<p>Because banks have to satisfy their capital requirements and they are not able to create high powered money.</p>
<p>Capital requirements are different for different banks because under the current rules they depend on how risky are assets that the bank holds (you can read about that <a href="https://www.investopedia.com/terms/c/capitalrequirement.asp" rel="nofollow noreferrer">here</a>). Suppose the capital requirement rules require some bank to hold capital worth of 10% of a loan it makes. Then if the bank wants to issue \$100 loan it has to keep \$10 as an extra capital reserve.</p>
<p>A consequence of this is that bank needs to have some extra money not created by the loan. If someone comes asking for \$100 loan they would have to have \$10 as a capital reserve that they cannot create themselves (this is also called high-powered money). To get these reserves they can either borrow money from other banks (which might have excess reserves), central bank (which can create reserves/high-powered money at will) or get deposits. Typically it is hard to attract new deposits quickly enough so most of the time bank is making more loans they have to get extra capital for their capital requirements by borrowing either from central bank or other banks.</p>

CC BY-SA 4.0
2021-09-18T09:51:36.510Z
This makes sense, thanks for this. However, assuming this is true, it seems odd that a bank may have equal funding from domestic deposits and short-term money markets (source below). Would you have any reason why? 

https://www.rba.gov.au/publications/bulletin/2018/mar/developments-in-banks-funding-costs-and-lending-rates.html - check out the first graph
chenchen
CC BY-SA 4.0
2021-09-18T09:51:36.523Z
This makes sense, thanks for this. However, assuming this is true, it seems odd that a bank may have equal funding from domestic deposits and short-term money markets (source below). Would you have any reason why? 

