the interface between the monetary and fiscal policies and its ramifications. It also discusses monetary policy objectives and targets. Finally, Sect. 9.6 concludes the arguments of the chapter.

  9.2 Money Creation by Banks

  There are multiple sources for obtaining credit (debt), for example, the government, cooperative societies, mutual funds, and individual money lenders, but most of the credit in modern times comes from commercial banks.

  We have already made a distinction in the preceding chapter between (i) currency or legal tender money and (ii) credit or bank money. The two together constitute the M1 version of money supply. The relationship between them lies at the heart of the Credit Creation process that commercial banks utilize. The volume of (i), i.e. currency in an economy, serves as the base for generating (ii), the credit money. Part of the base money (currency) always remains inside the central bank while the remaining part is held outside by the public.1 People deposit a part of the outside money with them in commercial banks as demand or time deposits that together constitute the cash deposits of the banking system. The banks have to keep with them a portion of deposits, say 10%, as a statutory reserve to meet the daily withdrawal needs of the depositors. The remaining they can lend on interest or invest in Islamic profit-earning schemes. In conventional banks, the sum loaned is credited to the account of the borrower. Thus, loans generate what we call credit

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  The Money Revolution

  How to Finance the Next American Century

  • Richard Duncan(Author)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  This chapter will show that the Fed also controls the amount of credit that the banking system can create. This power is of crucial importance to the conduct of monetary policy and to the economy because, under normal circumstances, the banking sys-tem creates a great deal more credit than the Fed does. For that Credit Creation by the Banking System 130 Credit reason, the Fed generally achieves its policy objectives by influ-encing the volume of bank credit. This chapter begins by explaining how the banking system creates credit. Next it describes the tools and methods the Fed employs to control the amount of credit the banking system cre-ates. Finally, it shows that over time the Fed steadily revised its regulations to enable the banking system to create ever larger amounts of credit in order to stimulate economic growth. Eventu-ally, these changes facilitated the creation of so much credit that credit growth became the most important driver of economic growth, fundamentally transforming the nature of our eco-nomic system. Subsequent chapters will show that economic growth became dependent on credit growth, which explains why the Fed is so desperate to ensure that credit continues to expand. The Fed understands that credit growth drives the economy and that if credit contracts there will be a depression. Commercial Banks Create Money, Too Part One described how the Fed creates money. But, the Fed is not alone in its ability to create money. The commercial bank-ing system also creates money by extending loans and creating deposits. The deposits that individuals, businesses, and other entities hold in commercial banks are considered to be a sec-ond kind of money because deposits can be withdrawn as cash and spent, or they can be spent simply by writing a check on a deposit in a checking account. The money that a central bank creates is called base money or the monetary base.

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  eBook - ePub

  Credit and Creed

  A Critical Legal Theory of Money

  • Andreas Rahmatian(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  44 See Chapter 3, sec. 1 and particularly Chapter 4.

  45 Schumpeter (1954: 1113–1115), and footnote 5 at pp. 1114–1115.

  The following discussion proceeds on the basis of the Credit Creation theory of money. The ex nihilo creation of money that ensues from the Credit Creation theory46 may have been unsettling, which has presumably contributed to the rejection of this theory by most economists, possibly even until today. However, the Credit Creation theory of money is the only theory that is in agreement with banking law, in the UK at least since 1848.47 It has also been confirmed as the only correct theory by the Bank of England in 2014 (which disapproved of both the financial intermediation theory and the fractional reserve theory),48 and, following the Bank of England, by the British Parliament in a debate devoted to money creation.49 Hence a lawyer cannot actually speak of a credit (creation) theory of money, because it is not just a theory: money is (circulating) credit, or – which is the equivalent – a debt.50

  46 See below under sec. 3(b).

  47 Foley v. Hill (1848) 2 HLC 28, and the discussion further below.

  48 Bank of England (2014a: 15).

  49 Hansard, House of Commons, Debate: ‘Money Creation and Society’, HC 20 November 2014, Vol. 588, col. 434.

  50 See particularly under sec. 3 below. On the historical basis of money as credit, see Desan (2014: 331).

  2. The creation of money by central banks

  Less than 5% of all money in the economy is created by central banks, but it is that form of money which the general public would usually associate with the term ‘money’, that is, cash. A central bank, such as the Bank of England, is the banks’ bank because a commercial bank needs to have operational accounts with the central bank, in order to keep reserves (as the fractional reserve theory of money prominently stresses), and to settle debts by netting payments due to other banks against those to itself.51 Netting, a form of set-off, is usually done among the banks via their accounts with the central bank. In addition, settlement (transfer of value to discharge a payment obligation) between banks within one jurisdiction can be done across the books of the central bank since both banks involved maintain accounts with the central bank.52 The central bank is also the government’s banker in that the central bank performs the bank services for the government that commercial banks provide for their customers.53

