WHAT DO BANKS LEND?

Evening Post, Volume CXL, Issue 59, 7 September 1945, Page 6

WHAT DO BANKS LEND?

Sir, —There still appears to be a good deal of confusion and muddled thinking both inside and outside Parliament about bank advances. Some state that a trading bank lends its deposits. Others that it lends against its deposits, and another section that a bank creates credit at no cost to itself. None of these statemens is correct. A bank cannot lend its deposits or against them because the deposits do not belong to it. They constitute a liability of the bank to its depositors, but against this liability the bank holds the cash or money it receives from its depositors, and which constitutes a bank asset. It is this money asset which a bank lends. To quote an example: I take £1000 in Reserve Bank notes and deposit the money v/ith a bank on fixed deposit at interest. The bank is then indebted to me for that amount, and therefore has a liability to me of £1000, and as an offset the bank has a., cash asset of £1000. Now, under the terms of the Reserve Bank Act, the trading bank is compelled to deposit 3 per cent, of my deposit, i.e., £30, with the Reserve Bank, and the remaining £970 the bank may hold in its strongroom or lodge to its own credit with the Reserve Bank, whichever it desires. The bank then has £970 which it can lend to its borrowing customers. Following is an example:—A building contractor is erecting a large building in the city and has to pay wages amounting to £500, but has not the money to do so until he can get a progress payment fiom the owners—say in a few weeks time. He arranges with the bank to lend him £500 in the meantime, and he draws that amount,in cash to pay his men. The bank asset is then changed. It now has £30 compulsory deposit at the Reserve Bank, £173 in cash, and £500 owing by the contractor, and its liability of. £ 1000 to its depositor remains.

The foregoing is a simple illustration. The methods of accepting nroney on deposit and relending are varied, but to give other examples here would take too much space, but every trans* action boils down to the simple example given above. A trading bank c&nnot create credit. The amount it can lend is entirely controlled by the cash in its strongroom, plus the amount it has lying to its credit with the Reserve Bank. These credits are mr.de up from unused shareholders' funds and monies received from customers. The only authority with power to create credit is the Government operating through the Reserve Bank. Thus the Government has the sole prerogative of controlling the quantity of money or credit, and it is the function of the trading banks to facilitate the circulation of money or credit.—l am, etc.,