The Proof That Banks Create MoneyMore than 97% of all the money in the economy exists as bank deposits – and banks create these deposits simply by making loans. When people first hear this, they often find it hard to believe. But we don’t want you to take our word for it. In March 2014 the Bank of England has released official papers and a video explaining that money is created by commercial banks:
Money in the modern economy: an introduction (531KB)
Money creation in the modern economy (111KB)
Where does money come from? In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood. The principal way in which they are created is through commercial banks making loans: whenever a bank makes a loan, it creates a deposit in the borrower’s bank account, thereby creating new money. This description of how money is created differs from the story found in some economics textbooks.
“Loans create deposits not the other way round.”
Find out more here
In this video Dirk Bezemer, Associate Professor at the University of Groningen and Michael Kumhof, an IMF Economist explain where money comes from in less than 2 minutes:
Below you can read many more quotes from central bankers, finance journalists, and commentators on the subject.
When banks extend loans to their customers, they create money by crediting their customers’ accounts.
Sir Mervyn King, Speech to the South Wales Chamber of Commerce at The Millenium Centre, Cardiff on 23rd October 2012
“The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending.”
Martin Wolf, Financial Times, 9th November 2010
The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money.
Lord Adair Turner, former chairman of the Finacial Services Authority, Speech to the South African Reserve Bank, 2nd November 2012
Banks do not, as too many textbooks still suggest, take deposits of existing money from savers and lend it out to borrowers: they create credit and money ex nihilo – extending a loan to the borrower and simultaneously crediting the borrower’s money account.
Lord Adair Turner, former chairman of the Finacial Services Authority, Speech Credit, Money and Leverage, 12th September 2013
By far the largest role in creating broad money is played by the banking sector… When banks make loans they create additional deposits for those that have borrowed the money.
Bank of England, Interpreting movements in broad money, p.377
Even before the crisis banks enjoyed various kinds of state support, including the effective right to create money.
Independent Commission on Banking Report
So when you take out a loan from the bank, the ‘money’ is just typed into your account and created effectively out of nothing. Here’s further proof from Paul Tucker, Deputy Governor of the Bank of England and Member of the Monetary Policy Committee (the term ‘extend credit’ is a synonym for ‘make loans’):
Banks extend credit by simply increasing the borrowing customer’s current account … That is, banks extend credit [i.e. make loans] by creating money
Paul Tucker, Deputy Governor for Financial Stability
“Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit “creation” – credit is created literally out of thin air (or with the stroke of a keyboard).”
Paul Sheard, Chief Global Economic & Head of Global Economics and Research, Standard and Poors
Friday, March 28, 2014
The process by which banks create money is so simple that the mind is repelled.
John Kenneth Galbraith
I can still remember small details of the room where I was sitting when someone explained the mysteries and glories of fractional banking to me. I did NOT believe him. I was in seventh grade and had already thoroughly absorbed the idea that banks attracted deposits by paying a low rate of interest, found worthy borrowers willing to pay a higher rate of interest, and made their living off that spread. It had to be true or else why would Milburn Drysdale put up with so much to keep Jed Clampett from moving his money out of Drydale's bank in the Beverly Hillbillies. Thankfully, by the time I was ready to write my chapter on Money in Elegant Technology, I had been overwhelmed by the evidence that the fractional banking story was true and the Beverly Hillbillies version was not.
Unfortunately, most people still believe the fairytale about the importance of depositors, big and small, to the banking business. I understand their skepticism because I was once one of them (in the seventh grade.) Even so, it is a bit unnerving to discover the true believers can be full-grown and aging adults. And their childish beliefs are even less understandable these days after the Bank of England (of all institutions) has decided to come clean on the facts of fractional banking (in March 2014).