How commercial banks create money — Economics, 14–17
Most money used in daily payments is not notes in a wallet. Commercial banks create deposit money when they make loans, while the banking system must still manage withdrawals, payments and the risk that borrowers cannot repay.
Idea
When a bank approves a loan, it usually does not hand over another customer’s exact banknotes. It records a new deposit in the borrower’s account, and that deposit can be spent. The loan is an asset for the bank, the deposit is its liability, and money is later destroyed when the loan is repaid.
Why it was needed
People often imagine that banks are only safe boxes that pass saved money from one person to another. That picture cannot explain why deposits can grow when new loans finance homes, firms or study. Understanding the balance sheet shows both the useful function of credit and why too much risky lending can cause trouble.
Worked example
You deposit €1,000. The bank approves a €900 loan and credits Ana’s account by €900: deposits now total €1,900, although the original cash was €1,000. Ana pays a builder, who deposits the €900 elsewhere, so payments move deposits around. If Ana repays €900, that loan-created deposit is cancelled, while interest is income for the bank.
The trap
A reasonable mistake is to think banks lend out the same deposits once, or that every loan creates free wealth. Bank deposits are promises to pay, and the bank must settle payments with other banks and survive withdrawals. Lending creates purchasing power together with a debt; it does not create a free house, car or service.
Where it appears
This matters when you compare mortgages, student loans or business finance: the bank is creating a deposit but also judging repayment risk. It also explains why bank failures can spread fear: people may rush to withdraw promises that cannot all be settled at once. Regulation, capital and deposit protection limit that danger.
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