Loans Create Deposits: How Banks Create Money, and Why They Still Compete for Your Deposits

The balance-sheet mechanics here have not changed in decades. The US banking figures are dated September 2026 and carry their own as-of dates.

The version of banking most people learn goes like this: savers put money in the bank, the bank keeps a slice in the vault, and it lends the rest to borrowers. The bank is a middleman moving existing dollars from people who have them to people who want them.

The Bank of England described what actually happens in a 2014 bulletin: “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”¹ The Bundesbank, the Bank for International Settlements and Federal Reserve teaching materials describe the same mechanism. In the UK, bank deposits make up 97% of the money in circulation, per the same bulletin. The US mix is similar: in August 2026, currency was about $2.4 trillion of a $23.3 trillion M2 money supply, and most of the rest was bank deposits.¹¹

The idea gets distorted online in the other direction. “Banks create money out of thin air” turns into “banks don’t need deposits,” which is false, and Silicon Valley Bank’s failure in March 2023 showed how false. Both facts hold at once. A bank does not need your deposit before it can make a loan. It very much needs funding after it makes one. Deposits fund banks as a whole; they do not fund individual loans one for one.

What happens on the books when a bank makes a loan

Suppose First Bank approves a $500,000 mortgage. Nobody’s savings get taken out of a vault. The bank makes two entries at the same moment:

The borrower’s checking account now shows $500,000 that did not exist as anyone’s deposit a minute earlier. That is new money. It is not new wealth: the borrower gained $500,000 of cash and $500,000 of debt, and the bank gained a $500,000 claim on the borrower and a $500,000 obligation to pay out on demand. Neither side is richer. The loan also did not create a house, lumber or labor. It created a claim that can be spent on them.

The Bundesbank put it directly in 2017: “a bank can grant loans without any prior inflows of customer deposits.”² The BIS said the same in its 2023 Annual Economic Report, noting that because borrowers hold deposit accounts, banks can “create deposits when making a loan.”³

What happens when the borrower spends the money

The borrower buys a house from a seller who banks at Second Bank. First Bank removes $500,000 from the buyer’s account, Second Bank adds $500,000 to the seller’s, and the two banks settle the payment by moving $500,000 of reserves, which are the balances banks hold in their own accounts at the central bank.

Across the banking system, the $500,000 deposit still exists; it moved banks. First Bank, though, still holds the loan and no longer holds the deposit that came with it. It has given up $500,000 of reserves and has to replace that funding. The Bank of England uses this same house-purchase example and says the lending bank would, if this went on, run down its reserves, so it tries to attract or keep deposits and other funding.¹

The sequence runs in this order:

1. The bank makes a loan, which creates a deposit.
2. The borrower spends it, and the deposit usually moves banks.
3. The banks settle the payment in central bank reserves.
4. The lending bank replaces what it lost with deposits, borrowing or asset sales.

The textbook story runs the other way: a saver deposits money, then the bank lends it out. The accounting shows the loan comes first.

Why banks still compete for deposits

If lending creates deposits, why do banks advertise savings rates and pay signing bonuses for checking accounts? Because deposits are usually the cheapest and most stable funding a bank can get, and every dollar that leaves for another bank takes reserves with it.

Deposits are the largest source of funding for US banks. On the Federal Reserve’s H.8 release for the week of September 16, 2026, commercial banks held $19.57 trillion of deposits against $23.32 trillion of total liabilities, about 84%.⁴ Checking and savings balances pay well under market rates, which is where much of a traditional bank’s profit comes from.

When those deposits leave, the replacements cost more. A February 2026 Federal Reserve staff note on bank resilience found that after SVB’s collapse, “a subset of banks experienced growing deposit outflows and were forced to replace those deposits with costlier wholesale funding sources.”⁵

The best-known research on this is Drechsler, Savov and Schnabl’s “The Deposits Channel of Monetary Policy” (Quarterly Journal of Economics, 2017).⁶ They find that when the Fed raises rates, banks with local market power raise deposit rates slowly, depositors move money elsewhere, and bank lending falls. In the working-paper version, a 100 basis point rise in the fed funds rate widened the gap between market rates and deposit rates by 61 basis points on average, and the authors estimate that a typical 400 basis point hiking cycle cuts large-bank deposits by about 14% and lending by about 9.5%, relative to leaving rates unchanged. The lending cut follows the deposit loss, even though no individual loan was ever made “from” a particular deposit.

The kind of depositor matters too. A 2025 New York Fed staff report found that banks funded mainly by retail depositors have cheaper, steadier funding and make lower-rate, longer-maturity loans than banks funded mainly by financial institutions.⁷

What limits how much a bank can lend

If a bank can create a deposit by typing, what stops it from lending a trillion dollars? Several things, and reserves are the least of them.

