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Let's consider this. When banks lend us money, (give us credit), we go into their debt. Of course, you say. The bank argues that since it is taking the risk of lending us money, (extending us credit), they require some security. So we put an asset on the line such as our home, our business or our farm. The bank then says it deserves a regular fee for its risk taking and for providing credit. That fee is interest, although other fees, such as establishment and management fees are also charged. Finally, the bank requires that if we cannot meet the agree- ment then they are entitled to any home, business, farm or other real asset that we may have put up as collateral. This is a simplified but reasonable accurate description of a bank's money-lending function and of how it goes about it. Let's look at it in detail under three headings: credit, collateral and interest. CREDIT Let's consider this. When banks lend us money, (give us credit), we the equation is a figure close to 14. All banks in Australia create go into their debt. Of course, you say. The bank argues that since it is money in this way with creation based on the level of demand. taking the risk of lending us money, (extending us credit), they require The Reserve Bank has some authority over this process, but not some security. So we put an asset on the line such as our home, our complete authority. (Extract from a letter from L.N. Hingley, business or our farm. The bank then says it deserves a regular fee for Joint National Secretary Finance Sector Union of Australia, to its risk taking and for providing credit. That fee is interest, although L.F. Hoins, 22 july 1991; my italics) other fees, such as establishment and management fees are also _Iff the ‘equation’ doesn’t make much sense, don't worry. We'll come to charged. Finally, the bank requires that if we cannot meet the agree- that next. The crucial words are the ones in italics. Banks create ment then they are entitled to any home, business, farm or other real money with creation based on the level of demand. If they want more, asset that we may have put up as collateral. they just create more. This is a simplified but reasonable accurate description of a bank's The only limitations are those of prudence and statutory rules. In money-lending function and of how it goes about it. Let's look at it in March 1988, a General Manager of the National Australia Bank wrote detail under three headings: credit, collateral and interest. this clear summary of the limitation in Australia today: CREDIT The process ... is called ‘create creation' and is the basic process ; . by which deposits and tending are connected in all lending sys- When banks give us a loan, does it actually cost them anything? tems. Curiously, it costs them virtually nothing. This is the special privilege There are 2 factors that influence the ability of a lending body to of the banker - the privilege of creating credit. create credit:- Many years ago, a report commissioned by the British Government 1. A gearing limitation - that is the statutory (in most countries) summarised it like this: or the prudential fimit to which the financial intermediary can It is not unusual to think of the deposits of a bank as being creat- gear its capital. Expressed another way this is the amount of cap- ed by the public, through the deposit of cash representing sav- ital that must back up each loan. ings or amounts which are not for the the time being required to At present Australian banks have a gearing imposed of 6.0% meet expenditure. But the bulk of the deposits arise out of the which in simple terms means that for every $100 of loans the actions of the banks themselves, for by Bank must have $6 of capital. granting loans, allowing money to be : : game = With finance companies gearing lev- rawn on an overdraft, or purchasing . els are usually set in their trust deeds, from ps 14 : a —_ os So banks have this great In the past gearing ratios of 8 to 1 ooks which is the equivalent of a ee * ie $8 of Joan f h deposit. (The Macmillan Repor, 1923. Privilege -that of creating = $7"¢(Cepial but over time that has 31, Inquiry into Banking and Finance money and credit. By the moved out to be closer to 15 to 1) ... and Credit, p.34, para. 74) a This j . oe Here is the crunch concept - the one we €@XEFCISE of that power, banks jd = deg was aah _ must grasp if we are to truly comprehend the ~— determine who sinks and WhO The summary goes on: power of banks. Most of us imagine that, a 2. A liquidity limitation - for exam- when — from a bank, ee ed swims, who eats and who ple, Pre mend lode must keep 7% out in a room, someone is pairing o . . { their deposits in Statutory Ri our need for an overdraft with somebody starves, who lives In luxury Tepes Sat wiki tie, fect else's deposit. We are not so naive as to and who in poverty. Bank and also maintain a Prime Asset think that bp are ae eal, — Ratio of 12%. The latter means that money, and moving it from one persons pile each Bank must have cash, Bonds, to another. But at least we think that the Treasury Notes, etc which represent bank must borrow before it lends. 12% of their assets. On top of these constraints the Bank must But no. The money does not need to exist either in a real, touchable also have enough liquid assets to meet any movements in the sense or in any other sense. After our interview with the credit manag- ebb and flow of money - naturally those sums can't be lent to er we walk away and begin to write cheques or use our credit card. All customers. There are varying such requirements in countries around the world. (Extract from a letter from D.M. Cowper, General Manager National Australia Bank, to O.K. Fauser, 21 March 1988). That is the most lucid statement of the current Australian situation that I have ever seen. And all this is enshrined in law. The Treasurer of Australia wrote to me in 1991, saying: Various rights and duties have been conferred on banks by legis- lation, the most important of which is the exclusive operation of the payments system and the unique ability to create credit. (Document 4A) It might seem, then, that there should be no doubt about the fact that credit creation exists and how it is limited. Yet there are people who deny it. Mr. Alan Cullen, Executive Officer of the Australian Bankers Association and spokesman for Australia's largest banks, made this that happens in the back room is that entries are made in books. Nothing more than ink on paper. Even simpler these days - nothing more than the click of computer keys. John Kenneth Galbraith, one of the most eminent and respected modem economists, wrote a book with the simple title, Money. In it he writes: The process by which banks create money is so simple that the mind is repelled. Where something so important is involved, a deeper mystery seems only decent. Graham Towers, the Governor of the Central Bank of Canada put it bluntly when asked how banks create money and credit: The ... process consists of making a written or typed entry on a card. That is all. (Testimony to the Canadian Committee on Banking and Commerce, Inquiry of 1939) That was 1939. Clicking today's computer keys makes it easier still. statement as recently as November 1991: Is there any limit on the amount they cam create? [n July 1991, the Credit creation is a sort of old fashioned religious idea. Joint National Secretary of the Finance Sector Union of Australia (Statement made during an ABC (SA Regional) debate with Paul wrote this: : . . McLean conceming the Report of the Martin Committee, 27 Nov On the basis of advice received from the research department of 1991). - Renevee — —_ | my —_— he me Deny it as he might, there can be no doubt that credit is not restricted following equation: M3 divided by Base Money. The result of bay the cmpennes the pa Baar wae. 12¢NEXUS AUGUST-SEPTEMBER 1992