A little challenge for a modern monetary theory

There’s an insistence out there that banks simply don’t lend out deposits. In one sense it’s even true. Banks lend money then look for the deposits to fund such lending. After all, capital plus deposits always does equal the loan book, as every bank balance sheet ever shows. Further, banks have to make sure those books balance at the close of the business day every business day.

That the funding comes after the loan - that’s what the bank’s treasury department does - doesn’t change the fact that the deposits fund the loans.

Therefore all this insistence that banks just create the money that they lend isn’t, in any useful sense, true.

We’ve now got a test of it. Silicon Valley Bank just went bust. There was a bank run. Deposits fleeing the bank that is. But if deposits fleeing the bank make it go bust then clearly deposits are important to a bank. They serve some important function, this must be so. And the function they serve is to fund the loan book. SIVB is bust because it can’t fund the loan book because the deposits went on that rat run.

Which is something of a challenge to this modern monetary theory that deposits don’t fund loans, banks just create the money by the act of lending. If it’s true that deposits don’t matter then Silicon Valley Bank isn’t bust. It is. Therefore deposits matter.

We would be interested to hear any attempts at explaining SIVB’s failure which conforms to that modern theory that banks don’t lend out deposits. But we do think that any such is going to run up against that ugly fact that SIVB is bust. As ever, when a theory is contradicted by reality it’s the universe that wins, not the hypothesis.