Exactly How Do Banks Create Money?

Banks create money in the process of lending, as has been pointed out by the Bank of England: “The majority of money in the modern economy is created by commercial banks making loans.” In this video, Ib Ravn from the monetary reform organization Gode Penge in Denmark explains exactly how money creation works.

Cash and money-on-account (bank money) are the two kinds of money that make up the money supply in a given country. To increase the money supply is to create money. Banks do this when they grant a loan to a customer.

The bank enters the relevant number into the borrower’s credit account with the bank. The bank also subtracts the same amount from a new “loan account” that the banks opens in the borrower’s name. This now records the borrower’s debt to the bank.

Since the money supply is made up by the balances in all bank accounts in a given country, adding the loan amount to the borrower’s credit account is equivalent to creating money.

When the borrower repays the debt, the money disappears from the borrower’s credit account (and is transferred to the loan account). This means that the money supply is reduced by the amount of the repayment: Money is destroyed.

All of this is effected through the payments system that the central bank operates for its member banks. This system of clearing both facilitates and obscures the money-creation process.

A key role is played by the so-called settlement accounts that banks have with the central bank. The money in these accounts also constitute the reserves that a bank holds, which are also known as its “liquidity”. How this all works is not generally known by the public but, confusing as it may seem, it is all laid bare in this presentation.

Other videos by Ib Ravn:

Banks don't lend money, they create it: Demystifying monetary and banking terminology
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A monetary system that promotes eudaimonia, not financial bubbles    • A monetary system that promotes eudai...