Banks Are Intermediaries of Loanable Funds

Some bad ideas are as hard to kill as crabgrass. In the field of monetary economics, the real- bills doctrine is a notorious example (Humphrey 1982; Laidler 1983). Less notorious, but no less obnoxious, is the claim that banks aren't financial intermediaries. Those who say so maintain that, instead of having to finance their lending by borrowing from others, as genuine intermediaries must, banks create all the funding they need "out of thin air." James Tobin (1963) once called this the "Fountain Pen" theory of banking, alluding to its implication that bankers only needed fountain pens to be able to "write up" as many loans as they liked. Since fountain pens are themselves no longer used in granting credit, let's just call it the "Thin Air" theory. This essay defends the supposedly naive "Intermediation" theory of banking against its lately de rigueur "Thin Air" rival. It holds that the Intermediary theory of banking comes much closer to describing the workings of actual banking systems than the Thin Air alternative.