How banks
create money.
A bank creates new money on a ledger when it makes a loan, rather than moving money from another depositor's account. The Bank of England confirmed this in 2014. Follow the 5-step mechanism and compare it with Bitcoin's issuance schedule.
Viewpoint. Besides explaining the topic, this page makes the site’s case on money and Bitcoin. The facts are sourced; that case is the site’s view. How pages are labeled.
Banks do not lend out other people's deposits. They create new deposits when they make loans. The loan is the asset on the bank's balance sheet, the deposit is the liability, and both come into existence in the same transaction. A commercial bank normally creates a matching deposit when it makes a loan. It must still fund settlement outflows and manage capital, liquidity, profitability and credit risk. Repayment of loan principal destroys deposits; not every recession produces falling M2. The Bank of England explanation is about modern money creation, not a measured 97% share of U.S. dollars or proof that gold-era banks could not create deposit credit.[1][2]
On this page
The textbook story (and why it's wrong)
For decades, introductory economics textbooks described banking as a simple intermediary process: depositors put money in, the bank keeps a fraction in reserve, and lends the rest out. New loans were supposed to be funded by existing deposits. This is the "loanable funds" model.
It is wrong, and the major central banks have now publicly said so. The Bank of England's 2014 paper "Money creation in the modern economy" was the cleanest debunking. The Federal Reserve and ECB have made similar statements. Banks do not need a depositor to lend - they create the deposit by lending.
If you believe banks just intermediate existing money, the money supply looks fixed and inflationinflationA general increase in prices over time, meaning each dollar buys less than it did before.Full definition looks like a Fed problem. If you understand banks create money on demand, the money supply looks elastic and inflation looks like a policy choice. Most public debate operates on the wrong model.
The 5-step flow when a bank makes a loan
Walk through what happens, in order, when you take out a $300,000 mortgage. No money moves from a vault. No depositor's balance changes. The bank executes a sequence of ledger entries and new money exists.
Loans create deposits. Deposits do not create loans. Repayment destroys deposits. This is the actual mechanism, and it is now stated explicitly in central bank publications.
The Bank of England, in their own words
The Bank of England's 2014 Q1 Quarterly Bulletin contained two papers - "Money in the modern economy: an introduction" and "Money creation in the modern economy" - that walked through the same mechanism described above. The papers were unusual in that they explicitly contradicted the textbook story.
"Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money."
McLeay, Radia, Thomas - "Money creation in the modern economy." Bank of England Quarterly Bulletin 2014 Q1, p.14The same paper noted that the textbook "money multipliermoney multiplierThe textbook model of bank lending: a bank keeps a fraction of each deposit as reserves and lends the rest, so at a 10% reserve requirement $1 of reserves could support about $10 of deposits. The Fed cut reserve requirement ratios to 0% effective March 26, 2020, and the Bank of England (2014) describes the process running the other way: loans create deposits.Full definition" model - where the central bank controls reserves and that controls lending - "is not an accurate description of how money is created in reality." The Federal Reserve and the ECB have published versions of this same correction in subsequent years.
This is not a heterodox or fringe claim. The Bank of England, the Bundesbank, and multiple Federal Reserve Bank research departments have published the same mechanism in the decade since. The textbook money-multiplier story has been officially retired by its former publishers. It still appears in undergraduate textbooks.
Post-2020: reserve requirements eliminated
On March 15, 2020, the Federal Reserve Board announced that, effective March 26, 2020, reserve requirement ratios for all depository institutions would be reduced to zero percent. The announcement was framed as a pandemic-response liquidityliquidityHow quickly and easily you can convert an asset to cash without significantly affecting its price.Full definition measure. The change has not been reversed.
In practice, reserve requirements had not been the binding constraint on U.S. bank lending for years before 2020. Banks were already operating in an "ample reserves" regime where the Fed steered rates via interest on reserve balances rather than reserve scarcity. The March 2020 change made that reality explicit.
Modern bank lending has several constraints: regulatory capital, liquidity and settlement funding, funding costs, expected credit losses, profitability and creditworthy demand. Which constraint binds varies by bank and conditions; neither reserve multiplication nor capital alone explains every loan decision.[1][3]
"There is no country at present, and there never was any country before, in which the ratio of the cash reserve to the bank deposits was so small as it is now in England. So far from our being able to rely on the proportional magnitude of our cash in hand, the amount of that cash is so exceedingly small that a bystander almost trembles when he compares its minuteness with the immensity of the credit which rests upon it."
Walter Bagehot, Lombard Street, Ch. I (1873): England's reserve ratio was 11.2% then. The US reserve requirement is now 0%.Five implications most people miss
Once you understand that loans create money, several features of the modern economy stop being mysterious.
