peer to peer lending / borrowing

[RevdTess]

Then for what purpose is the bank rate? And why does a negative bank rate encourage commercial banks to lend? Isn't it because the commercial bank is being paid by the central bank to make loans? Ie they are buying money from the central bank for negative amounts.

[UndercoverElephant]

Then for what purpose is the bank rate? And why does a negative bank rate encourage commercial banks to lend? Isn't it because the commercial bank is being paid by the central bank to make loans? Ie they are buying money from the central bank for negative amounts.

The bank base rate is for banks who need to temporarily borrow money because of internal cashflow problems, or in order to invest it.

Negative base rates discourage banks from "parking" their own money at the central bank, thereby encouraging them to do something else with it in order to make enough profit to offset inflation.

[RevdTess]

I think where the confusion lies (mine, perhaps) is in this quote:

Monetary policy acts as the ultimate limit on money
creation. The Bank of England aims to make sure the
amount of money creation in the economy is consistent with
low and stable inflation. In normal times, the Bank of
England implements monetary policy by setting the interest
rate on central bank reserves. This then influences a range of
interest rates in the economy, including those on bank loans

Banks first decide how much to lend
depending on the profitable lending opportunities available to
them — which will, crucially, depend on the interest rate set
by the Bank of England.

To me that suggests that the Bank of England controls how much commercial banks are willing (and able) to lend through the mechanism of the base interest rate.

If that's the case then there must be some connection between the base rate and the incentive for commercial banks to lend.

My conclusion, which you say is wrong, is that commercial banks have to pay the central bank when they create money by lending. And the cheaper the rate, the more likely a commercial bank will want to create money by lending.

Edit: I guess it's just rather surprising to me that the banks can lend at no cost even if the base rate were 10% or whatever. It would seem to incentivise more lending when interest rates were higher rather than lower. I can see however that a 10% base rate would encourage a commercial bank to put their deposits with the central bank for a zero-risk return of 10%. But since lending doesn't depend on deposits, it would still seem to imply that lending would be more rapid with higher base rates than lower rates, if the commercial bank is not paying anything for the privilege of lending.

[RevdTess]

Further relevant quotes

By influencing the level of interest rates in the
economy, the Bank of England’s monetary policy affects
how much households and companies want to borrow.
This occurs both directly, through influencing the loan
rates charged by banks ...

The interest rate that commercial banks can obtain on money
placed at the central bank influences the rate at which they
are willing to lend on similar terms in sterling money markets
— the markets in which the Bank and commercial banks lend
to each other and other financial institutions. [...]

Changes in interbank interest rates then
feed through to a wider range of interest rates in different
markets and at different maturities, including the interest
rates that banks charge borrowers for loans and offer savers
for deposits.

which still doesn't quite explain to me why commercial banks must raise their lending rates when the base rate rises, if they can simply create money at zero cost regardless. How do base rates 'feed through' to the commercial lending rates? I can see the link for reserves but not for money creation.

Very interesting paper. Thanks for highlighting it.

[UndercoverElephant]

I think where the confusion lies (mine, perhaps) is in this quote:

Monetary policy acts as the ultimate limit on money
creation. The Bank of England aims to make sure the
amount of money creation in the economy is consistent with
low and stable inflation. In normal times, the Bank of
England implements monetary policy by setting the interest
rate on central bank reserves. This then influences a range of
interest rates in the economy, including those on bank loans

Banks first decide how much to lend
depending on the profitable lending opportunities available to
them — which will, crucially, depend on the interest rate set
by the Bank of England.

To me that suggests that the Bank of England controls how much commercial banks are willing (and able) to lend through the mechanism of the base interest rate.

If that's the case then there must be some connection between the base rate and the incentive for commercial banks to lend.

My conclusion, which you say is wrong, is that commercial banks have to pay the central bank when they create money by lending. And the cheaper the rate, the more likely a commercial bank will want to create money by lending.

All I know is that your conclusion is definitely wrong. It's there in black and white in that statement from the Bank of England, and any residual doubt is cleared up, for me at least, by the fact that the release of that statement earlier this year has completely ended all of the debate on this topic. It was the last word: the naysayers, apart from Dominic, have disappeared. Even the Financial Times has been running articles about it, and the only argument was about what could/should be done as an alternative system, not how the current system works.

Edit: I guess it's just rather surprising to me that the banks can lend at no cost even if the base rate were 10% or whatever. It would seem to incentivise more lending when interest rates were higher rather than lower.

Yes and no. It seems to incentivise it because the returns are greater, but the flipside is that this makes all loans more risky, because of a much greater chance of people not being able to repay them. Rising interest rates, right now, would lead to a massive increase in defaults. This would not increase bank profits. It would much more likely lead to more bank failures and bailouts.

I can see however that a 10% base rate would encourage a commercial bank to put their deposits with the central bank for a zero-risk return of 10%. But since lending doesn't depend on deposits, it would still seem to imply that lending would be more rapid with higher base rates than lower rates, if the commercial bank is not paying anything for the privilege of lending.