https://www.rba.gov.au/publications/bulletin/2018/mar/developments-in-banks-funding-costs-and-lending-rates.html - check out the first graph
chenchen
CC BY-SA 4.0
2021-09-18T10:04:31.617Z
@chenchen why would that be odd as explained above deposits are also sources of reserves
1muflon1
CC BY-SA 4.0
2021-09-18T10:25:20.850Z
For example, a bank makes \$100 in loans, and must hold \$10 capital reserve. 
Then it will borrow that \$10 from somewhere, so on their liabilities, we should see something like deposits/(other funding types) = 10/1, based on what you're saying
chenchen
CC BY-SA 4.0
2021-09-18T10:32:54.077Z
@chenchen yes that 10USD can come from not just loans, central bank but also deposits, it does not really matter how the bank gets that capital reserve (owners of the bank could inject extra money as well etc) but it has to have some otherwise it violates the law (although 10% was just an example, every country will have different requirements and some countries still have reserve requirements instead of capital reserves but they work in similar way except reserve requirements are usually fixed at same level for all banks whereas capital reserves are different for assets of different risk
1muflon1
CC BY-SA 4.0
2021-09-18T10:36:09.220Z
@chenchen but banks are allowed to hold excess reserves, in fact in past this was very rare and you would see that banks actually held reserves just at the bare minimum, but post 2009 financial crisis which toppled some under capitalized banks and caused problem for multiple banks holding bare minimum capital, banks started to hold excess reserves. Also again 10% is just an example, irl different risky assets (eg loans that bank makes) will have different capital reserve requirement for some low risk loans bank might only be required to have 4% reserve for others 16% etc
1muflon1
CC BY-SA 4.0
2021-09-18T12:55:31.487Z
This thread seems to confuse the terms ‘capital’ and ‘reserves’.  ‘Capital’ is an issued liability, such as stock.  ‘Reserves’ is an asset, generally consisting of balances held at the Fed.  In most countries there are capital requirements and reserve requirements.  It is the capital requirements that drive the debt issuance.
dm63
CC BY-SA 4.0
2021-09-18T13:01:03.707Z
@dm63 1. no most countries already got rid of reserve requirements 2. Reserves at the central bank are part of the capital requirements in fact that is how large number of the required capital requirements are satisfied by holding reserves at central bank, I do not confuse the two but you can google central’s bank reserves from Fred data and you see that they are not zero even after abolishment of reserve requirements, and this is not because banks would be holding them just for giggles but because having these reserves counts as a capital buffer
1muflon1
CC BY-SA 4.0
2021-09-18T13:03:35.813Z
@dm63 in fact reserves are required to be used as capital buffers under Basel III, so this is no confusion of terms, reserves are literally mandated to be used for these purposes. In addition, free reserves even count as tier I capital, under Basel, if I remember correctly
1muflon1
CC BY-SA 4.0
2021-09-18T14:09:47.270Z
I think you’re referring to the liquidity rules under Basel 3. The Liquidity Coverage Ratio and the Net Stable Funding Ratio.  These mandate holding sufficient liquid assets.
dm63
CC BY-SA 4.0
2021-09-18T15:12:45.873Z
@dm63 no you can look in this chart that capital buffers are part of the capital requirements under Basel https://www.bis.org/bcbs/basel3/b3_bank_sup_reforms.pdf, also if you check Basel on Wikipedia you will see that reserves (among other things) are mentioned under both tier I and tier II capital requirements depending on type of reserves https://en.m.wikipedia.org/wiki/Tier_1_capital.
1muflon1
CC BY-SA 4.0
2021-09-18T15:37:27.923Z
Your second reference does talk about reserves, and I think this is a terminology difference between Europe and US.  I think reserves in this case is what US would call retained earnings.  Nothing to do with assets held at the central bank.  Happy to leave it there.
dm63
CC BY-SA 4.0
2021-09-18T15:58:54.900Z
@dm63 but in double entry accounting everything has to have an counterbalance for every dollar on retained earnings there has to be dollar on cash reserve or reserves parked at central bank etc
1muflon1
CC BY-SA 4.0
2021-09-17T17:41:49.117Z
2021-09-17T17:55:10.810Z
2021-09-17T17:55:10.810Z
1muflon1
<p>Even if there are no liquidity or capital requirements imposed by regulators a prudent bank, which must make interbank payments as a going concern, must issue a mix of liabilities and equity to retain legal control over its portfolio of assets.</p>
<p>Classify the bank assets as reserves, securities, and loans. Classify the bank liabilities and equity as deposits, borrowings, bonds, and equity. Here the borrowings are short term debt to distinguish from bonds as longer term debt.</p>
<p>If the bank does not issue the mix of liabilities and equity equal to the assets then it will be unable to make interbank payments as the outflow of reserves to other banks in the bank sector. So the bank must actively attract liabilities and equity, so it can keep making its payment obligations through the cash reserve account, so it can expand and hold the asset portfolio in the balance sheet.</p>

CC BY-SA 4.0
2021-09-18T15:52:51.217Z
2021-09-18T15:52:51.217Z
SystemTheory
<p>Banks issue debt because they need to satisfy various capital requirements set by regulators (in the US, the Fed).  What is capital exactly?  Basically, capital is the sum of Tier1 capital and Tier2 capital.  Tier1 capital is essentially issued equity and retained earnings.  Tier2 capital is essentially eligible debt securities that have been issued.  See here for a good presentation <a href="https://www.davispolk.com/sites/default/files/2017-01-11_davis_polk_federal_reserves_final_rule_on_tlac.pdf" rel="nofollow noreferrer">https://www.davispolk.com/sites/default/files/2017-01-11_davis_polk_federal_reserves_final_rule_on_tlac.pdf</a></p>
<p>Why do these rules exist ? Essentially the Fed wants to be able to easily wind down a bank without causing chaos as occurred in 2008/9.  They envision doing this by causing holders of Tier1 capital to receive zero in bankruptcy (stock goes to zero) and holders of Tier2 capital (debt) will receive haircuts as necessary after the assets are resolved.</p>
<p>For all this to work, banks must have issued enough eligible  debt securities, even if they have no immediate use for the funds. That is the case today in the US.</p>

CC BY-SA 4.0
2021-09-18T10:56:12.523Z
2021-09-18T10:56:12.523Z
dm63
<p>When a bank gives out a loan, a simultaneous liability and asset is created on their balance sheet, and 'external' funding doesn't fit into this picture... so why do they need to borrow money?</p>

