Lending creates deposits

You are granted a mortgage of 240,000. The bank types a number into your account. Where did the money come from?

The usual answer — from someone else's savings — is wrong in a specific and interesting way. Nobody's balance went down. The bank wrote two entries: a loan of 240,000 owed by you, and a deposit of 240,000 owed to you. Both are new. Neither existed on Monday.

The entries, drawn out

Before the loan, the bank's books have deposits on one side and loans and reserves on the other. After the loan:

Bank's assets                    Bank's liabilities
  Loan to you      +240,000        Your deposit    +240,000

That is the whole event. The two new entries are equal and opposite, so the bank is no richer for having made them — its assets and its liabilities both grew by the same amount. What it has acquired is a future income stream, and what it has taken on is a promise to honour a deposit it created out of a keystroke.

Predict

You spend the 240,000 buying a house. The seller banks at a different institution. What happens to the money?

Choose one answer

It vanishes from your bank and appears at theirs, and the two banks settle upIt is destroyed, since it was created out of nothingNothing happens — the deposit stays where it was createdThe central bank prints the money to cover the transfer

Lock in answer

What actually limits lending

Profitability. A loan has to be worth making. If borrowers who will repay cannot be found at a rate that covers funding, costs and losses, the bank stops lending, and this is what happens in most downturns.

Capital. Regulators require the bank's owners to have their own money behind each loan, in proportion to how risky the loan is. Capital is expensive and finite, and it is the binding constraint in normal times.

Reserves and settlement. As above: created deposits leave, and settling costs central bank money.

Demand. Somebody has to want to borrow. Central banks have discovered repeatedly that they can make credit cheap and available and nothing happens, because nobody wants a loan.

Something people say

“Banks lend out your deposits.”

Why it spreads

It is how banking was taught for a century, it is a reasonable description of what the bank does with your money in aggregate, and the alternative sounds like a conspiracy theory even though it is on the central banks' own websites.

The part that is true

In aggregate and over time, deposits really do fund banks. A bank whose created deposits all leave must find funding from somewhere, and that funding is largely other people's deposits. It is also true that your money is not sitting in a drawer with your name on it.

Which part of the everyday version is doing the damage?

That banks make money from lendingThe order of events — that the saving has to happen firstThat deposits are owed back to depositorsThat banks need reserves at all

Where reasonable people still disagree

The accounting above is not controversial. Central banks publish it. What is genuinely argued about is what follows from it.

Two readings

Credit is largely demand-led

Banks lend when creditworthy borrowers want to borrow, and policy works mainly by changing that demand.

Measured in

Loan volumes against measures of borrower appetite and income

For example

Cheap credit sitting unused after a crash, because nobody wants a loan at any price.

Rests on

That the supply of willing, creditworthy borrowers is what binds, and banks accommodate it.

Chase it alone and

Underrates how much lending standards themselves move, and how much of a boom is banks becoming willing rather than borrowers becoming eager.

Credit is largely supply-led

Banks' willingness to lend expands and contracts on its own, and that cycle drives asset prices and the economy with it.

Measured in

Lending standards, collateral values and credit growth ahead of income growth

For example

Property prices rising because lending criteria loosened, not because incomes rose.

Rests on

That the constraint is inside the banking system — capital, competition and confidence — rather than in borrower demand.

Chase it alone and

Underrates that a bank cannot force a loan on anyone, and that demand collapses in downturns regardless of what banks would like to do.

Both sides accept
Both accept the accounting: a new loan creates a new deposit, and repayment destroys it. Both accept that credit expands faster than income in booms. The argument is about which side of the transaction is doing the driving, and therefore which lever a policymaker should reach for.

Who pays, who benefits, who carries the risk

Who pays. The borrower, in interest, for money that did not exist before the loan. And everybody holding the currency, a little, because more claims on the same output is what inflation is made of — though the effect is far smaller and slower than the mechanism makes it sound, since repayment destroys money at roughly the rate lending creates it.

Who benefits. The borrower, who gets a house now instead of in thirty years. The bank, on the spread. And an economy that can build things before it has saved for them, which is not a small thing — it is most of what separates a developed economy from one where you must have the whole sum in advance.

Who carries the risk. The bank first, and then, when enough loans go bad at once, the deposit protection scheme, the central bank and the state behind it. This is the mechanism by which private lending decisions become public liabilities, and it is why the people who make those decisions are supervised.

Worth remembering

• When a bank lends it creates a deposit and an equal debt at the same moment; the money is new and disappears again on repayment.
• Most of the money in a modern economy was lent into existence rather than printed.
• Lending is limited by profitability, regulatory capital, settlement reserves and borrower demand — not by a pile of pre-existing savings.
• The order of events matters: if credit required prior saving, it would be limited by thrift rather than by banks' willingness to lend.
• The accounting is not disputed; whether credit cycles are driven mainly by borrower demand or by bank supply is genuinely contested.