Bank credit does real work: the $300,000 deposit in the example above is also a $300,000 home purchase, and community banks, with 15% of the banking industry's loans, held 36% of its small business loans and 70% of its agricultural loans at year-end 2019 verify×DON'T TRUST, VERIFYClaim: At year-end 2019, community banks held 15% of the banking industry's total loans, 36% of its small business loans and 70% of its agricultural loans.Verify at: FDIC Community Banking Study 2020, Chapter 4 ↗ Source 4 in the list belowPages 4-1 and 4-7. Small business loans are the Call Report definition: loans under $1 million, counting both commercial and industrial loans and loans secured by nonfarm, nonresidential property. That share was 42% at year-end 2011. Community banks also held 30% of the industry's commercial real estate loans, $690 billion.. Banks have to lend profitably in a competitive market and manage the risk of each new loan, and capital rules limit how much risk they can take on: the FDIC's capital rule sets minimums of 4.5% common equity tier 1, 8% total capital and a 4% leverage ratio verify×DON'T TRUST, VERIFYClaim: Every FDIC-supervised bank must hold a common equity tier 1 capital ratio of 4.5%, a tier 1 capital ratio of 6%, a total capital ratio of 8% and a leverage ratio of 4%.Verify at: 12 CFR 324.10, eCFR ↗ · Federal Reserve, FDIC and OCC release, April 23, 2026 ↗ Source 5 in the list belowA qualifying bank under $10 billion in assets that opts into the community bank leverage ratio and keeps it above 8% is deemed to meet these minimums (12 CFR 324.12). The threshold dropped from 9% to 8% on July 1, 2026.. The Bank of England paper quoted above names 3 sets of limits on how much money banks can create: limits on the banks themselves (profit, risk and regulation), the choices of households and businesses, and monetary policy as the ultimate limit verify×DON'T TRUST, VERIFYClaim: Three main sets of constraints restrict how much money banks can create: limits on the banks themselves (lending profitably in a competitive market, managing risk, and capital and liquidity regulation), the behaviour of households and businesses, and monetary policy as the ultimate constraint.Verify at: Bank of England, Money creation in the modern economy, Quarterly Bulletin 2014 Q1 ↗ Source 1 in the list belowSection "Limits to broad money creation", PDF pages 4 and 6. The paper describes the UK system.. The three implications below are about the costs of a money supply built on debt and about who receives new money first, not about whether credit is useful.
Full version of the mainstream case, with sources: The mainstream steelman →
Note that this is the banking-system view. For how it fits with the Fed, QE and the Cantillon effect, see How Money Is Actually Made.
Credit contraction and recession: related, not identical
Repayment of bank-loan principal with deposits reduces deposits and credit together. A loan default/write-off instead initially reduces bank assets and equity; the deposit created when the loan was spent may still be elsewhere. Aggregate money also changes through other transactions, so credit losses and M2 are not interchangeable.[1]
Banks can tighten lending when capital, liquidity or expected borrower repayment deteriorates, while borrowers can reduce loan demand. Do not infer an M2 contraction in 2008 from the financial crisis; inspect the exact M2SL dates and growth calculation.[1][2]
When credit contracts, the Fed's response is to cut rates and make new borrowing cheap enough that the flow of new loans resumes. The goal is to restart the credit-creation machine. QEQuantitative Easing (QE)When a central bank creates new money electronically to buy government bonds and other assets, expanding the money supply. is a stronger version of the same impulse. Every tool the Fed deploys in a crisis is aimed at restoring private credit growth.
Why Bitcoin is the contrast
Bitcoin's issuance is non-discretionary. New bitcoin enters circulation only as a block rewardblock rewardThe brand-new Bitcoin a miner earns for adding the next batch of confirmed transactions to the public ledger. The reward is how new Bitcoin enters circulation, and it gets cut in half every four years. to miners who solve the proof-of-work puzzle. The reward halves approximately every four years (the halvingHalvingThe scheduled event, built into Bitcoin's code, that cuts the new bitcoin paid to miners per block in half. It happens every 210,000 blocks, about every four years; the April 2024 halving at block 840,000 cut it from 6.25 to 3.125 BTC, slowing the rate of new supply.Full definition) and the total supply asymptotes to 21 million coins.
No bank can extend a bitcoin-denominated loan that creates new bitcoin. A bank could lend bitcoin it already has on hand - the way a custodian might - but it cannot conjure new bitcoin into existence by booking an IOU. The asset is finite by protocol.
The supply expands and contracts based on credit demand and central bank policy. A 41 percent expansion in 25 months is possible (and happened in 2020 to 2022). There is no hard cap.
Issuance follows a published schedule. Every halving cuts new issuance in half. The 21 million cap is enforced by every full node. No vote, election, or emergency can change it.
This contrast - elastic credit money versus a hard-cap monetary asset - is the entire reason Bitcoin exists. See Stock to Flow and Monetary Premium for the deeper economics.
Where to go from here
Sources
Bracketed numbers and verify badges in the text link to these sources. Figures, rates and rules change: check each source’s date before acting on it.
- Bank of England Quarterly Bulletin 2014 Q1 ↩
- Federal Reserve Board - Money Stock Measures - H.6 - August 25, 2026 ↩
- Federal Reserve Board. "Reserve Requirements" (March 2020 elimination) - action of March 15, 2020 effective March 26, 2020 - federalreserve.gov/monetarypolicy/reservereq.htm ↩
- Federal Deposit Insurance Corporation, FDIC Community Banking Study 2020, Chapter 4 ↩
- 12 CFR 324.10, eCFR ↩
- Bank of England. McLeay, Radia, Thomas. "Money creation in the modern economy." Quarterly Bulletin 2014 Q1 - bankofengland.co.uk
- Bank of England. McLeay, Radia, Thomas. "Money in the modern economy: an introduction." Quarterly Bulletin 2014 Q1 - bankofengland.co.uk
- Federal Reserve Bank of St. Louis FRED. M2 Money Stock (M2SL) - fred.stlouisfed.org/series/M2SL
- Deutsche Bundesbank Monthly Report, April 2017. "The role of banks, non-banks and the central bank in the money creation process" - bundesbank.de
- Werner, Richard A. "Can banks individually create money out of nothing? - The theories and the empirical evidence." International Review of Financial Analysis, 2014 - sciencedirect.com
- Bitcoin whitepaper. Nakamoto, Satoshi. "Bitcoin: A Peer-to-Peer Electronic Cash System." 2008 - bitcoin.org/bitcoin.pdf
- Bagehot, Walter. Lombard Street: A Description of the Money Market. 1873. Ch. I on the fragility of fractional-reserve credit. Full text at Project Gutenberg. The 11.2% reserve ratio is from Appendix Note A.
Last updated . Not financial advice. Do your own research. Disclosures · How pages are reviewed