Primer: A Deposit’s Life

Published on April 10, 2023 by Free

This post illustrates how banks deposits can be created, transformed, and destroyed. Banks deposits are the numbers in one’s bank account and the most common form of money. They are just digits in a bank’s database that are created when a bank makes a loan or buys an asset, and erased when a loan is repaid or when a bank sells an asset. They can also be transformed into other bank liability types when a bank borrows from investors. Bank deposits can also indirectly be created or destroyed through changes in a central bank’s balance sheet, such as RRP participation and quantitative easing. It is very difficult to draw economic conclusions from changes in deposit levels because the changes have many potential drivers.

[Note: T-Accounts for all transactions are shown in the Appendix II below]

From the Beginning

Bank deposits are created when a bank makes a loan or purchases a security. Rather than “lend out” deposits, a bank simply types digits in its database to add numbers to a borrower’s bank account. This can be seen from how closely deposit growth tracks loan growth, though it is not a perfect relationship as a bank can also fund its assets with other liability types. A bank’s ability to create money is heavily regulated and constrained by concerns such as profitability, liquidity, and capital costs.

Deposit growth closely historically tracked bank loan growth very closely.

Analyzing deposit growth became much more nuanced with the greater market footprint of the Fed, who can indirectly create bank deposits. The Fed operates a two tiered monetary system, where banks hold deposits at the Fed and non-banks hold deposits at banks. When the Fed purchases an asset from a non-bank investor, it creates a deposit in the investor’s bank’s account at the Fed. The bank in turn adds deposits to the investor’s account at the bank. This transaction increases the amounts banks have on deposit at the Fed, but also increases the amounts non-banks have on deposit at banks.

Deposits can also be indirectly created through the actions of central banks. Deposit levels surged when Fed unleashed turbo QE in 2020. Assets above are Fed Assets.

To the End

Bank deposits can be destroyed by reversing the processes described above, or when they are transformed into another bank liability. Someone who repays a bank loan or buys an asset from a bank destroys their bank deposits. The bank deletes the asset on their balance sheet, as well as the deposits liabilities used for payment. Similarly, a bank who issues debt is essentially asking someone to exchange bank deposits for bank debt. The liability composition of the banking system changes to fewer deposits and more debt.

The decline in deposits at small banks is in part because small banks sold some securities. Note right scale is slightly smaller.

Bank deposits can also be destroyed through a reduction in the size or change in the composition of the Fed’s balance sheet. When the Fed shrinks its balance sheet with QT it is a reducing the amount of cash banks hold on deposit at the Fed. The decline is bank assets is usually matched with decline in bank deposit liabilities. The most common path for this mechanism is Treasury issuing new Treasuries to repay the Fed, and non-bank investors purchasing those Treasuries using their bank deposits.

Deposit levels declined in line with QT shrinking the Fed’s balance sheet.

The level of bank deposits can also fluctuate with changes in the composition of the Fed’s balance sheet. For example, non-bank investors can lend to the Fed via the RRP facility. This destroys their deposits in exchange for a RRP loan asset. Tax payments can also decrease deposit levels as as deposits are sent to the Treasury’s account at the Fed, which is outside of the banking system. These fluctuations are beyond the control of the Fed and can sometimes be significant.

Money is Complicated

The use of deposit aggregates in economic analysis was not useful in the 1980s, and has become even less useful in an era large central bank balance sheets. Changes in deposit levels may merely reflect the implementation of monetary policy, changes in RRP participation, or the cash management choices of Treasury. Furthermore, a focus on deposit aggregates obscures the increasingly important impact of money like assets like Treasury securities.

The $500b monthly decline in bank deposits in March 2023 is a good illustration of the difficulties in interpreting deposit declines. The decline corresponded with a steep drop to bank security holdings, a mild drop in bank loans, on-going Fed quantitative tightening, an increase in RRP participation, a decline in the Treasury’s account, and significant increases in money market fund assets. The interplay of all these mechanics make it very difficult to infer causality, and draw broader economic conclusions.

[Note: Deposits that moved into money market funds often make their way right back into the banking sector. See Appendix I].

Appendix I: Flows into MMF Don’t Necessarily Reduce Deposits

In some cases moving money into a money market fund does not change deposit levels.
In other cases moving money to an money market fund will reduce deposit levels.

Appendix II: T-Accounts For Deposit Creation, Transformation, and Destruction

23 comments On Primer: A Deposit’s Life

  • Powell eliminated reserve requirements and destroyed deposit classifications. Powell eliminated the 6 withdrawal restrictions on savings accounts, which isolated money intended for spending, from the money held as savings. Powell thinks banks are intermediaries.

    Never are the banks intermediaries in the savings-investment process. Banks don’t lend deposits. Deposits are the result of lending. Hence, all bank-held investment/savings type accounts are unused and unspent. That’s the cause of secular stagnation, a deceleration in the transaction’s velocity of funds.