CC BY-SA 4.0
2021-09-17T15:18:09.143Z
https://voxeu.org/article/banks-do-not-create-money-out-thin-air. Worthwhile alternative perspective to the literature. I.e. Positive Money, Kumhof, etc.
EB3112
CC BY-SA 4.0
2021-09-17T15:40:26.347Z
Because they can't re-loan a loan? Their balance sheet cash is now a requirement for them to hold because of the liability, so they can't just loan it again. And they have a different kind of asset on their balance sheet, one that is not loanable.
Criticize SE actions means ban
<macroeconomics><finance><banking><nonexpert>
Why do banks need to borrow money (i.e. bond issuance)?
chenchen
# Why do banks need to borrow money (i.e. bond issuance)?

(Asked by: username_0 on 2021-09-17)

When a bank gives out a loan, a simultaneous liability and asset is created on their balance sheet, and 'external' funding doesn't fit into this picture... so why do they need to borrow money?

**Tags:** macroeconomics, finance, banking, nonexpert

> **Comments:**
> **username_1**: https://voxeu.org/article/banks-do-not-create-money-out-thin-air. Worthwhile alternative perspective to the literature. I.e. Positive Money, Kumhof, etc.  
> **username_2**: Because they can't re-loan a loan? Their balance sheet cash is now a requirement for them to hold because of the liability, so they can't just loan it again. And they have a different kind of asset on their balance sheet, one that is not loanable.  

---

## 3 answers

### Answer by username_3 on 2021-09-17. Score: 0 | Accepted answer

Because banks have to satisfy their capital requirements and they are not able to create high powered money.

Capital requirements are different for different banks because under the current rules they depend on how risky are assets that the bank holds (you can read about that [here](https://www.investopedia.com/terms/c/capitalrequirement.asp)). Suppose the capital requirement rules require some bank to hold capital worth of 10% of a loan it makes. Then if the bank wants to issue \$100 loan it has to keep \$10 as an extra capital reserve.

A consequence of this is that bank needs to have some extra money not created by the loan. If someone comes asking for \$100 loan they would have to have \$10 as a capital reserve that they cannot create themselves (this is also called high-powered money). To get these reserves they can either borrow money from other banks (which might have excess reserves), central bank (which can create reserves/high-powered money at will) or get deposits. Typically it is hard to attract new deposits quickly enough so most of the time bank is making more loans they have to get extra capital for their capital requirements by borrowing either from central bank or other banks.

