How do banks create money when they make a loan?
Most of the money in your account was never printed. It was typed into existence by a bank when someone borrowed. Here is how that works, and what keeps it in check.
Education only, not investment, tax or legal advice. Crypto-assets are high-risk — risk disclosure.
The short answer
When a commercial bank makes a loan, it credits the borrower's account with a new deposit. That deposit is new money. Repaying the loan deletes it again. Banks are limited not by savers' deposits but by profitability, risk, capital rules and central bank interest rates.
Key takeaways
- Bank deposits, not notes and coins, are most of the money people use day to day; the Bank of England puts cash at about 3% of it.
- A new loan creates a matching new deposit, so lending adds money to the economy and repayment removes it.
- Reserves held at the central bank are used for payments between banks; they do not cap lending through a simple multiplier.
- What really limits money creation is whether loans are profitable and safe, capital rules, and the policy interest rate set by the central bank.
Where does most of our money come from?
Most people assume the central bank prints our money. It does print banknotes, but they are a small slice of the total. Most money today is a number in a bank account: a deposit, which is simply a bank's promise to pay you on demand.
The Bank of England estimates that commercial banks create around 80% of the money in the UK economy as electronic deposits, while banknotes and coins make up only 3%2. The rest is reserves: electronic money that banks keep in their own accounts at the central bank2. Its 2014 Quarterly Bulletin put the same point another way: deposits were 97% of the broad money in circulation, with currency the remainder1.
Figure · What money in the UK is made of
How does a bank loan create new money?
The key step is surprisingly simple. When a bank approves a loan, it does not hand over someone else's savings. It adds the amount to the borrower's account. In the words of the Bank of England's 2014 paper, whenever a bank makes a loan it creates a matching deposit at the same time, and that deposit is new money1.
Figure · Life of bank-created money
- 01Loan approvedbank checks the borrower
- 02Deposit creditednew money appears
- 03Money is spentmoves to other accounts
- 04Loan repaidthe deposit is deleted
On the bank's books, two entries appear together. The loan is an asset for the bank, because the borrower owes it money. The new deposit is a liability, because the bank owes that money to the account holder. Both sides grow by the same amount.
A bank's balance sheet before and after a 10,000 loan (illustrative numbers)
| Item | Before | After the loan | Change |
|---|---|---|---|
| Loans (asset) | 0 | 10,000 | +10,000 |
| Borrower's deposit (liability) | 0 | 10,000 | +10,000 |
| Money held by the public | unchanged | 10,000 higher | new money |
Worked example
A loan in practice
Maya borrows 10,000 to buy a used car. Her bank records a 10,000 loan and puts 10,000 in her current account. She pays a car dealer who banks elsewhere, so the deposit moves there; the money still exists. To settle the payment, Maya's bank transfers reserves to the dealer's bank through their accounts at the central bank2.
Don't banks just lend out savers' deposits?
Many textbooks describe banks as middlemen that collect savings and lend them out, or describe a money multiplier in which the central bank fixes the amount of reserves and banks lend a multiple of it. The Bank of England's 2014 paper calls both descriptions misconceptions: reserves are not a binding limit on lending, and the central bank does not fix how many reserves are available1.
Figure · Textbook story versus how it works
Textbook story
- Savers deposit first
- Bank lends out those savings
- Reserves cap total lending
Modern central bank view
- Lending creates the deposit
- Loan and deposit appear together
- Reserves settle bank-to-bank payments
The United States shows how little the old reserve ratio story now explains. The Federal Reserve announced on 15 March 2020 that it was cutting reserve requirement ratios to zero, effective 26 March 2020, which removed the requirement for all depository institutions3. Banks still need reserves to pay each other, but there is no fixed ratio to multiply.
What stops banks from creating unlimited money?
If lending creates money, why don't banks lend without end? Because every loan has to make sense for the bank, and rules and the central bank stand in the way. The Bank of England groups the limits roughly like this12:
- Profit and competition. A bank has to charge a rate that covers its costs and still wins customers from rival lenders.
- Risk. Borrowers can default, and a bank must be able to make payments to other banks when its customers spend the money2.
- Capital rules. Regulation requires banks to hold financial resources, called capital, to absorb losses if loans go bad2.
