How Do Banks Create Money?

First Part(credit creation)

Bank A and Bank each have 1000 customers. Each of these customers borrows £1000. Bank and Bank B credit their 2000 customer accounts with £1000 each, in total £2,000,000.

Second Part(credit transaction)

Bank  A customers spend a total of £999,990 with Bank B customers.(using electronic payment)

Bank customers spend £1,000,000 with bank customers.(using electronic payment)

Third Part

Bank and Bank settle and balance their accounts at the end of the working day.

£1,000,000 – £999,990 = £10

Bank contacts the central bank and moves £10 of bank B cash reserves to bank A cash reserves.

The two banks have created £1,999,990 of bank credit with £10 cash reserves.

If borrowers withdraw their loans in cash and spend with cash banks cannot create credit.

I hope this explains the myth of fractional reserve banking.

If not look at these diagrams.

IMG_20160429_212043

credit creation-1

IMG_20160205_191919

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3 thoughts on “How Do Banks Create Money?

  1. Nice illustration! And good to see you include the Third Part (which I would subtitle in brackets “Clearing”), because this is the sensational part: So much money created with so little money! Which, to add a few remarks, means that is it, precisely, not a Fractional Reserve phenomenon: the fraction of £10 to £1,999,900 is immaterial. You don’t even calculate it. Take Werner’s lead and see the process as Credit Creation, something quite different from Fractional Reserve Banking. “Reserves” in modern banking are fictions. My other small point is that no cash is moved in any central bank, of course – all done by bookkeeping. Or were you just being pedagogical? Keep it up. I enjoy your tweets tremendously! 🙂

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    1. Thanks for your kind words it means a lot to me. I do accept that banks create credit with out using electronic cash reserves held in the CB. I just wanted to expose the whole system. If customers of the same bank borrow money and transact between themselves no central bank intervention is needed to balance the banks books and create credit. Hopefully the more people learn the sooner it can be challenged and changed. Thanks again.

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