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Banks create credit, money and purchasing power

Bank Loan to entrepreneur Credit to entrepreneurs deposit account

100

100

Institute For New Economic Thinking

Credit, Money & Leverage

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Categories of credit
Loans to businesses / entrepreneurs
to finance real investment projects!

Loans to businesses / speculators / investors Mortgage loans to households

to finance purchase of existing assets!

to finance residential houses

Loans to impatient / temporarily cash limited / poorer households


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to bring forward consumption

Credit, Money & Leverage

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Categories of bank debt: UK, 2009

bn
Other corporate Commercial real estate
232 243

Primarily productive investment Some productive investment and some leveraged asset play

Residential mortgage (including securitizations and loan transfers)

1235

Mainly purchase of existing assets

Unsecured personal

227

Pure life-cycle consumption smoothing

Institute For New Economic Thinking

Credit, Money & Leverage

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Credit and asset price cycles


Increased credit extended

Increased lender supply of credit

Increased borrower demand for credit Expectation of future asset price increases

Increased asset prices

Favourable assessments of credit risk

Low credit losses: high bank profits ! Confidence reinforced ! Increased capital base

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Credit, Money & Leverage

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Private and public leverage cycles


5

Source: McCulley and Pozsar

Institute For New Economic Thinking

Credit, Money & Leverage

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What the UK banking system did: 1964


Banks & Building Societies lending/deposits Private non-financial sector as % of GDP
Liabilities Assets

Household lending

Household deposits

Corporate lending

Corporate deposits

Source: Bank of England

Institute For New Economic Thinking

Credit, Money & Leverage

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Household deposits and loans: 1964 2009


100% 90% 80% 70%
% of GDP

Securitisations and loan transfers Deposits

Loans

60% 50% 40% 30% 20% 10% 0% 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Source: Bank of England, Tables A4.3, A4.1

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Credit, Money & Leverage

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Corporate loans by broad sector: 1987 2008

Source: ONS, Finstats

Note: Part of the increase in real estate lending may be due to re-categorisation of corporate lending following sale and lease-back of properties and PFI (public finance initiative) lending, but we do not think these elements are large enough to change the overall picture. Break in series from Q1 2008 due to inclusion of building society data. Sterling borrowing only.

Institute For New Economic Thinking

Credit, Money & Leverage

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UK bank balance sheets 2007


% of GDP

Liabilities
UK residents deposits Non-residents deposits (including from banks) Deposits from UK banks Repos Other Capital & reserves

Assets
"! Cash, central bank, T-bills, gilts Advances to UK & non-residents Market loans to UK residents Market loans to nonresidents (including banks) Market loans to UK banks Repos Investments Other

Total = 497%

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Credit, Money & Leverage

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Long-term trends in bank capital & liquidity ratios


Sterling liquid assets

Source: Bank of England and Bank calculations.

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Credit, Money & Leverage

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Credit and asset prices: with securitised credit and mark-to-market accounting
Increased new credit extension at lower spreads Increased real asset prices, e.g. real state

Increased on balance sheet lending at low spreads

Increased investor demand for credit securities at lower spreads

Increased price/ reduced spreads of credit securities

Favourable assessments of credit risk

Expectation of future asset price rises

Mark-to-market accounting generates bank profits and capital increase ! High bonuses and motivational reinforcement ! Increased capital for own account trading or on balance sheet lending

Institute For New Economic Thinking

Credit, Money & Leverage

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Velocity of money circulation


Velocity of Money (Nominal GDP/M2) Velocity of Money (Nominal GDP/M4)

Source: Bank of England, Bank of Japan, Datastream

Institute For New Economic Thinking

Credit, Money & Leverage

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