- Monetary policy. The central bank's policy rate shapes what banks pay for funds and therefore what they charge borrowers1.
- Borrowers' choices. Households and firms decide whether to borrow at all, and people who receive new money may use it to pay down their own debts.
In the US, the Federal Reserve steers its benchmark rate mainly by changing the interest it pays banks on their reserve balances, along with the rate on an overnight reverse repurchase facility5. That is why decisions about interest rates matter so much: they change how attractive it is to lend and to borrow, and so how fast bank money grows1.
What happens to the money when a loan is repaid?
It disappears. The Bank of England puts it plainly: just as a new loan creates money, repaying a loan destroys it1. When Maya makes her final car payment, the bank reduces her deposit and closes the loan. Both entries shrink together, and that money is gone from the economy.
So bank money grows when new lending outpaces repayments and shrinks when it does not. Central banks can also add money directly. Under quantitative easing, the central bank buys assets, mostly from non-bank financial firms, which raises deposits directly1.
Why does this matter for crypto and stablecoins?
A bank deposit is a private promise, but it sits inside a system of regulation, capital rules and, in many countries, deposit insurance. In the US, the FDIC covers up to $250,000 per depositor, per insured bank, for each account ownership category, and says no depositor has lost a penny of insured funds since it was founded in 19334.
Crypto assets are on the FDIC's list of products it does not insure4. A stablecoin is also a private promise to pay a dollar, but it is issued by a private company and backed by a pool of reserve assets rather than by loans. A central bank digital currency would be different again: a direct claim on the central bank itself.
Three kinds of digital money compared (a retail CBDC is still a proposal in most countries)
| Deposit | Stablecoin | CBDC | |
|---|---|---|---|
| Owed by | Your bank | The issuer | Central bank |
| Created when | Bank lends | Issuer gets funds | Central bank issues |
| Deposit insurance | Yes, to a limit | No | Not needed |
What do beginners get wrong about bank money?
Common beginner mistakes
Thinking your deposit sits in a vault
Your balance is a claim on the bank, not a pile of notes with your name on it. The bank holds loans and other assets against it.
Believing the central bank prints most money
Cash is a small share. Most money is created by commercial banks through lending2.
Treating reserves as a lending cap
Reserves are used to settle payments between banks. In the US the required reserve ratio has been zero since 20203.
Assuming every digital balance is insured
Deposit insurance covers deposits at insured banks up to set limits. It does not cover crypto assets, stocks or bonds4.
Risk warning
Check what protects your money
Before keeping savings with any app, find out whether the balance is a deposit at an insured bank, a claim on a crypto company, or something else. The protection can be very different. See our risk disclosure and our guide on how to check a regulated firm.
Frequently asked questions
Does a bank need my deposit before it can lend?
Not in the way most people imagine. The loan creates the borrower's deposit. Banks do need enough funding, capital and reserves to manage the risks and payments that follow, which is why deposits still matter to them.
Is bank-created money less real than cash?
No. You can spend a deposit just like cash, and you can usually swap it for notes on demand. The difference is who owes it: a deposit is owed by your bank, cash by the central bank.
Does money creation cause inflation?
What happens to deposits if a bank fails?
In the US, insured deposits are protected up to $250,000 per depositor, per insured bank, for each ownership category4. Amounts above the limit, and products such as crypto assets, are not covered by that insurance.
The bottom line
Banks do not just pass savings along. When they lend, they create new deposits, and that is where most everyday money comes from. Repayments destroy that money again. What keeps the system in check is profitability, risk, capital rules and the central bank's interest rate, not a fixed pool of savings. Knowing this helps you compare a bank deposit with a stablecoin or a future CBDC: each is a promise from a different kind of institution.
Sources
- Money creation in the modern economy (Quarterly Bulletin 2014 Q1) — Bank of England, 2014 Primary source
- How is money created? — Bank of England, 2019 Primary source
- Reserve Requirements — Board of Governors of the Federal Reserve System, 2020 Primary source
- Understanding Deposit Insurance — Federal Deposit Insurance Corporation (FDIC) Primary source
- Economy at a Glance: Policy Rate — Board of Governors of the Federal Reserve System Primary source
How we checked this page: every figure above links to the numbered source it came from. Spotted an error? Tell the desk — see our editorial policy.
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