By privately owned bank, I mean specifically a bank that is not registered as a corporation with publicly tradable shares.

Does it ever happen that such banks create money by lending it to their own owners? The owners could simply borrow the money indefinitely, and spend it on luxury goods, keeping the bank in debt until they die, at which point they don't care anymore.

e.g. if the bank starts out for the first time, and obtains 1 B in cash deposits which it has as reserves, it could have a 10% reserve ratio, and lend 900 B to the owners, which they use to party and buy yachts. The other 100 M they keep as reserves.

Assuming a bank run doesn't occur, this can be stable indefinitely.

Does this ever happen? examples? or why not?

e.g. if it does not happen, is that because it is illegal, or are there incentive reasons intrinsic to banking why it would never happen?


3 Answers 3


There wouldn't be much point creating a bank that "lends" money to its owners. What is there to gain by doing that?

You seem to suggest that it's possible to create a bank with 100 and somehow get more than that (e.g. 500) as "loans." That's not possible. Where will you get the extra 400? Banks can not print money.

  • $\begingroup$ No, in my example it would get 95 as deposits, 5 as capital and keep only 10 as reserves, lending the other 90, 5 of which to the owners $\endgroup$
    – user56834
    Apr 18, 2017 at 18:09
  • $\begingroup$ And the gain is that the owners have a quick buck for themselves which they officially borrow, but indefinitely so that they can act as if they own the borrowed money. $\endgroup$
    – user56834
    Apr 18, 2017 at 18:11
  • $\begingroup$ Don't they own all of the 95 since they were the ones who made the deposits? How have they benefitted? $\endgroup$ Apr 18, 2017 at 20:21
  • $\begingroup$ The deposits are just the deposits of other depositholders $\endgroup$
    – user56834
    Apr 18, 2017 at 20:44
  • $\begingroup$ I now understand your question. There are two problems with that proposal. First, it's probably unethical to start an enterprise in which the owners collect other people's money fraudulently for the purpose of enriching themselves. Second, unless the owners are paying back the loans at or above market interest rates, the enterprise will eventually fail and not succeed. $\endgroup$ Apr 18, 2017 at 21:56

Bank regulations vary by country, but it is a safe bet that they would frown upon having such a concentrated loan portfolio. Furthermore, there are presumably restrictions on lending to related parties, but how that would be defined would definitely vary by jurisdiction.

By doing a quick search on the internet, it was possible to find this FDIC letter about concentration risk. Link to FDIC page On that page is a link to a PDF which indicates that concentration risk is defined as 25% of capital. Unless the owners can get others to buy capital of the bank (which is unlikely if the only business plan of the bank is to lend money to the owners), the owners can only lend themselves back 25% of the money they put in before the regulators shut them down. (And in practice, I doubt that regulators would even let them get close to 25% of capital for related party lending.)

From a business perspective, it's not as if deposits can be attracted for free. The bank has to either pay interest for deposits, or else has to offer services (branches, ATMs, lending) which requires employees and cost money. A bank could not survive without having a lending portfolio that is paying a market rate of interest.

Finally, the bank needs equity, provided by the owners. Any sweetheart lending deals the bank offers the owners would reduce the profits on their equity. If the bank does not have a credible business plan, it is not going to attract other investors to supply capital needed for regulatory purposes.

The Savings and Loan Crisis in the United States offers a lot of examples of the breakdown of the regulation of small banks, but even then, the self-dealing was generally hidden.

  • $\begingroup$ I know that running a bank has costs, but given that banks often have very low capital ratio's, it seems the owner could generate a lot of "wealth" (in the form of indefinitely borrowed money) for himself by borrowing only a fraction of the bank's deposits. e.g. lets say that the bank has 95 M deposits and 5 M capital. the bank owner could lend himself 5 M, so that he now has 5M in cash, and 5M worth of shares in the bank. that only took a little more than 5% of the total deposits, which is manageable in terms of paying the costs of running the bank. $\endgroup$
    – user56834
    Apr 18, 2017 at 13:25
  • $\begingroup$ Do you know of specific legislation in the US that such a thing is illegal? or are you saying it isn't illegal? $\endgroup$
    – user56834
    Apr 18, 2017 at 13:26
  • $\begingroup$ Illegal is probably not the word to use; against regulation. Every jurisdiction defines concentration risk differently, but the basic principle is that particular loans are not above a certain small percentage of bank capital. Since it never comes up in practice, I cannot quote any examples. $\endgroup$ Apr 18, 2017 at 13:31
  • $\begingroup$ The amount of the loan the bank would be permitted to give to the owner is going to be less than the size of the owner's equity in the bank (due to loan concentration rules). The owner is just giving himself a loan, using the bank as an intermediary. There's a lot of easier ways to give yourself loans. During the S&L crisis, there were certainly fraudulent lending going on, which sort of accomplished this. However, the loans allegedly paid a market rate. $\endgroup$ Apr 18, 2017 at 13:35

The owners would not be able to spend more than their bank has in excess reserves, even if they were permitted by law to loan themselves much more. This is because banks use reserves to settle (aka clear) their debts with each other.

Suppose their bank has 1B in deposits that are fully backed by 1B in reserves. They then instruct it to extend to them 9B in loans, giving them 9B in deposits. The bank now has 10B in total deposits with 1B in reserves and a 10% reserve ratio, the minimum permitted by law. If the owners try to spend their money at a store (or yacht dealership) that banks somewhere else, their bank would have to send reserves to the store's bank to cover the purchase. This is a problem because their bank has no reserves to spare and therefore cannot transfer any without going insolvent.

They could, however, loan themselves 0.9B and spend it without making their bank insolvent (it would end up with the original 1B in deposits but only 0.1B in reserves and a 10% reserve ratio), but this wouldn't be increasing the money supply. They would just be ripping off their investors (ie their depositors) by taking money with no intention to repay, same as any company is able to do.

The owners could try to avoid this problem by only spending their money at stores that bank with them, eliminating the need to transfer reserves to another bank, but this would just push the problem further down the road. The bank's depositors will always be spending money mostly at places that bank somewhere else, eventually bringing the reserve ratio down to about what it would be had the bank owners spent their deposits at a store that banks somewhere else.


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