Private Banks – Not the Government or Central Banks – Create 97 Percent of All Money
Who creates money?
Most people assume that money is created by governments … or perhaps central banks.
In reality – as noted by the Bank of England, Britain’s central bank – 97% of all money in circulation is created by private banks.
Bank Loans = Creating Money Out of Thin Air
But how do private banks create money?
We’ve all been taught that banks first take in deposits, and then they loan out those deposits to folks who want to borrow.
But this is a myth …
The above is from an official video released by the Bank of England.
The Bank of England explains:
Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.
The reality of how money is created today differs from the description found in some economics textbooks:
- Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.
In reality in the modern economy, commercial banks are the creators of deposit money …. Rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.
Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.
This description of money creation contrasts with the notion that banks can only lend out pre-existing money, outlined in the previous section. Bank deposits are simply a record of how much the bank itself owes its customers. So they are a liability of the bank, not an asset that could be lent out.
Similarly, the Federal Reserve Bank of Chicago published a booklet called “Modern Money Mechanics” in the 1960s stating:
[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.
Monetary expert and economics professor Randall Wray explained to Washington’s Blog that:
Bank deposits are bank IOUs.