A proposal for Banking reform - Force Banks to say what proportion of loans involves pre-existing money, and what proportion is newly created

Here's a proposal for Banking reform that I believe could fix many of the problems that are built into the current system.

The vast majority of people believe that when they  go to a Bank for a loan, the Bank will lend them money that had previously been deposited by savers. People believe that when savers get one rate of interest (say 2%), and borrowers pay another rate of interest (say 5%), the difference in interest rates is how Banks make their money. This sounds fine, because the Bank is simply paying itself for providing a service - acting as the middleman between savers and borrowers.

However, I hope that you all know that this story is a complete myth. As explained by the Bank of England in an article in their Quarterly Review  last year called "Money in the Modern Economy : An Introduction",, Commercial Banks effectively create money when they make loans. I quote:

“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves…  When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created…”

They also confirmed Positive Money's claim that 97% of the money in circulation in the UK economy has been created as interest bearing debt by those Commercial Banks.

Effectively, Commercial Banks have a licence to create new money. Now there are some economists who will accept this fact, but they will claim that the total amount of new money being created by Commercial Banks can be controlled by Central Banks. But this too is a myth.  Again, it is the Bank of England who made the point clearly (page 2 of another document published in their Quarterly Bullentinentitled "Money Creation in the Modern Economy").  I quote :

"“…the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them…It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England.”

So, here is my suggestion.

When Banks make loans, they should be legally obliged to state what proportion of the money they are lending comes from preexisting deposits, and what proportion involves the creation of "new money". While this would certainly require some additional accounting for the Banks, it would actually make things far easier to understand for the Bank's clients.

Imagine - you go to the Bank to get a mortage for £500,000. On the loan agreement it would be written clearly that (say) £100,000 corresponded to preexisting savings deposits that were being loaned out, whereas the remaining £400,000 was being created by the bank.

The same would be true for governments when they go to the markets to borrow. As I have been arguing recently, the fact that the risk weighting on lending to sovereign governments with credit ratings between AAA and AA- is set by the Basel Banking Regulations at 0% means that, particularly in this case, Banks are likely to create all the money needed to make the loan. 

At the end of each financial year, the Bank would be able to compile a clear statement of precisely which types of loans involved recycling preexisting money, and which ones involved creation of new money. This would greatly clarify where the banks have been using their money creation licence. For example, are they using newly created money to lend to businesses? Or to provide loans for mortgages? Or for consumer credit? Or for lending to governments? It would all be very informative.

By forcing the Banks to be honest about the nature of the money they are lending, I believe that the nature of the current Banking system will at last become obvious to everyone. And once taxpayers realize that they have been paying interest to Banks that have lent money that they didn't actually have, I suspect that people may decide that there might just be a more sensible way to set up the system.