How can non-US banks issue USD loans?

Question

I understand, commercial banks are entitled by the Central Bank to "create new money" when they issue a loan and correspondingly "destroy the money" when the loan is paid back (with the constraints of the fractional reserve system). Correct?

If so, I wonder how a Swiss bank, which is entitled by the Swiss National Bank rather than the FED, can issue a new loan in USD. What is the mechanism?

thank you!

Answer 1

In order to understand this its important to understand how actually commercial banks contribute to money creation. It is true that commercial banks are part of money creating process but I think that you misunderstand the way in which they are part of it. When you go to commercial bank to get a loan commercial bank neither domestic or foreign is allowed to just create the money for that loan out of thin air. Only central bank can do that.

Rather the money creation process works in a way that central bank creates base money and in addition also allows commercial banks to borrow from it newly created reserves. Afterwards, the commercial banks help to multiply the base money due to fractional reserve system. For example, if fractional reserve requirement is $10\%$ that means that if a person deposits $\\\$100$ into the commercial bank they are allowed to lend out $\\\$90$ and keep $\\\$10$ as a reserve. Afterwards when the person who borrowed $\\\$90$ deposits them (or spends them and someone else deposits them), bank will again be allowed to keep only $\\\$9$ as reserve and lent out $\\\$81$. In this way eventually up to $\\\$1000$ of new money can be created. This process is reversed once the loan is being paid back. The point is that commercial banks cannot simply create the money out of nothing so their domestic/foreign status does not matter that much.

Foreign commercial banks can make loans in dollars by simply first entering the forex market, buying some amount $X$ of dollars and then lending that amount to its customers. Alternatively foreign bank can also borrow dollars from other bank that has them and then lend them further. When we talk about dollars in particular foreign banks have even access to federal funds market (see this Fed Cleveland explainer) so they can borrow from there as well.

Answer 2

Banks are the primary lenders, who conjure almost all currency.

The 12 Member Banks of the Federal Reserve System only make loans in special circumstances.

The Swiss Bank is outside of the Federal Reserve System, in what is called the EuroDollar market. EuroDollars are USD's (they are not Euros) held by other non-US banks, as reserves or for currency exchange purposes.

I don't know the Swiss Bank, but I suspect they use these EuroDollars as reserves on their balance sheet, which they in turn use for currency creation in their own currency.

EuroDollar bank loans are also offered in USD's, but a Swiss Bank cannot conjure USDs directly. They would need to conjure Swiss Francs and exchange these francs for USDs.

Only US Chartered Banks who are part of the Federal Reserve System can conjure currency - and the Fed in certain circumstances.

"Fractional reserve banking is the banking system used throughout the world today. Banks use fractional reserves to create loans for businesses and consumers." (https://www.investopedia.com/terms/f/fractionalreservebanking.asp)

12 Member banks of the Federal Reserve System only make loans (conjure currency) in a liquidity crisis. Otherwise, chartered banks are the primary place currency is conjured. Obviously, the 12 Member Banks and Federal Reserve Board set policy for targeting the currency supply size. "The Federal Reserve lends to banks and other depository institutions--so-called discount window lending--to address temporary problems they may have in obtaining funding." This is the repo market and QE. (https://www.federalreserve.gov/faqs/banking_12841.htm)

"This article explains how the majority of money in the modern economy is created by commercial banks making loans.

1. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.
2. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’." (https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf)

A Swiss bank operates as part of the Eurodollar market. This market is outside of the control of the federal reserve system.(https://corporatefinanceinstitute.com/resources/foreign-exchange/eurodollar/)