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  eBook - PDF

  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Chapter 8 Money Creation Using money is such a routine part of our daily lives that it is easy to overlook the fact that the creation of money is a business , which is conducted by financial institutions to make profits. Therefore, when central banks regulate their na-tions ’ money supplies, they also regulate financial intermediaries ’ profits. This chapter discusses the money creation powers of financial intermediar-ies. Because most nations have a wide variety of them (e.g., commercial banks, savings banks, credit unions, and other thrift institutions), we will focus on those financial intermediaries that take deposits and make loans . As a group, we will call them “ banks. ” One of the best ways to understand the money-creation process and the power a single bank possesses to create money is by analyzing the effect a loan has on the bank ’ s balance sheet and the nation ’ s money supply. From this discussion, it is a natural step to discuss the money-creation powers of the banking system 1 and how it amplifies the powers of a single bank. In Chapter 9, “ Central Banks, ” this foundation will be vital to understanding how central banks regulate financial intermediaries and, thereby, control their nations ’ money supplies. The Basics Creation of Money by a Single Bank Banks have the power to change a nation ’ s money supply. They do so by mak-ing loans and purchasing securities because these bank assets are paid for with newly created checking accounts or with cash from banks ’ vaults. Let ’ s trace the effects that loans and security purchases have on a bank ’ s balance sheet and then show the impact these changes have on a nation ’ s money supply. Figure 8.1 shows the balance sheet of First National Bank before making a loan. Notice that total assets equal $10,000 million, and the sum of the bank ’ s liabilities plus stockholders ’ equity also equals $10,000 million.

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  eBook - ePub

  The Production of Money

  How to Break the Power of Bankers

  • Ann Pettifor(Author)
  • 2017(Publication Date)
  • Verso

    (Publisher)

  As noted above, less borrowing implies less money in circulation and therefore fewer savings. Such a shrinkage of available finance in due course takes the form of falling prices, falling wages and incomes – in other words, the contraction of credit implies deflationary pressures. Falling prices apply pressure on profits and lead to bankruptcies, which likely lead to job losses. The unemployed are even less likely to borrow and spend, which means that the nation’s income contracts even further.

  What is needed in the economically depressed circumstances outlined above, is for governments to begin to create money or savings by issuing debt that will finance investment in projects involving the new production of goods or services that in turn create employment. These activities will then provide both private incomes and the tax revenue with which the public debt can be repaid.

  Savings, as Andrea Terzi writes, need to be funded, and at times of private sector weakness, the best the way to fund savings would be for governments or private banks to issue new debt.

  To sum up: credit (or debt) is how all money is created or produced in the first instance. With the development of sound and well-managed monetary systems, there need be no limit on the availability of finance or credit for sustainable, income-generating activity. As Keynes argued, what we create, we can afford.5 The credit system enables us to do what we can do within the physical limits imposed by our own, the economy’s and the ecosystem’s resources.

  That is the good news: a well-developed monetary system can finance very big projects, projects whose financing would far exceed an economy’s total savings, squirrelled away in piggy banks or other institutions. That means a society based on a sound monetary system could ‘afford’ a free education and health system; could fund support for the arts as well as defence; could tackle diseases or bail out banks in a financial crisis. While we may be short of the physical and human resources needed to transform economies away from fossil fuels, society need never be short of the financial relationships – the claims we make on each other – needed for the urgent and vast changes required to ensure the environment remains liveable. However, if a monetary system is not managed and operates instead in the interests of just a few, it can have a catastrophic economic, political and environmental impact.

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  Theory of Economic Development

  • Joseph A Schumpeter(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  ad hoc which can be backed neither by money in the strict sense nor by products already in existence. It can indeed be covered by other assets than products, that is by any kind of property which the entrepreneur may happen to own. But this is in the first place not necessary and in the second place does not alter the nature of the process, which consists in creating a new demand for, without simultaneously creating, a new supply of goods. This thesis needs no further proof here, but follows from the arguments of the second chapter. It provides us with the connection between lending and credit means of payment, and leads us to what I regard as the nature of the credit phenomenon.

