MacroBusiness Mailbag

One problem we have at MacroBusiness is that all our bloggers have day jobs. We would love to be doing this full-time but obviously we have to pay for our existence and also like to spend time with our families. There are a number of topics that I would love to concentrate on full time and write about at length, but I simply don’t have the time. I am however passionate about sharing knowledge and I am a big believer in economic democracy.

I see the general public’s lack of knowledge of the economy as a bit of a concern because in order to make rational decisions about economic policy you need to at least have a basic understanding of how the economy actually functions. It would however be fairly obvious to readers of MacroBusiness that even the so-called “experts” struggle with that. But we mustn’t be disheartened.

On my previous blog I used to have a weekend mailbag where I answered questions from readers. I found that process quite valuable and rewarding, and I hope my readers did to.

As I stated above we are all a bit time poor at MacroBusiness, I am however passionate about sharing knowledge so in order to get some more economic awareness out there I thought I would try a bit of an experiment (which may or may not work). I am going to (re-)start a MacroBusiness mailbag weekly post, but instead of leaving it up to only the MacroBusiness bloggers to provide the answers I will  throw the question open to all MacroBusiness readers. (Obviously the bloggers will also provide comment if they can)

If you want to send in a question then please use the contact page or send any of the individual bloggers a message. Hopefully this will stir a bit of shared learnings about all things economic. So let’s see how we go.

The first question from the mailbag comes from Christine. If you think you can provide an answer , link and/or example for her please leave a comment.


I was just wondering something about Australian banks.  Recently I have seen articles in the newspaper stating that they are lowering their exposure to foreign markets by using more local deposits to fund their loans. I don’t really understand how this works. I have been told that banks don’t need deposits to give out loans so why are they doing this?  and how is a “foreign borrowing” equivalent to a deposit anyway ? isn’t one a debt and the other money ?

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  1. They are both debt from the banks perspective

    A deposit from a local customer needs to be repaid when the customer wants their money back

    Borrowing from overseas needs to be repaid when it falls due

    In order to make loans (i.e. assets to the bank), the bank first needs to get funding (i.e. get loans or deposits or equity). A bank does need deposits to make loans, otherwise it may breach capital adequacy requirements.

    Arguably, having liabilities in the form of deposits from customers is safer for a bank than having foreign loans (that are often short term in nature). Generally, the foreign loans need to be repaid when they mature whereas deposits tend to be maintained in the bank by customers. The big 4 would see their reliance on overseas funding as dangerous in the current environment as overseas banks are likely to call on these assets in the event that they cop a hit on other assets (i.e. greek assets) and need to de-leverage their balance sheets.

    The big issue for the Big 4 is mortgage arrears as they could result in some big write-offs which means they will need to reduce liabilities to maintain adequate capital.

    I hope I am on the write track here…not 100% sure.

    On another note can someone confirm that for every $1 I deposit with a bank, it can lend out 90c?? Is it any different if the bank lends $1 from another bank?

  2. I agree with why the Big 4 is doing this. Going on a bit of a tangent, one main issue during the financial crisis was the availability of USD funding worldwide. In periods of flight-to-quality investors held onto safe haven assets, e.g. gold, USD, JPY, etc. They held on so much so that the overnight borrowing cost of actual USD cash (supply of USD cash was low because no one was willing to lend it out b/c of credit concerns of their counterparty or that they just needed it themselves) became prohibitively expensive (banks typically source funds through bond markets, of which the USD is the deepest, and they would swap that into cheap overnight funding, also in USD). I believe one advantage of sourcing local funding, especially through deposits, is that generally they are stable funding from retail accounts, i.e. not “hot” money. You and I aren’t going to make a run on the bank just b/c stocks are down 10%.

    On the last question, I think it depends on the reserve requirement ratio where the bank is domiciled and this is different for different countries. In textbooks this would be the money multiplier, and is one way the government controls the size of the money supply.

    • Good points. Regarding deposit funding, the reason it is so stable is that most countries today have deposit insurance, so the risk of bank runs has largely disappeared. The issue with banks that was exposed in the recent crisis is the greater their dependency on wholesale funding(rather than deposits), the greater the liquidity risk that they face.

      Liquidity risk is basically the risk that a bank won’t be able to obtain funds (at a reasonable price) when it needs them to meet its obligations. The problem with funding from the overseas bond markets is that unlike depositors, these investors are not insured, and therefore are much more sensitive to the credit quality of the bank. Their appetite for risk is also heavily impacted by what is going on in the financial markets more broadly.

