Banking Example #1.1: Loan and Purchase

Example of a bank customer using a loan to make a purchase. See Example 1 for an example of a loan and deposit transfer.

Setup: one central bank (CB), two commercial banks A and B, and two people x and y. Person x banks at A and person y banks at B. No reserve requirements or capital requirements and everyone's balance sheet initially clear (empty).

Initial balance sheets (for CB, A, B, x and y):

CB, A, B, x, y

Assets	Liabilities
$0	$0

Balance sheets after x takes a $100 loan from A:

Bank A

Assets	Liabilities
$100 loan to x	$100 deposit for x

Person x

Assets	Liabilities
$100 deposit at A	$100 borrowing from A

Balance sheets after x purchases $100 of services from y:

Central Bank

Assets	Liabilities
$100 reserve overdraft for A	$100 reserve deposit for B

Bank A

Assets	Liabilities
$100 loan to x	$100 overdraft at CB

Bank B

Assets	Liabilities
$100 reserves	$100 deposit for y

Person x

Assets	Liabilities
$0 deposit at A	$100 borrowing from A
Negative Equity	Equity
$100	------------------------

Person y

Assets	Liabilities
$100 deposit at B	$0
Negative Equity	Equity
------------------	$100

Balance sheet after Bank A borrows $100 of reserves from Bank B and repays CB the overdraft amount by the end of the day (note: Bank A could have borrowed from any other bank, the Central Bank's discount window, or the money market or it could have attracted new transfer deposits but I've chosen to show the case where it borrows from Bank B):

Central Bank

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$100 loan to x	$100 reserve borrowings from B

Bank B

Assets	Liabilities
$100 loan of reserves to A	$100 deposit for y

Person x

Assets	Liabilities
$0 deposit at A	$100 borrowing from A
Negative Equity	Equity
$100	------------------------

Person y

Assets	Liabilities
$100 deposit at B	$0
Negative Equity	Equity
------------------	$100

At the conclusion of this example, person y has $100 of "permanent" bank created (inside/endogenous) money unencumbered by any offsetting liability (note, however, that person x is encumbered by this liability without an offsetting asset!), and yet, just as in Example 1, the central bank's balance sheet still ends up clear.

Note: it doesn't have to be services that x purchases from y of course, but this prevents me from having to put some object on y's initial balance sheet. However, assuming it's some kind of object x purchases from y, such as a car, could help in imagining A giving x the loan in the first place since that could serve as collateral. Also, if we were to add in reserve requirements, A then has a collateralized loan to in turn offer the CB as collateral when borrowing the required reserves which the CB keeps on its balance sheet "permanently" at the conclusion of a similar scenario with reserve requirements (see Banking Example #2).