The Old Textbook View of Banks and Credit Creation
- Banks take deposits of money from savers and lend it to borrowers
- Banks then lend money to businesses, thus allocating funds between alternative investment projects
How Modern Commercial Banks Create Credit
- Banks create credit by extending loans to businesses and households – pure and simple!
- They do not need to attract deposits from savers to do this
- When a bank makes a loan, for example to someone taking out a mortgage to buy a house, or a business taking out a loan to finance their expansion it credits their bank account with a bank deposit of the size of the loan/mortgage.
At that moment, new money is created!
“Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy.”
(Source: Bank of England)
