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Banks are not intermediaries of loanable funds — facts, theory and evidence Zoltan Jakab and Michael Kumhof June 2019 This is an updated version of the Staff Working Paper originally published on 26 October 2018 Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Committee. Staff Working Paper No. 761 Banks are not intermediaries of loanable funds — facts, theory and evidence Zoltan Jakab(1) and Michael Kumhof(2) Abstract In the loanable funds model, banks are modelled as resource-trading intermediaries that receive deposits of physical resources from savers before lending them to borrowers. In the financing model, banks are modelled as financial intermediaries whose loans are funded by ex-nihilo creation of ledger-entry deposits that facilitate payments among nonbanks. The financing model predicts larger and faster changes in bank lending and greater real effects of financial shocks. Aggregate bank balance sheets exhibit very high volatility, as predicted by financing models. Alternative explanations of volatility in physical savings, net securities purchases or asset valuations have almost no support in the data. Key words: Banks, financial intermediation, loanable funds, money creation, bank lending, bank financing, money demand. JEL classification: E41, E44, E51, G21. (1) International Monetary Fund. Email: [email protected] (2) Bank of England. Email: [email protected] The views expressed in this paper are those of the authors and should not be attributed to the Bank of England or the International Monetary Fund. This is a comprehensively revised draft of our 2015 Bank of England Staff Working Paper No. 529, ‘Banks are not intermediaries of loanable funds — and why this matters’. The authors are grateful for many comments and helpful suggestions from seminar participants at Autorité de Contrôle Prudentiel et de Résolution, Banco Central do Brasil, Banco de España, Bank of Finland, Bank of Italy, Bank of Korea, Bank of Lithuania, Banque de France, BIS, Bundesbank, Central Bank of Ireland, Central Bank of the Russian Federation, CEPR-IMFS Macro-Modeling Conference, CER-ETH Zürich, Czech National Bank, ECB, Econometric Society World Congress, Her Majesty’s Treasury, Institute of International and European Affairs, International Labor Organization, Kingston University, Money Macro and Finance Conference, National Bank of Poland, Österreichische Nationalbank, Oxford-New York Fed Conference on Monetary Economics, Princeton JRCPPF Conference, Royal Economic Society Annual Conference, Sciences Po, Sheffield University, Stockholm School of Economics, Universidad Carlos III, University of Essex, University of Geneva, University of Leeds, University of Nottingham, University of Saint Andrews, University of Surrey and University of Zürich. The Bank’s working paper series can be found at www.bankofengland.co.uk/working-paper/staff-working-papers Bank of England, Threadneedle Street, London, EC2R 8AH Telephone +44 (0)20 3461 4030 email [email protected] © Bank of England 2019 ISSN 1749-9135 (on-line) 1.