Credit Creation

A bank loan does not move money from savers to borrowers. It creates a deposit and a matching asset at the same moment - and repaying the loan destroys both.

A loan creates a deposit

Banks do not lend out reserves that savers deposited. When a bank approves a loan it writes two entries: the borrower owes the bank, and the borrower's account is credited. A loan and a deposit appear together.

That is credit creation. The deposit is new money. It did not exist before the loan, and it is exactly the amount the borrower can now spend.

The T-account in prose

Picture the bank's books. On the asset side a loan of 100 appears. On the liability side a deposit of 100 appears, the borrower's balance. The two entries are one act: the bank created both, the loan as its claim and the deposit as its debt.

Repayment destroys it

When the borrower repays, the process runs backwards. The deposit is debited and the loan is written off, so both sides of the balance sheet shrink by the same amount. Money is destroyed at the same rate it was created.

This is why broad money is tied to lending. A banking system that lends more creates more deposits; one that shrinks its loan book destroys them. The money multiplier is one way to summarise that relationship, and it describes the outcome rather than controlling it. One checkable use: look for the matching loan, not just the deposit, before calling any balance new money.

Related: Broad Money · Bank Reserves · Base Money

Next: Money Multiplier