What would happen if the central bank cancelled its loans to indebted banks?

hatrickpatrick

This has probably been discussed already but I've been thinking about this over the last while:

Since money initially gets into circulation via a loan from a central bank, when a credit crunch / banking recession such as this one occurs, what would happen if the central bank cancelled the debts from those banks, thereby preventing a banking collapse while avoiding a never ending debt cycle of issuing another loan to repay the first?

As en emergency measure, what would happen? Would it cause the same kind of chaos that simply printing more money would supposedly cause? My instinct is telling me it wouldn't, since the issue in these cases is not a lack of supply or demand, but a technical problem in the circulation of money which is jamming up the gears, if you will.

So what would happen if this was tried? Anyone been into this idea before?

noodler

Well, I can't speak in terms of other Central Banks but in the Eurozone the ECB 's shareholders (the largest beng Germany of course) would have any ECB losses imposed on them proportionally.

In a more theory based answer there is obviously inflationary fears, particularly if other Central Banks followed a similar strategy to "recapitalise" their banks.

andrew

As far as I'm aware, money is created when the Central Bank buys securities from a bank, and they pay for those securities with money they create. As in, I don't think commercial banks are established purely on the basis of loans from the central bank. That said, Banks can also get loans from the central bank to finance their day to day operations, and during a credit crunch the central bank reduces the rate on those loans, and accepts more kinds of collateral. And so I think, what you're proposing essentially, is that instead of loans, the bank just credits the bank's account with a certain amount of money, essentially.

I suppose this would be bad because it'd amount to giving the banks free money. There's a lot of confusion on the internet about how money is created, and I constantly hear things which make me realise I don't fully get it. But I'm pretty sure that's how it works.