      That means that when the #%^$ hits the fan and the banks are most in need of liquidity, there is a good chance these investors are going to bail. ie they won’t be willing to roll over their funding to the Aussie banks. To the extent the Australian banks can reduce their dependence on this type of potentially unstable funding, it’s a good thing.

  3. My understanding of Fractional Reserve Banking was that for every dollar deposited the bank can lend out $9 (Dependent on the ratio, ie 1:9 etc)

    • How is this possible? The banks don’t have $9! If I look at every one of the Big 4’s financial statements, they have about 10% of their assets in equity and the rest in liabilities

    • If I am not mistaken, banks can lend 9/10 of the money that is deposited by customers (where the deposits come from is irrelevant); and 9 times the capital they have deposited with the central bank (which in our case is the RBA?)

      Or at least that’s how it works (or used to work) in the USA, not sure about Australia.

    • I’m pretty sure Aussie banks don’t operate under FRB…

      Though they have some other system managed by APRA, i think, that is somehwat similar, generally….?

      Anyone care to expand?

  4. “I have seen articles in the newspaper stating that they are lowering their exposure to foreign markets by using more local deposits to fund their loans.”
    First of all, don’t believe what is written in the newspapers. There is no publicly available data published by RBA / APRA or the banks themselves, that supports this assertion.

    • Actually Mav, I think you’ll find the banks list the sources of their funding in their annual reports and mid year financial updates. I rembering seeing decreasing proportion of off-shore funding when looking at the ANZ and CBA mid year updates in April.

    • Just a pathetic squiggly graph (one source is S&P no less) for the whole of Aussie banking?? I am sorry, I expected something more than a chart – along the lines of the APRA’s Monthly banking stats.
      As you can see in the Table 3/4 of APRA’s stats, there isn’t any break up whatsover of the liabilities, while they have a nice break up of the bank’s assets in Table 1/2.

  5. There is no ‘FRB’,
    nor is there any reserve requirements?
    If there is, what is it for Aussie banks?
    Surely, equity/deposits on peoples
    homes via the mortgage cant be considered
    reserves. This would be a bit dodgy.
    They inflate the assets through lending,
    then count the assets as reserves.
    Ponzi on the ponzi. Or is this naive?

    With regards to raising the debt ceiling
    – no doubt those unreconstructed
    austrians will be rubbing their hands.

    • “Surely, equity/deposits on peoples
      homes via the mortgage cant be considered

      If a bank creates money from a loan for someone who buys your house, and you deposit it with a bank (be it the same or different bank), it counts as a deposit, and the bank can lend against it (90% I believe?).

  6. “and how is a “foreign borrowing” equivalent to a deposit anyway”

    As Heath said, they are the same thing on the balance sheet: liabilities. You have simply borrowed money from two different sources. However, as Rotten Apple said, they behave very differently during times of market stress.

    It is good to use less funding from offshore. Of a number of scenarios, here are two:

    – If offshore funding is being replaced with onshore wholesale funding, you are only improving the situation a little, not a lot. 30-90 day deposits from institutions who have a duty to look after other peoples money are never good things to rely upon when the water gets hot. But if you must depend heavily on that type of funding, better to get it onshore.

    – If offshore funding is being replaced by domestic retail deposits (e.g. money in our savings accounts), then it is a significant improvement to the domestic bank’s liquidity position. Banks love to apply behavioral modeling to retail deposits that treats them as very stable.

    Finally, and most importantly, assessing the term structure and product composition of a banks funding profile is half-meaningless without also assessing the liquidity of their assets during times of stress.

    [Likewise assessing assets quality without reference to liability structure is also half-meaningless]

  7. cost of hedging is another advantage of local term deposits. CBA used to have a advantage in regards to this issue. Not sure now though.

  8. Let’s clear off some confusions.

    A bank is an institution which borrows money from one group of people, and then lends it out to another. It CANNOT lend out money it doesn’t have. (unless you have ‘Free Banking’ where banks can print money), so for every dollar lent, it has to borrow a dollar.

    Because sometimes loans don’t get repaid, there is a mandated capital reserve requirement, so in effect a bank can only lend out around 90c for each dollar. Some banks use off the book SPV to get around the limit. Fortunately, the ‘Big 4’ has no been doing this too much.

