At the end of this answer there is an explication of the fractional reserve system. It is taken from another question that was closed as duplicate:
The problem I have with this concept is the following: A bank give a
Merry loan of 100,000$. Merry buys a house with this money. For a
period of 1 year, Merry has paid back 10,000 to the bank. Afterward
Merry's finance condition worsen and she no longer can pay her debt.
So in theory, if all the bank borrowers end up in the same situation
as Merry did, the bank is going to bankrupt. But if the bank never had
the load money in the first place, every penny received from borrowers
is a pure profit. Even if Merry returned only 10% of her loan, the
Bank still profits 10,000 because the given 100,000 to Merry were not
bank's money in the first place. This leads me to the question: Why do
banks put interest on top of this fraud?
My answer to that question is under the line below.
To answer yours:
- Your question came 8 years too late. It was inherently unstable but there was nothing anyone was willing to do about it: the rewards were too great for those involved in legislation. The financial crisis was caused by this system unravelling. Today, the same system is essentially in place, but in order to avoid collapse of modern civilization the central banks now have a permanent QE in place to replace the private sector credit growth the system depends on, but can no longer produce. Incidentally, Japan has been in the same situation since the 90s. The capitalism we have to day is kept alive entirely by state stimulus.
- You have separated concepts unnecessarily. When you say "lend more money than it actually has", that is not the most useful way to look at it. As you will see below in my little explication of the credit creation mechanism, the liability created as a deposit account amount to you is money. Today, what you trade with other people are bank liabilities, and the whole thing is underpinned by trust in the banks. If a major bank were to go down, the money would evaporate. It is better to just realise that banks are licensed to create money and that is that.
- Reserve requirements are practically irrelevant. Today in the USA the reserve requirement is 0% for all institutions, and your assertion that it was 10% is incorrect. It was 10% for only certain types of account at the central bank. Nevertheless, you will see in my explanation below that the total amount of synthesized money created can be potentially infinite, and of course the reserves can be 10%, 20% or whatever you like but it is always 10 or 20% of newly synthesized money. To be clear, if the banking system generates a trillion dollars of debt-money, 10 or 20% of that would need to be parked at the central bank. So again, practically irrelevant.
- There are/were some capital risk assessment requirements tightened after 2008. But these are loosening again. The whole system was completely unstable and bound to blow up. Several economists predicted this prior to the crisis. Note that the crisis has not been resolved, it is merely on ice to preserve the status quo, while central banks synthesise new credit and inject this continuously into the economy to prevent the complete unravelling of the banking system and reversal of debt creation. (Prevent debt-deflation, technically).
Let's break it down:
A bank give a Merry loan of 100,000$
Concretely, the bank records an asset of 100,000 (the loan) and a liability of 100,000$ (the amount recorded in Merry's deposit account).
Note that at this point, the liability is what appears on your internet banking statements as 'money' and those liabilities to you from banks are today what is traded in exchange for goods and services. In this sense the liability is 'money', and it is why people consider this money to have been synthesized commercially ex nihilo. This is essentially correct. Banks are licensed to create this money from nothing.
Merry buys a house with this money.
Analyse it in detail: Merry finds a supplier, who implicitly trusts the bank, who probably has an account at another bank (though not necessarily), and agrees to accept payment in the form of a bank liability. Merry initiates a bank transfer from MerryBank to SupplierBank. MerryBank decreases its liability to Merry by 100,000, keeping only the asset, but adds a new liability to SupplierBank. SupplierBank records an asset of 100,000 (MerryBank's liability to SupplierBank) and a liability to Supplier of $100,000.
For a period of 1 year, Merry has paid back 10,000 to the bank.
Yes, in 99% of cases in the form of bank transfers from other newly created debt from other banks. These become assets in the books of MerryBank (liabilities from SomeOtherBank) and the loan asset is reduced. So while MerryBank gains a 10k asset from SomeOtherBank it actually cancels 10k of loan asset, so its position has not changed - only its risk position.
Afterward Merry's finance condition worsen and she no longer can pay
her debt. So in theory, if all the bank borrowers end up in the same
situation as Merry did, the bank is going to bankrupt.
No. The bank still has an asset of 90,000$ and will use debt collectors to take Merry's property. The bank will then cancel the 90,000 loan asset and record a property asset at market value.
But if the bank never had the loan money in the first place,
Yes. Fractional reserve requirements for loans was/is often 0%. Also, the asset (for example) at SupplierBank is then used as reserves to issue further debt. Two banks in a fractional reserve system act as feedback-loop amplifiers, so if the reserve requirement was 10%, that does not mean that the money multiplier would be 10 times, but depending on flow rates and dynamic systems calculations you can end up with hundreds of thousands times the base reserve. Incidentally, this was the keystone to the financial crisis.
every penny received from borrowers is a pure profit. Even if Merry returned
only 10% of her loan, the Bank still profits 10,000 because the given
100,000$ to Merry were not bank's money in the first place.
No. See above. The asset position is unchanged.
This leads me to the question: Why do banks put interest on top of
this fraud? And what prevents banks from putting huge amount of money
to some people's account (for example to the Bank's CEO )? This black
magic is not quite clear to me.
Interest rate is primarily determined by interbank lending rates to cover reserve and capital requirements.
I don't know if it applies to the rest of the world, but the main source of income for banks where I live is actually transaction fees.
As for CEO payments, auditors. But in general CEOs reward themselves by issuing debt (bonds) to cover stock buybacks, to boost stock price, to which their bonuses are tied. Calling this kind of activity fraud is to some extent true, as outside the US a lot of this kind of thing is regulated.
Banks could be pure digital banks that have a employees in the hundreds. Typically they are dinosaur institutions that employ in the 10s or 100s of thousands of people. The banks use fees and interest to cover the cost of employees mainly. Incidentally, this is one reason why governments chose to assist banks in 2008. Directly and indirectly they employ a big chunk of the economy, a consequence of Western deindustrialization and financialization.