    The volume of money (stock) is irrelevant unless it is turning over (flow). And not much has changed in over 100 years. 95 percent of all turnover, debits to transaction accounts, is confined to demand deposits.

    • If a Bank X originates a $13,000 loan for me to buy a bulldozer,then they create a $13,000 loan asset on their books and a $13,000 deposit liability or in my case a $13,000 bank check made out to the dealer…either way it’s a $13,000 liability on Bank X T account

      Now tell me what happens when Bank X has to honor that $13,000 check. That liability has to be satisfied IMMEDIATELY. And with what ?

      Either BORROW $13,000 from a wholesale lender or use $13,000 of deposits….but something has to come off the Asset Side of Bank X T-account (and it needs to come out NOW) that liability must be either satisfied by drawing from assets left hand side of the T (which will lower the overall equity recorded on the right) OR transformed into some other liability (borrow $13,000 from wholesale lender or use $13,000 of existing deposits

      We can see the original T account entry of the loan origination 13,000 | 13,000

      Bank check is cashed and goes to dealer. Now Bank X would look like this 13,000 | 0

      Where did the $13,000 come from to satisfy the liability?

      It came from another T account entry we had from either deposits OR borrowing from wholesale lender.

      So now it looks like this at a moment in time.

      13000 loan asset | 0
      13,000 borrowed asset | 13,000 owed

      After check clears and Bank Book Balances

      13,000 loan asset | 13,000 owed to depositors or wholesale lender

      • Bank X will settle its obligation by transferring an asset of $13k – namely, Federal reserves – to the recipient’s bank. So its reserve assets will decrease, and the offset is a decrease to its deposit liabilities to you.

        The recipient bank will then increase its reserves by $13k (asset) and also increase its deposit liabilities to the recipient.

        • Thank you. I have since learned that. I bought Joseph’s book and dug into a textbook I have. Thanks for clear answer it adds much value to the comments on this post 🙂 Reserves. Base Money. Staying in “the system” Quite a concept once one finally “gets it”

  • re: “The use of deposit aggregates in economic analysis was not useful in the 1980s,”

    That’s B.S. Contrary to economists, the monetary transmission mechanism was not interest rates, but roc’s in required reserves (which Powell eliminated). As I said in response to Powell removing legal reserves: “The FED will obviously, sometime in the future, lose control of the money stock.” May 8, 2020. 10:38 AMLink

    What happened was the deregulation of interest rates. This increased both the volume and percentage of savings/investment type accounts at banks. As banks don’t lend deposits, the impoundment of monetary savings slowed velocity. That was recognized in the early 1960s. And Dr. Philip George rediscovered the paradigm calling it “The Riddle of Money Finally Solved”.

  • Thanks for writing this. Practically all financial journalists today write as if banks simply aggregate savings and lend them out. This misconception is worsened by comments like “banks borrow short to lend long.” The problem is they miss the banks’ role as money creators in the economy, and when you don’t understand that, you don’t understand the myriad ways government can influence money creation and direct the new money to their favored party (crony, cause, etc). Thanks also for pointing out that just because someone buys a money market fund, that money has to leave the banking system. Much of it does if the MMF buys Treasurys direct, or if the MMF lends to the Fed’s RRP program, but not all and not necessarily, as you point out. BTW I like your book “Central Banking 101.”

  • Maybe the more interesting quantity, with regards to bank solvency, is the difference between bank deposits and bank reserves. Can you talk about the different ways in which the difference can change?

    • This is not a solvency issue; it’s a liquidity issue. The difference between total assets and total liabilities is a solvency issue.

  • I liked your writing, including the title! A deposit can be born or can die, just like life. I also liked your book Central Banking 101. Money is complicated. Thank you for sharing your understanding!

  • Vincent Spreuwenberg

    Thanks for the post. Glad you point out that the monetary system changed over time. Aso – glad that you point out that MMFs don’t decrease the quantity of deposits in the system, just ownership of those deposits. Not sure why this is not more main stream. If anything, by purchasing MMFs you are swapping ( below 250k at least) sovereign risk ( FDIC insurance) for private sector risk ( to the degree that the MMF holds commercial paper etc and not treasuries). So is that incremental return worth the private sector risk?

    • Right. The NBFIs are the DFI’s customers. But it was a irresponsibly a point of contention which argued for the complete deregulation of interest rates.

      Louis Stone — whom the movie “Wall Street” was dedicated to – Vice President Shearson/American Express wasn’t fooled:

      WSJ: “In a letter of March 15, 1981, Willis Alexander of the American Bankers Association claims that: ‘Depository Institutions have lost an estimated $100b in potential consumer deposits alone to the unregulated money market mutual funds.’