    Banks borrowings are usually of a shorter duration than the loan they hand out. A mortgage loan is typically 25 years, where as a term deposit is less than 1 year. Since the bank is not in a position to repay their loans, most borrowings are ‘rolled over’ : i.e. they’re repaid by borrowing from someone else. If a bank cannot rollover their loans at an acceptable interest rate, they go bust. There is no difference between an illiquid bank and insolvent bank.

    The interest rate charged by overseas borrowing is dictated by the global market. The interest rate on term deposit is pretty much determined by the RBA. If you’re expecting global financial turmoil, you definitely don’t want to borrow at the global market rate. Term deposits are also more likely to rollover. This is why the banks are going for more local deposits : they are expecting trouble.

    • Montgomery Burns

      The other thing worth mentioning is that in Australia there is no reserve requirement. Fractional reserve banking is a fiction that exists in books, sort of like hansel and gretel, little red riding hood, or Goldilocks the three bears.

      Asserting policy prescriptions derived from fractional reserve banking is akin to prescribing a law about the porridge because you’ve read Goldilocks.

      • Montgomery Burns

        …or designing building codes because of the threat of a wolf blowing a building down.

        …and so on 🙂

      • Yes that is correct, we don’t have fractional reserve banking in Australia, and as Dr Mitchell rightly points out in the article that reserve management is an “after the fact” action from banks.

        Steve Keen also has some data showing that credit leads reserves.—pothole-or-mountain/

        There are however some APRA requirements around banking liquidity which specify that ( unless otherwise managed ) and ADI must have at least 9% of its liabilities available in liquid assets.

        Search for “Minimum liquidity holdings” in this document

        So some proportion of deposits is actually required to be “reserved” for liquidity.

        But that is what deposits are for, they are a liquidity mechanism to allow banks to meet their over the counter and interbank transaction obligation that occur after they have issued loans.

        “Loans create deposits” is what you usually hear from people, but they neglect the second part of the sentence… “, but they don’t create reserves”.

        That is why banks need deposits and/or the overseas bond market, because they need reserves.

        For a discussion of the interbank market, and how the central bank control interest rates ( but not money supply ) by controlling this market check out this article

        I understand Christines confusion however. If you do a search on the internet you will find this sort of question all over the place. It is usually accompanied by long rants from people arguing whether a bank deposit is actually money… But that is another topic for another time.

        • Montgomery Burns

          “Loans create deposits” is what you usually hear from people, but they neglect the second part of the sentence… “, but they don’t create reserves”.

          FWIW I think it is pretty clear in Bill Mitchell’s stuff that creating the loan out of thin air is not the end of the process. He discusses at length the various mechanisms that exist for the banks to acquire funds.

  9. You don’t understand how it works because it doesn’t actually work, a bank deposit is the obligation of the bank, in other words, debt.

    “Money and debt are as opposite in nature as fire and water; money extinguishes debt as water extinguishes fire.” Charles Holt Carroll

    • Montgomery Burns

      Al it is important to emphasize that Steve is explaining the operations of a textbook fantasy so as to debunk it. Christine’s question from the mailbag relates to the real world.

  10. From the original Mail Bag question:

    “I have been told that banks don’t need deposits to give out loans…? ”

    That is simply wrong.

    I physically can’t lend you a book for you to read until I first physically borrow it from a library myself. Money is no different.

    You can lend that book to your Father if you like. And he can lend it to his brother.

    In this case, as with money, no new books have been created out of thin air.

    • Not all the money lent out by banks comes from deposits. Banks also borrow money in the Australian and Global financial markets (bonds/notes are not deposits).

      Money is not created out of thin air, but more money can be injected into the economy than is available domestically from deposits because investors want to invest their money.

    • db, Jake and others.

      Again, there is no such thing as fractional reserve banking, or “banks need deposits before making loans”.

      Its empirically falsified – there is a demonstrable lag between the two (i.e credit first, reserves found later).

      Banks create a loan AND a deposit simultaneously when they lend money, using a security (your house, business etc) as collateral.

      Then, in accordance with statutory requirements, they seek the reserves (US and EU) or capital (Australia) later.

      This has been empirically proven going back decades and admitted to by the Fed Reserve no less.

      Money is created out of thin air – but done so against the “value” of another asset (e.g a house).

      No debate can go forward unless you realise these modern facts of banking and realise that monetary authorities have NO CONTROL over the private banking doing so (except setting rates, reserve and capital requirements).

      Sorry, them’s the facts.

      • Montgomery Burns


        they make a loan by creating a deposit in the borrowers account out of “thin air.”

