Chapter 2 - Bank Money
1. The "creation" of bank money.
"We have seen in the preceding chapter how the transference of
claims to money may be just as serviceable for the settlement of
transactions as the transference of money itself. It follows that
members of the public, when they have assured themselves that
this is so, will often be content with the ownership of transferable
claims without seeking to turn them into cash. Moreover there
are many conveniences and incidental advantages in handling
bank money over handling cash.
A modern bank is an institution which is made possible by the
establishment of habits of this kind. Historically a bank may
have been evolved from a business which dealt in the precious
metals or in the remittance of money from one country to another,
or which offered its services as an intermediary to arrange
loans or for the safe custody of valuables, or which borrowed the
savings of the public on the security of its reputation and then
invested them at its own discretion and at its own risk. But we
shall be concerned in what follows with banks of the fully developed
modern type existing as going concerns.
Such a bank creates claims against itself for the delivery of
money, i.e. what, hereafter, we shall call deposits, in two ways.
In the first place it creates them in favour of individual depositors
against value received in the shape either of cash or of an
order (i.e. a cheque) authorising the transfer of a deposit in some
bank (either another bank or itself). A member of the public
comes along with cash in his pocket or with a cheque drawn on a bank,
which he hands in on the understanding that he is entitled
in return to a claim to cash (i.e. a deposit) which he can
either exercise or transfer to someone else.
But there is a second way in which a bank may create a claim
against itself. It may itself purchase assets, i.e. add to its investments,
and pay for them, in the first instance at least, by establishing
a claim against itself. Or the bank may create a claim
against itself in favour of a borrower, in return for his promise
of subsequent reimbursement; i.e. it may make loans or advances.
In both cases the bank creates the deposit; for only the bank
itself can authorise the creation of a deposit in its books entitling
the customer to draw cash or to transfer his claim to the order of
someone else; and there is no difference between the two except
in the nature of the inducement offered to the bank to create the
deposit.
It follows that a bank in active business will be, on the one
hand, continually creating deposits either for value received or
against promises, and, on the other hand, cancelling deposits,
because claims against it are being exercised in cash or transferred
to other banks. Thus it is constantly receiving cash and paying
out cash; and it is constantly receiving claims against other banks
and having to meet claims from other banks.
Now it is evident that the bank must so conduct its business
that these opposite processes can be approximately offset against
one another, i.e. so that the amount of cash paid out day by day
together with the amount of the claims from other banks are not
very different from the amount of cash received together with the
amount of the claims against other banks. The practical problem
of the banker consists, therefore, in so managing his affairs that
his daily accruing assets in the shape of cash and claims shall be
as nearly as possible equal to his daily accruing liabilities in these
forms.
It follows that the rate at which the bank can, with safety,
actively create deposits by lending and investing has to be in
a proper relation to the rate at which it is passively creating them
against the receipt of liquid resources from its depositors. For
the latter increase the bank's reserves even if only a part of them
is ultimately retained by the bank, whereas the former diminish
the reserves even if only a part of them is paid away to the customers
of other banks; indeed we might express our conclusion
more strongly than this, since the borrowing customers generally
borrow with the intention of paying away at once the deposits
thus created in their favour, whereas the depositing customers
often have no such intention."