      As any unbiased banker should know, all the money taken in by the money funds goes right back into the banks, in the form of CDs or bankers’ acceptances or other money market instruments; there is no net loss of deposits to the banking system. Complete deregulation of interest rates would simply allow a further escalation of rates by the banks, all of which compete against each other for the same total of deposits.”

  • The FED’s Ph.Ds. don’t know a debit from a credit, a bank from a nonbank. The money stock was misclassified (overstated) by MSBs between 1913 and 1980. The correspondent balances of the S&Ls and CUs have been misclassified (overstated) since 1980. The DIDMCA turned the thrifts into banks in 1980 and then included their liabilities in the money stock, but not their assets in commercial bank credit. O/N RRPs are misclassified.
    Large CDs should be included in the money stock, etc.

  • If a Money Center Bank creates a deposit and offsets it with a loan, my question is: doesn’t the cash outflow usually follow to someone outside of the Bank?
    Example: A borrower buys a house from Beazer Homes. JPM creates a deposit for the customer and creates a loan. But, in this scenario it still must wire the money to Beazer Homes at their bank. Credit Cash and Debit the Deposit to reflect the deposit leaving. I’ve worked at very small banks and they don’t create deposits to fund loans. They wire money to someone else to fund the loan. But I realize the Big Banks are different.

    • Yes I’ve been using a one bank world as a simplified example – there is more detail in real life. In your example the created deposit leaves one bank and ends up in another. So the bank originating the loan must either give up assets (cash at the Fed) or find new liabilities (brokered deposit etc). The bank receiving the deposits ends up with more deposit liabilities balanced by more assets (cash at the fed). However at the end of the day the banking system as a whole has a higher level of loan assets/deposit liabilities.

    • I see it like this. Thousands of banks originating loans generating loan assets ,creating deposits,then honoring the liabilities wiring money out the front door………and they can do this because the same banks are getting deposits coming in the BACK door ….those deposits themselves being the creation of thousands of OTHER loan originations from thousands of OTHER banks….this would include byproducts of those loans like cash …

      So I see it as a giant circular thing…not a top down or side to side thing. This explains and justifies ALL views and explains that British paper that says 97% of all money is created by banks originating loans.

      And this cycle spins up and is governed by the relevant CAPITAL ADEQUACY RATIO be it mandated or self imposed by each bank.

      Simple. Elegant.

  • Hi Joseph, I was wondering how the US has a private debt to M2 money supply ratio of 4.5? That seems really high seeing as debt/credit creation is linked to money creation. For the ratio to be significantly >1 it seems to me that a lot of the private debt would have to be straight up money transfers instead of net money creation at the time of credit extension? Or is it that a lot of bank liabilities (long dated CD’s, special deposits idfk) aren’t counted in M2??

  • Stupid question alert:

    Why do bank reserves go down in QT? I understand that they kind of must get destroyed in order for the Fed’s balance sheet to re-balance, because reserves were the matching liability created when the Fed bought the treasury security.

    But what’s the mechanism for the reserve going down, and how exactly does this happen. Is it an accounting/keyboard move by the Fed, or is there some money-plumbing process by which the reserve automatically gets destroyed?

    • An asset matures on the Fed’s BS, and the Fed’s computer automatically subtracts the proceeds for that maturing asset from the Treasury General Account (TGA) which is a Fed liability. So unless the Fed is maintaining or growing the BS size by purchasing additional assets, the BS automatically shrinks when an asset matures. Reserves go down because in the process of restocking the TGA, the Treasury issues new debt (purchased by the banks or non-banks, in which case M2 also drops) or by awaiting more tax receipts. The end result is less reserves.

  • Your T-Accounts for QT seems wrong. So far QT involves the Fed allowing Treasuries to roll off. The US Treasury then issues a new Treasury to replacethe matured Treasury.
    So the Fed balance sheet:(Asset, Liability)
    Treasuries -100 , TGA -100 ( the Treasury matures )
    No change on Asset side , TGA +100 , Reserves -100 ( a new Treasury is issued to a private investor))

    You show the end point as the Fed having reduced reserves by 200 and the TGA up by 100. The TGA it seems, would be unchanged and the Reserves go down 100.

  • Why is the TGA excluded from the definition of the money aggregate? Tax payments involve reduction of reserves held by the taxpayer’s bank and an increase in TGA balances. It falsely appears that money is destroyed in the process when, in fact, money is recorded in an account artificially excluded from the money supply, the TGA. It seems to me that balances in the TGA are every bit as “spendable” as any other form of money that makes up M1 and M2.

  • We say that commercial money is created when banks make loans or purchases assets from non-banks. What about when a Bank pays its employees and suppliers? I believe, these cases also result in money creation as expenses in P&L are debited and accounts of employees and suppliers are credited in the balance sheet of the bank. Could someone confirm this is the case?

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