        There is no reserve requirement (paragraph 4):

        If and when they source capital offshore it is presumably based on a decision about access to funds and borrowing costs.

        BTW, regarding the data of foreign borrowing discussed above, Bill Mitchell reproduces it and cites RBA and APRA as sources so it must be publicly available. If all else fails log a question on either of those sites. When I have done so in the past I have got replies within a day or two.

        • From rba doc

          >The Reserve Bank does not place any restrictions on the amount of ES funds that an individual institution holds (other than that the institution cannot go into overdraft). Moreover, unlike central banks in a number of other countries, the Bank imposes no reserve requirements.

          Because ES balances earn an interest rate below the cash rate, ES account holders generally attempt to minimise overnight ES balances. Nevertheless, most ES account holders maintain modest precautionary balances in their ES accounts overnight.

          I suspect ARPA’s liquidity requirements also play their part in those balances staying modestly positive.

      • >No debate can go forward unless you realise these modern facts of banking and realise that monetary authorities have NO CONTROL over the private banking doing so (except setting rates, reserve and capital requirements).

        Yes that is correct.

        They have no control over the decision of a bank to issue a loan based on whether they think a customer is credit-worthy, and they also have no control over the bank attaining the required reserves to meet its liquidity obligations to match that loan issuance.

        They do however have the ability to set interest rates, which will have an effect on the judgement of said customer to seek new credit, and they also have the ability to set new rules on capital requirements and liquidity. That is exactly what Basel is all about.

      • Except Basel and other solvency measures are going the wrong way IMO, but that’s for another discussion.

        Again, its a funny world we live in where the first half of what we just discussed is not agreed upon by the majority of economists, and the second half is measured incorrectly and with too much complexity.

      • If a loan to a customer is ever to be physically drawn down and spent in the economy, of course a bank needs a physical deposit (liability) before making a loan (asset).

        If the loan is made (simultaneously with the bank creating a deposit for the borrowing customer), but never draw down, then so what. The banks balance sheet as an A and n L with the same customer and no cashflow.

        I can’t believe this is even being discussed.

          • I worked very successfully for 15 years in a number of bank treasury departments in several different countries. That is good enough for me. I understand the practical realities of a bank balance sheet, the funding thereof, the nature of real cashflows between institutions. I also understand every well the accounting of bank balance sheet borrowing v. lending PnL. Trust me, there is no money created out of thin air.

        • Montgomery Burns

          db if banks can only ever lend money they physically already have how/why does the money supply expand?

        • DB

          So if I paid my builder to build my house and paid him $300,000 but he happenned to bank at the same bank as me. Did that bank seek to find $300,000 in deposits instantly to back that loan ?

          No, they have no need to because it is just balances in their computer. They only need a small percentage to match the liquidity of the request on that money.

          That is the point, and why it need to be discussed. The amount of reserves in the banking entire banking system is a very very small percentage of the amount of money the banks claim to have.

          The GFC proved that point.

          • I agree , there are three places I know of where the money is created out of thin air
            a)Government buys its own bonds and spends is
            b)Private sector credit money creation when it is not matched dollar to dollar by deposits
            c)The central bank providing forex in the exchange markets when it tries to target an exchange rate ( the last point I am not 100% sure , if someone can clarify)

      • Guys,

        I’m sorry to be dense, but how is it that a bank can create a deposit at the same time as a loan? If the deposit is a debt owed by the bank, who is the creditor?

        • Montgomery Burns

          Lachlan if you go to your bank and take out a loan for $10K they will stick $10K in your bank account. This is what is being referred to, the double entry nature of it all — $10K loan matched by $10K deposit.

  11. Hi Christine

    It helps if you first keep two things in mind, which can seem a bit backwards if you are used to thinking as a bank customer or equity investor rather than as a bank:

    – liabilities and equity are similar in many ways to a bank or other company. They are both obligations to pay out to somebody (either interest or dividends).
    – for a bank, a bank deposit is a liability (to give the depositor their money back), and a loan is an asset (to be repaid by the borrower).

    Banks use their customers’ term deposits (which are the bank’s liabilities) to make loans (their assets) to their customers at higher rates. They keep the difference.

    However the banks want to lend out more money than they can get in deposits from Australian customers. Australians want more mortgages!

    So the banks also market to international investors who essentially also provide deposits to the banks, but on different terms. They require more security and pay lower rates. The banks make loans with this money too, and keep the difference.