> **Comments:**
> **username_0**: This makes sense, thanks for this. However, assuming this is true, it seems odd that a bank may have equal funding from domestic deposits and short-term money markets (source below). Would you have any reason why?   https://www.rba.gov.au/publications/bulletin/2018/mar/developments-in-banks-funding-costs-and-lending-rates.html - check out the first graph  
> **username_0**: This makes sense, thanks for this. However, assuming this is true, it seems odd that a bank may have equal funding from domestic deposits and short-term money markets (source below). Would you have any reason why?   https://www.rba.gov.au/publications/bulletin/2018/mar/developments-in-banks-funding-costs-and-lending-rates.html - check out the first graph  
> **username_3**: @username_0 why would that be odd as explained above deposits are also sources of reserves  
> **username_0**: For example, a bank makes \$100 in loans, and must hold \$10 capital reserve.  Then it will borrow that \$10 from somewhere, so on their liabilities, we should see something like deposits/(other funding types) = 10/1, based on what you're saying  
> **username_3**: @username_0 yes that 10USD can come from not just loans, central bank but also deposits, it does not really matter how the bank gets that capital reserve (owners of the bank could inject extra money as well etc) but it has to have some otherwise it violates the law (although 10% was just an example, every country will have different requirements and some countries still have reserve requirements instead of capital reserves but they work in similar way except reserve requirements are usually fixed at same level for all banks whereas capital reserves are different for assets of different risk  
> **username_3**: @username_0 but banks are allowed to hold excess reserves, in fact in past this was very rare and you would see that banks actually held reserves just at the bare minimum, but post 2009 financial crisis which toppled some under capitalized banks and caused problem for multiple banks holding bare minimum capital, banks started to hold excess reserves. Also again 10% is just an example, irl different risky assets (eg loans that bank makes) will have different capital reserve requirement for some low risk loans bank might only be required to have 4% reserve for others 16% etc  
> **username_4**: This thread seems to confuse the terms ‘capital’ and ‘reserves’.  ‘Capital’ is an issued liability, such as stock.  ‘Reserves’ is an asset, generally consisting of balances held at the Fed.  In most countries there are capital requirements and reserve requirements.  It is the capital requirements that drive the debt issuance.  
> **username_3**: @username_4 1. no most countries already got rid of reserve requirements 2. Reserves at the central bank are part of the capital requirements in fact that is how large number of the required capital requirements are satisfied by holding reserves at central bank, I do not confuse the two but you can google central’s bank reserves from Fred data and you see that they are not zero even after abolishment of reserve requirements, and this is not because banks would be holding them just for giggles but because having these reserves counts as a capital buffer  
> **username_3**: @username_4 in fact reserves are required to be used as capital buffers under Basel III, so this is no confusion of terms, reserves are literally mandated to be used for these purposes. In addition, free reserves even count as tier I capital, under Basel, if I remember correctly  
> **username_4**: I think you’re referring to the liquidity rules under Basel 3. The Liquidity Coverage Ratio and the Net Stable Funding Ratio.  These mandate holding sufficient liquid assets.  
> **username_3**: @username_4 no you can look in this chart that capital buffers are part of the capital requirements under Basel https://www.bis.org/bcbs/basel3/b3_bank_sup_reforms.pdf, also if you check Basel on Wikipedia you will see that reserves (among other things) are mentioned under both tier I and tier II capital requirements depending on type of reserves https://en.m.wikipedia.org/wiki/Tier_1_capital.  
> **username_4**: Your second reference does talk about reserves, and I think this is a terminology difference between Europe and US.  I think reserves in this case is what US would call retained earnings.  Nothing to do with assets held at the central bank.  Happy to leave it there.  
> **username_3**: @username_4 but in double entry accounting everything has to have an counterbalance for every dollar on retained earnings there has to be dollar on cash reserve or reserves parked at central bank etc  

---

### Answer by username_5 on 2021-09-18. Score: 1

Even if there are no liquidity or capital requirements imposed by regulators a prudent bank, which must make interbank payments as a going concern, must issue a mix of liabilities and equity to retain legal control over its portfolio of assets.

Classify the bank assets as reserves, securities, and loans. Classify the bank liabilities and equity as deposits, borrowings, bonds, and equity. Here the borrowings are short term debt to distinguish from bonds as longer term debt.

If the bank does not issue the mix of liabilities and equity equal to the assets then it will be unable to make interbank payments as the outflow of reserves to other banks in the bank sector. So the bank must actively attract liabilities and equity, so it can keep making its payment obligations through the cash reserve account, so it can expand and hold the asset portfolio in the balance sheet.


---

### Answer by username_4 on 2021-09-18. Score: 0

Banks issue debt because they need to satisfy various capital requirements set by regulators (in the US, the Fed). What is capital exactly? Basically, capital is the sum of Tier1 capital and Tier2 capital. Tier1 capital is essentially issued equity and retained earnings. Tier2 capital is essentially eligible debt securities that have been issued. See here for a good presentation <https://www.davispolk.com/sites/default/files/2017-01-11_davis_polk_federal_reserves_final_rule_on_tlac.pdf>

Why do these rules exist ? Essentially the Fed wants to be able to easily wind down a bank without causing chaos as occurred in 2008/9. They envision doing this by causing holders of Tier1 capital to receive zero in bankruptcy (stock goes to zero) and holders of Tier2 capital (debt) will receive haircuts as necessary after the assets are resolved.

For all this to work, banks must have issued enough eligible debt securities, even if they have no immediate use for the funds. That is the case today in the US.


---

