Nairametrics| Money is any “item” or “verifiable record” that is accepted as payment for goods and services. Total money in Nigeria as at the end of October 2016 stands at N22.3tn. Most people who are not financially savvy about the concept of fractional reserve banking will likely believe that all the money in the economy – estimated at N22.3tn as at October, 2016- is created by the central bank of Nigeria.
In reality, “central bank created money” is only a fraction of the total money in circulation. As at October 2016, the value of currency in circulation is estimated at N1.82tn or 8.16% of the total money in the economy, hence, the balance popularly called “bank money” or “credit money” is created by banks.
How “bank money” is created today differs from the description found in most economics textbooks. Theoretically, it is said that all that banks do is mobilise deposits and lend out money, with economists and analysts portraying banks as playing intermediary roles.
Most people believe banks can only lend out pre-existing money, i.e “Bank NKB Ltd” takes a deposit from “Abubakar” and lends to “Abayomi” with regulations, bank supervision, the law governing the administration of banking and the moral argument around bank “bailout” centering around preserving Abubakar’s deposit. But in reality bank transactions are more complicated than that.
The truth of how banking works today differs from the description found in most economics textbooks. The Bank of England, a “major player in fractional reserve banking” agrees completely that the “test book model” is false.
Banks do not lend out pre-existing money, rather they create money out of thin air when they make loans.
To someone taking out a mortgage to buy a house or car, banks do not hand them millions of Naira worth of banknotes. Instead, the bank credits the person’s account with a “bank deposit” of the size of the mortgage. At that moment, new “bank money” is created, as no particular money is deducted from anyone’s account and moved into the beneficiary’s account.
Interestingly, a bank’s balance is simply a record of how much the bank owes its customers, which is simply a liability of the bank and not an asset that could be lent out.
Banks, in reality, create deposits when they lend out funds. The ability of businesses and individuals to pay back debts is critical to having a stable and growing economy. However, it is important that industrial, fiscal, trade and monetary policies should be aligned to ensure the system works.
Interestingly, “bank money” accounts for the biggest proportion of money in Nigeria today and the health of the banks in one way or the other are critical to ending poverty and inequality. So when the numbers show that the non- performing loans of banks are getting above the manageable threshold, it is okay to be apprehensive.
First, regulators and investment professionals are trained to believe banks are only playing an intermediation roles and they may not be well-trained to manage the reality that we face. Having limited knowledge about a crisis is a crisis in itself as many now question the capacity of staffs at the central bank of Nigeria.
Second, the adverse effect of the 2009 banking crisis is hurting the economy till date. Businesses are increasingly living on a very tight line, with costs of production rising every day due to accelerating price of raw materials on the back of currency problems and supply disruption(inflation). A banking crisis could make access to loans near impossible, further escalating the economic crisis.
How do we explain how CBN’s holdings in federal government securities of N756bn leapt from December 2015 level to N1.85tn in September 2016? One cannot clearly see an institution ready to act in good faith, if it is silently printing cash to bailout the federal government in the face of escalating inflation which threatens the sanity of the business environment.
Finally, the monetary authorities are already stretched thin and the central bank may find it extremely difficult to take in more pressures. Especially from the banking system whose magnitude of required bail out fund may dwarf the amount it expends on the fiscal authority.
How do we get out of this hole?
We need an economic team that understand economics, not people who are wired to spend and say “yes” to any call.