How UK banks draw interest on money created from nothing
Long ago the Bank of England, the model for virtually all central banks in the world today, was granted a monopoly on magic monopoly money – the power to conjure money from the very air and lend it out at interest.
Today, the Bank plays more of a symbolic role as the regulator and overseer of the UK private banking system. The real power to create money has been transferred to private banks. Paper money has been replaced with electrons. When private banks make loans, they simply type numbers and enter them into electronic deposit accounts. These electrons function as 97% of the money in our economy.
This is how it works:
You take out an interest-only mortgage, let’s say £300,000 at one of the big banks, let’s say Barclays.
When you sign the contract, promising to pay back the loan plus interest, the bank enters the principal of the loan – £300,000 on the left side of its balance sheet as an asset. It leaves out the interest on the loan.
Then based on your promise to pay back the loan the bank then types £300,000 into your bank account which is entered as a liability on Barclay’s balance sheet.
This money did not come from other depositors’ savings or anywhere else. It was created at that very moment from nowhere.
Some would argue that this is not “money” in a legal sense. To all intents and purposes, it functions exactly the same, however. In fact, 97% of all monetary transactions are based on this kind of “money”, leaving 3% for physical cash – the notes and coins with the queen and dead white people on them.
To claim, as some try, that this money has not been created out of nowhere, or out of thin air because the money is fully backed by a new asset – the loan, is a confidence trick.
This is because the contract, the asset itself, has also been created out of thin air and is based on a promise. A legally binding promise to pay the loan back in the future. To place this contract of servitude backing a loan created from nothing as an asset on a balance sheet is accounting legerdemain and nothing more.
I myself have gone into debt to make this information available to you. A debt of gratitude to the research and campaigning organisation – Positive Money.
Their insight into how the UK banking system operates is second to none and I wholeheartedly recommend you take a look at their website, particularly their Banking 101 video course:
Remarkably, 85% of MPs surveyed by Positive Money and nearly 100% of the public are not aware that every time a bank makes a loan, new money is created.
If you yourself still find this hard to believe, then listen to Mervyn King, former governor of the Bank of England:
“When banks extend loans to their customers, they create money by crediting their customers’ accounts.”
or Martin Wolf of the Independent Commission on Banking:
“the essence of the contemporary monetary system is the creation of money, out of nothing, by private banks’ often foolish lending”
The Bank of England:
“Commercial [i.e. high-street] banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.”
Michael Kumhof, IMF Economist and former Banker:
“Banks create money out of thin air.“
Professor Dirk Bezemer at the University of Groningen:
“At this point money has been created, this money did not exist this morning when I got up and decided to buy the watch and take out a loan.”
How Banks Create Money
Now, back to your imaginary loan. Each year, you pay the interest, say 3.99% of £300,000 created from nothing to Barclays, amounting to £11,970. The bank pockets this as profit. The bank has made no investment to receive this profit which can reach £239,400 over 20 years.
When you finally manage to pay back the principal of £300,000, this amount is then destroyed and returned to the ether. The interest is kept but does not appear on the balance sheet.
The stock of money in the economy is then concentrated and the reference unit, the British pound, is enhanced. The interest “earned” by the bank now has more purchasing power, more “bang for the buck.”
50% of all such monopoly bank lending goes to mortgages
27% goes to other financial corporations
8% to high-cost credit such as credit cards and overdrafts.
Just 15% to non-financial corporations – the productive economy.
The amount of money has increased on average by 11.5% per year over the last 40 years, diluting purchasing power and debasing the pound. This has priced out an entire generation from buying homes, pumped up by rampant speculation based on easy monopoly money.
Now you may be wondering as to how, granted this ludicrous privilege, a private bank can ever go bust.
Remember that when a bank creates money as a loan, the money is entered as a deposit, a liability that is backed by an asset – the borrower’s promise to pay.
A bank can become insolvent when the loans of debt servitude serving as assets on the left side of the balance sheet lose their value or disappear when the borrower fails to pay or defaults altogether. Now the assets may be less than the bank’s liabilities, which include debts and deposits, appearing on the right side of the balance sheet. The difference between the assets and the liabilities is called the equity. Negative equity means the bank risks insolvency.
Let’s go back to our example and imagine that you fail to keep up your payments on your £300,000 mortgage on your house. Barclays then repossesses your house, although in light of what we have learned, can we say that it ever “possessed” this house in the first place? Regardless, Barclays legally takes your house and sells it at a loss. Let’s say for £200,000. If it loses asset value on just one mortgage this is usually not a problem as it has enough from profits to buffer its balance sheet. However, if there are enough defaults across its mortgages and loans to financial corporations, it will go into insolvency.