It's purely about risk, which is why what happened in 2008 was so utterly obscene. The banks were supposed to moderate their own behaviour in order to make sure that when time got tough, they would be able to withstand the rising level of defaults. Lending doesn't depend on deposits - it depends, or should depend, on the ability of good loans and built-up reserves to cover defaults. That's the one and only thing the bankers were required to do in return for the exorbitant privilege of being able to create money and lend it to people, and they failed utterly.

[RevdTess]

All I know is that your conclusion is definitely wrong. It's there in black and white in that statement from the Bank of England, and any residual doubt is cleared up, for me at least, by the fact that the release of that statement earlier this year has completely ended all of the debate on this topic. It was the last word: the naysayers, apart from Dominic, have disappeared. Even the Financial Times has been running articles about it, and the only argument was about what could/should be done as an alternative system, not how the current system works.

Fair enough, but bear in mind that I wasn't arguing at all what Dominic is arguing, which I agree is obviously denied by that article (ie the idea that money exists somewhere before being lent out).

What I was proposing (that banks have to pay interest to the central bank on the money they create) isn't explicitly denied by that article but reading between the lines I'd have to assume that since they don't talk about it explicitly it does mean that I was wrong.

Edit: I guess it's just rather surprising to me that the banks can lend at no cost even if the base rate were 10% or whatever. It would seem to incentivise more lending when interest rates were higher rather than lower.

Yes and no. It seems to incentivise it because the returns are greater, but the flipside is that this makes all loans more risky, because of a much greater chance of people not being able to repay them. Rising interest rates, right now, would lead to a massive increase in defaults. This would not increase bank profits. It would much more likely lead to more bank failures and bailouts.

Yes, raising lending rates certainly increases the risk of defaults which leads to less willingness to lend and less demand for loans. This doesn't explain however why banks need to increase their interest rates when the base rate goes up. In fact I can't quite see the incentive to do that since it increases the rate of default and lowers demand. It would only make sense if money was in short supply and they wanted to lend the little they had at a higher rate.

Clearly if they're buying funds in the money markets then base rates do impact the rate at which they're able to obtain those funds, but as we've been discussing this doesn't apply to the creation of new loans. Since the cost to the bank of that money is entirely in the risk of the loan defaulting, why does the BoE base rate affect it in any way?

I feel like we're still missing something.

It's purely about risk, which is why what happened in 2008 was so utterly obscene. The banks were supposed to moderate their own behaviour in order to make sure that when time got tough, they would be able to withstand the rising level of defaults. Lending doesn't depend on deposits - it depends, or should depend, on the ability of good loans and built-up reserves to cover defaults. That's the one and only thing the bankers were required to do in return for the exorbitant privilege of being able to create money and lend it to people, and they failed utterly.

This would certainly explain why commercial lending rates are so slow to fall in line with central bank rates. If commercial loan rates reflect ONLY the risk of the loan defaulting then actually we don't care about Bank of England guidance. In which case loan rates would only go down due to competition from other banks. Which is probably what we see.

[UndercoverElephant]

All I know is that your conclusion is definitely wrong. It's there in black and white in that statement from the Bank of England, and any residual doubt is cleared up, for me at least, by the fact that the release of that statement earlier this year has completely ended all of the debate on this topic. It was the last word: the naysayers, apart from Dominic, have disappeared. Even the Financial Times has been running articles about it, and the only argument was about what could/should be done as an alternative system, not how the current system works.

Fair enough, but bear in mind that I wasn't arguing at all what Dominic is arguing, which I agree is obviously denied by that article (ie the idea that money exists somewhere before being lent out).

What I was proposing (that banks have to pay interest to the central bank on the money they create) isn't explicitly denied by that article but reading between the lines I'd have to assume that since they don't talk about it explicitly it does mean that I was wrong.

Ah, I didn't quite understand what you were proposing. I certainly haven't heard anybody else say this, and that includes the people who have tried to defend the bankers.

It's purely about risk, which is why what happened in 2008 was so utterly obscene. The banks were supposed to moderate their own behaviour in order to make sure that when time got tough, they would be able to withstand the rising level of defaults. Lending doesn't depend on deposits - it depends, or should depend, on the ability of good loans and built-up reserves to cover defaults. That's the one and only thing the bankers were required to do in return for the exorbitant privilege of being able to create money and lend it to people, and they failed utterly.

This would certainly explain why commercial lending rates are so slow to fall in line with central bank rates. If commercial loan rates reflect ONLY the risk of the loan defaulting then actually we don't care about Bank of England guidance. In which case loan rates would only go down due to competition from other banks. Which is probably what we see.

Yes.

[RevdTess]

Ah, I didn't quite understand what you were proposing. I certainly haven't heard anybody else say this, and that includes the people who have tried to defend the bankers.