    Australian banks use international investors for this purpose more than any other banks in the world, because Australians don’t put much cash in term deposits.

    The risk is that the international investors lose interest or want to charge higher rates. They might do this because they see Australian mortgages as risky, or because their are problems like the GFC in 2008 which cause them to stop investing in anything but cash or government debt.

    In that case, the banks cannot make up the shortfall, so they either reduce their margins and go bust, or they put up rates for Australian mortgages, tank the housing market in Australia, and go bust, or they simply stop lending, tank the housing market, and go bust. It’s a very, very low margin business (the profits come from enormous volume) so they would have to do one of those things.

    By “go bust” I mean that after they’ve taken the interest from the money they’ve lent out, and paid their costs and the interest to term depositors and international investors, their is nothing left to pay their equity holders.

    So to avoid this risk they are lately paying higher interest rates to entice greater deposits from Australian depositors (which are safer as they are less subject to GFC-style disruption), and also increasing the duration of their international funding to reduce how often they need to go back to the international market to get more.

    This is very simplified but I hope gives a clearer picture than the arguments above about fractional reserve banking etc which a lot of people are passionate about but I don’t think is really the core of your question.


    • Yatima said “… the arguments above about fractional reserve banking etc which a lot of people are passionate about but I don’t think is really the core of your question.”

      Then why was this little absurd gem slipped into her question?

      ” I have been told that banks don’t need deposits to give out loans”

      Without it, the question was so banal as to not even be worth answering beyond one line: a liability is a liability , irrespective of whether it came from offshore or onshore.

      This question from ‘Christine’ was not a question from the public, it was created by and for the benefit of Macro Business.

  12. Known unknowns. There is approximately $15 Trillion (give or take) in derivatives listed at the RBA. I know that most involve interest rates and currencies.

    Are they:
    1. Genuine hedges
    2. Speculative bets.
    3. Both.

    If 3 then what are the ratios? i.e. the ratio of genuine hedges to speculative bets.

  13. Just one other question, the Yen carry trade, is this another source of short term lending, that the doemstic banks use for mortgages.

  14. I do find it strange that a Christine’s question re Foreign funding of Banks is considered in isolation without reference to either the Current Account or Asset sales to foreign interests.

    It is possible to come at this from two directions. As everyone but yours truly approaches it here, the Banks just get funding wherever they can and issue Credit on that basis.
    From another direction however, if the bank creates loans to customers a fair proportion of that loan ends up spent on imports. To the extent that we run a CAD this must be financed by overseas funding or sales of assets. So if Banks have decreased their foreign exposure, at the same time as we run the CAD, doesn’t this mean we must have necessarily had ‘Foreign Investment’?
    It is probably also relevant to ask here, if Banks’ exposure to Foreign funding has been reduced has that reduction been in Foreign Currency denominated loans or loans in A$ denominated paper.
    In the short term one could imagine a scenario where the Public Foreign Liability of the Banks is replaced by a Government Liability with the issuance of Bonds directly into Foreign markets? For my own enlightenment I’d like to hear from someone who understands the mechanics of that. However if we run a CAD, and Banks have reduced their foreign Funding, then someone else has to have taken on more Foreign Liability or we have had greater Asset sales than is necessary to cover the CAD.

  15. The genral public always have a problem excepting how banks issue debt, not suprisingly.

    So why not a post on alternatives. I would be for 100% reserves (i.e only lend what they have on deposit) then the govs increase the monetry suppy by spending into the economy (from thin air) of course taxs would probably have to go and house prices would plummet so this wont do will it?

  16. If you look at the Reserve Bank Statistics

    Tables B2 and B3 provide details of bank assets and liabilities respectively.
    Non-resident assets have been around 5 % to 6% of total assets for the last ten years.

    Similarly, foreign liabilities have been around 19% to 24% of total bank liabilities. About 70% to 80% of that is denominated in foreign currency. About 2% of resident deposits are denominated in foreign currencies.

    So to answer Christine’s question, much of this so-called “foreign funding” comprises the deposits of foreign residents with Australian banks. About one quarter to one third of the non-resident funds are due to the operations of Australian banks overseas, such as in New Zealand.

    I doubt that an Australian bank would be going to the Bank of America or any other foreign bank to borrow funds. Holding deposits for non-residents is just part of their normal banking business.

    As this blog has been discussing, banks create deposits when they make loans.
    There is a short explanation of bank lending and the difference with non-bank lending in the appendix to my submission on the Senate inquiry into bank competition.