However, all is not lost for Barclays. The private banking system is tightly interlocked with 46 banks having accounts at the Bank of England in a “closed loop.”
Of these, the most powerful UK banks, the “Four Horsemen of Perfidious Albion” are:
- Lloyds Banking Group
- The Royal Bank of Scotland Group
Just before the financial crisis of 2008, these four owned 65% of the commercial banking sector. After Lloyds had merged with HBOS to become Lloyds Banking Group, their piece of the pie amounted to 75%.
These banks settle their differences each day, after internal payments have been cancelled out and cleared. To do this they use Central Bank Reserve Money. This money can only be used between private banks and can only be created or destroyed by the Bank of England.
If one bank, in our imaginary case – Barclays, does not have enough central bank reserves at the end of the day, one of the other banks with surplus reserves will usually lend to the bank in need through the inter-bank lending market.
If all the banks lend out created money at approximately the same rate, then the money supply can keep on increasing without need for additional reserves. It is in the interest of these oligopolies to collude with each other in this fashion just as it is to bail out each other’s books whenever required. This enabled the ratio of private bank money to central bank reserves to reach 80:1 before the financial crisis.
It was in such a spirit of cooperation that the ancestral oligarchs founded the Bank of England. The central bank does not serve to reign in private banks, rather it insulates them from the misery that the general public endures and ensures their perpetual rape and pillage.
If it should happen that the other banks refuse to lend to the troubled bank then the Bank of England can pump in huge quantities of reserves so that the banks no longer need to lend to each other. Barclays now can enter enough central bank reserves as assets on its balance sheet to balance its liabilities and remain solvent.
These reserves are of course created ex-nihilo and backed by government bonds. This increases the national debt and the amount of interest the public has to pay in tax towards the Bank of England. It is true that the Bank is now owned by the State (or is the State owned by the Bank?) but it still counts as debt and the interest is ploughed, one way or another, back into the private banking network which the Bank represents.
The Bank of England therefore, places minimal restraint on private banks lending money into existence.
What then does restrain banks?
What about fractional reserve ratios where the bank has to keep 10% of customers’ money in reserve, limiting expansion of the money supply to 10 times?
The UK equivalent was called the liquidity ratio, requiring banks to hold liquid assets equal to a percentage of their deposits. Even then, this was not a real restriction as the assets in reserve could be government bonds in addition to cash and central bank reserves. Government bonds of course are loans to the government which eventually find their way into circulation.
From 1850, private banks used a liquidity ratio of 60% to avoid the risk of a run on the banks.
After the banking crisis of 1866, the Bank of England took on the role of lender of last resort. This safety net enabled the private banks to reduce the liquidity ratio to 30%.
In 1947, when the Bank of England was nationalised, the liquidity ratio became 32%.
In 1963 the liquidity ratio dropped to 28%.
After 1971, the onset of deregulation, it fell to 5% and led to a massive expansion in the amount of bank created money circulating in the economy and the consequent mountains of public and private debt.
In 1981, the liquidity ratios were completely abolished and this holds today. Private banks make their loans and find the reserves to balance the books later, if at all required.
So, reserve or liquidity ratios no longer a factor in restraining private banks.
What about the “Basel Accords” – Capital Adequacy Ratios? These require private banks to keep a buffer of shareholder equity big enough to absorb losses on the assets side of the balance sheet. When private banks are lending and making profits, the size of the buffer increases, leading them to lend even more and make more profit and so on. During the boom phase then, lending is not restrained by the Basel Accords. During the bust phase, when there is markedly less lending and less profit, the buffer shrinks and restrains lending when it is needed the most. Therefore, the Capital Adequacy Ratios exacerbate boom and bust phases and only exist to insulate the banks themselves and not the general public from the harmful effects of busts.
And do the banks then begin lending again once they have rebalanced their books?
Not until the economy is sterilised of inflation and prices have finished plummeting.
Then the cycle begins anew.
I suspect that the private banks allow a troubled member to flounder precisely in order to signal to the public that the economy will crash if the banking system is not bailed out. This also gives the appearance that the private banks are suffering along with the general public which is not the case. It is my contention that the private banking cartel benefits from financial crises and intentionally brings them about.
We will address this angle of orchestration in the next part.