Why Bank Money Creation?

Center for Financial Studies Working Paper No. 678

62 Pages Posted: 3 May 2022

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Sebastian Zelzner

affiliation not provided to SSRN

Date Written: April 27, 2022

Abstract

We provide a rationale for bank money creation in our current monetary system by investigating its merits over a system with banks as intermediaries of loanable funds. The latter system could result when CBDCs are introduced. In the loanable funds system, households limit banks’ leverage ratios when providing deposits to make sure they have enough “skin in the game” to opt for loan monitoring. When there is unobservable heterogeneity among banks with regard to their (opportunity) costs from monitoring, aggregate lending to bank-dependent firms is inefficiently low. A monetary system with bank money creation alleviates this problem, as banks can initiate lending by creating bank deposits without relying on household funding. With a suitable regulatory leverage constraint, the gains from higher lending by banks with a high repayment pledgeability outweigh losses from banks which are less diligent in monitoring. Bank-risk assessments, combined with appropriate risk-sensitive capital requirements, can reduce or even eliminate such losses.

Keywords: monetary system, banking, money creation, loanable funds, capital requirements, leverage constraint, asymmetric information, moral hazard, CBDC

JEL Classification: E42, E44, E51, G21, G28

Suggested Citation

Gersbach, Hans and Zelzner, Sebastian, Why Bank Money Creation? (April 27, 2022). Center for Financial Studies Working Paper No. 678, Available at SSRN: https://ssrn.com/abstract=4095335 or http://dx.doi.org/10.2139/ssrn.4095335

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Research ( email )

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IZA Institute of Labor Economics

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CESifo (Center for Economic Studies and Ifo Institute)

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Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Sebastian Zelzner

affiliation not provided to SSRN

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