  Since credit in the one case in which it is essential to the economic process can only be granted from such newly created means of payment (provided there are no results of previous development) ; and since, conversely, only in this one case does the creation of such credit means of payment play more than a merely technical rôle, then to this extent giving credit involves creating purchasing power, and newly created purchasing power is of use only in giving credit to the entrepreneur, is necessary for this purpose alone. This is the only case in which we cannot, without impairing the truth of our theoretical picture, substitute metal money for credit means of payment. For we can assume that a certain quantity of metal money exists at any time, since nothing depends upon its absolute magnitude; but we cannot assume an increase of it to appear just at the right time and place. Therefore if we exclude from lending as well as from the creation of credit instruments those cases in which credit transactions and credit instruments play no essential part, then the two must coincide, if we neglect the results of previous development.

  In this sense, therefore, we define the kernel of the credit phenomenon in the following manner: credit is essentially the creation of purchasing power for the purpose of transferring it to the entrepreneur, but not simply the transfer of existing purchasing power. The creation of purchasing power characterises, in principle, the method by which development is carried out in a system with private property and division of labor. By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it. It temporarily substitutes, as it were, a fiction of this claim for the claim itself. Granting credit in this sense operates as an order on the economic system to accommodate itself to the purposes of the entrepreneur, as an order on the goods which he needs: it means entrusting him with productive forces. It is only thus that economic development could arise from the mere circular flow in perfect equilibrium. And this function constitutes the keystone of the modern credit structure.

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  eBook - ePub

  Money

  What It Is, How It's Created, Who Gets It, and Why It Matters

  • Sergio M. Focardi(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  In summary, the endogenous money creation theory holds that money is created by commercial banks without the intervention of the central bank. The central bank intervenes only to provide reserves so that regulatory standards are met and it is possible to make transfers of funds between banks. In this view, banknotes play no role in the money generation process. Banknotes are supplied to individuals on demand but do not influence the total money generation process. An endogenous money generation process can start from zero with banks making loans and creating deposits. This is a fundamental difference with the verticalist theory which holds that the money generation process depends on exogenous money supplied by central banks and multiplied (but not created) by commercial banks. The main difference is given by the handling of reserves and by the role of currency.

  5.6 Other ways to create money

  In addition to the creation of money or near-money that we have discussed thus far, there are additional ways to create purchasing power, including private credit and the issuing of digital currencies. The purchasing power thus created does not always qualify as money.

  5.6.1 Private credit

  We have discussed the role of commercial banks in creating money by issuing loans. But commercial banks are not the only ones to accord credit or issue loans. There are two other commonly used ways to accord credit: commercial payment terms and peer-to-peer lending.

  In according payment terms to their business partners, firms extend credit to clients, thereby according them increased purchasing power. Consider, for example, clothing stores. Typically shops order goods well in advance of the season when products can be sold and, at the beginning of the season, keep inventory. Modern techniques of flexible production allow just-in-time delivery of products on short notice but, still, any clothing store must keep a minimum of inventory. It makes a difference if the supplier insists on being paid on delivery, within say 60 days, or only in the case of a sale, accepting to take back unsold inventory. By increasing the purchasing power of clients, commercial payment terms are loans and fulfill one of the key functions of money. However, firms that give favorable payment terms are using their own money or reducing their own credit and, ultimately, their own purchasing power. The sum of credit/ debt is zero.

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  eBook - ePub

  New Keynesian Economics / Post Keynesian Alternatives

  • Roy Rotheim(Author)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  Blinder, 1987 ).

  Second, New Keynesian theory persists in the mainstream view of money in terms of loanable funds. Citing Bernanke:

  ‘By Credit Creation process I mean the process by which, in exchange for paper claims, the savings of specific individuals or firms are made available for the use of other individuals or firms (for example, to make capital investment or simply to consume).

  (1993, p.50)

  Further:

  Many economists have suggested that banks and similar institutions play a particularly central role in credit markets because of their expertise in conveying the savings of relatively uninformed depositors to uses… that are information-intensive and particularly hard to evaluate.…Among factors that have been cited are economies of specialisation (lending officers can gain expertise in a particular industry, for example), economies of scale (it is cheaper for a bank to evaluate a loan than for many small savers to do so independently), and economies of scope (it is efficient to provide lending services in conjunction with other financial services).

  (ibid., p.53)

  Thus the discussion of credit rationing is couched in terms of spare capacity to extend credit, with the implicit notion of a ceiling to that capacity. This differs markedly from the Post Keynesian view of endogenous Credit Creation as being subject only to influence by the authorities, not control, and of credit as being a potential initiator of income, and thus savings, generation.

  Third, while the New Keynesian theory refers to a volume of Credit Creation which is insufficient for full employment, there is no scope for excessive Credit Creation. Where there have been marked expansions of credit, as in the 1970s, this is understood as reflecting the best information available at the time, so that there is no sense in which it could be regarded as excessive.

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