Unit 1 · Level 1 · What money is
Banks create money
Most people never learn this: when a bank gives you a loan, it doesn't hand over someone else's savings. It types a new deposit into your account, money that didn't exist a second earlier. Loans create deposits. Most of the money in the economy was born exactly this way.
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What you get asked
Put the life of a €10,000 car loan in order.
Lending creates money, repayment destroys it. The money supply breathes in and out with the credit cycle.
Where does the money for most bank loans come from?
Banks are not piggy-bank middlemen. The Bank of England spelled it out in 2014: lending creates deposits, not the other way round.
When you repay a bank loan, that deposit money is effectively ___.
Repayment reverses the creation: the deposit shrinks and the loan shrinks with it. The money vanishes from the system.
If banks can create money by lending, why can't they lend without limit?
Regulators require banks to hold capital against losses, and every loan carries default risk. Create money recklessly and the bank itself goes bust.
If everyone repaid all their bank loans at once, the money supply would…
Since loans created most deposits, mass repayment would destroy most money. A debt-free economy sounds virtuous, but it would be nearly cashless. 🐜
The rest of this unit
Shells, paper, pixels: why money works at all, and who really creates it.