• Profit. Each loan has to earn more than it costs to fund, service and lose on defaults. Lending more means cutting rates or taking worse borrowers, and at some point the next loan loses money. The Bank of England lists competition for profitable lending as the first constraint.¹
• Capital. A loan adds an asset and a liability but no equity. Basel rules require banks to hold capital against risk-weighted assets, so every new loan uses up capital the bank has to have or raise.⁸
• Liquidity. Large banks must hold enough high-quality liquid assets to cover 30 days of stressed outflows under the liquidity coverage ratio.⁹
• Borrowers. A bank cannot book a mortgage nobody wants at the rate offered, or one it expects not to be repaid.
• Monetary policy. The Bank of England calls it “the ultimate limit on money creation.” The central bank sets the price of short-term money, which feeds into what banks pay for funding and what borrowers will pay for loans.¹

James Tobin made the same point in 1963. He agreed banks create money when they lend, but wrote that “there is at any moment a natural economic limit to the scale of the commercial banking industry.” His image for the fantasy of unlimited lending was the widow’s cruse, the biblical jar of oil that never runs out: “Neither individually nor collectively do commercial banks possess a ‘widow’s cruse.’”¹⁰

The money multiplier doesn’t describe US banking

Many textbooks still teach the money multiplier: the Fed supplies $100 of reserves, the bank keeps 10% and lends $90, that $90 gets deposited and 90% of it is lent again, and the process ends with $1,000 of money. Money supply equals reserves divided by the reserve ratio.

Two facts from the past two decades show it doesn’t hold:

• Reserves exploded and money didn’t follow. Total bank reserves went from $45.8 billion in August 2008 to $2.84 trillion in August 2014, about 62 times larger, as the Fed bought bonds. M2, the broad money measure, grew 47% over the same period, from $7.81 trillion to $11.48 trillion.¹¹ Fed economists Carpenter and Demiralp concluded in 2012 that the multiplier and the reserve-driven bank lending channel do not describe how policy works.¹²
• The reserve ratio is zero. The Fed cut reserve requirements to 0% effective March 26, 2020.¹³ Divide by zero and the multiplier is undefined, yet banks kept lending. A 2021 St. Louis Fed teaching piece titled “R.I.P. Money Multiplier” calls it “an outdated concept.”¹⁴

Banks decide whether a loan pays, make it, and then manage reserves and funding for the balance sheet that results. Reserves still matter for settling payments; they just don’t determine how much banks lend.

Repaying a loan destroys money

The process also runs in reverse. If you pay $10,000 of mortgage principal from your checking account, the bank cuts your loan by $10,000 and your deposit by $10,000. That money no longer exists. “Just as taking out a new loan creates money, the repayment of bank loans destroys money,” in the Bank of England’s words.¹ The bulletin names lending and repayment as the main ways bank money is created and destroyed; banks buying securities from the public, or selling them, also adds or removes deposits.

An old idea: Eccles, Tobin and the central banks

This gets presented online as a secret or as a discovery by one school of economists. It is neither. Testifying on the Banking Act in March 1935, Fed Chairman Marriner Eccles told Congress: “Money is created by debt. Our banking system creates money… the process of loaning money, extending credit, increases bank deposits.” His written summary for the same hearings gave the arithmetic: “A bank making a loan of a thousand dollars to a customer creates a thousand dollars of deposits.”¹⁵ In 1935 that loan also raised the bank’s required reserves by about $100. Today it raises them by nothing.

Tobin’s 1963 paper opens by granting that “a long line of financial heretics have been right in speaking of ‘fountain pen money,’” meaning deposits a banker creates with a pen stroke, and then spends most of its length on the limits covered above.¹⁰ Post-Keynesian economists later built a theory of “endogenous money” on the idea that lending drives the money supply. After 2008, the central banks themselves started saying it plainly: the Bank of England in 2014, the Bundesbank in 2017, the BIS in 2023.

The disagreement was mostly with introductory textbooks, which blended two separate things banks do: creating money when they lend, and moving savings between people. Modern banks do both.

The case for calling banks intermediaries

The strongest objections come from economists who accept the accounting but think “loans create deposits” is misleading about economics.

• Deposits have to be held willingly. Paul Krugman argued in a 2012 exchange that the deposits a bank creates are only useful if the public chooses to hold them at the going interest rate, which makes banks one channel among many linking lenders and borrowers.¹⁶ George Selgin’s 2024 Cato working paper “Banks Are Intermediaries of Loanable Funds” develops this at length: because a lending bank loses deposits and reserves when borrowers spend, it can only keep lending if it attracts funding, which is what an intermediary does.¹⁷ The economist Nick Rowe answered the question “loans create deposits, or deposits create loans?” with “Yes. Neither.”
• Real resources still come from somewhere. A bank can create purchasing power. It cannot create the steel, labor or housing that purchasing power buys. BIS economists Claudio Borio and Piti Disyatat separate the two ideas: “Saving, as defined in the national accounts, is simply income (output) not consumed; financing, a cash-flow concept, is access to purchasing power… Investment… require[s] financing, not saving.”¹⁸ Saving still equals investment in the national accounts after the fact. What does not follow is that one person has to save $100 first before a bank can finance someone else’s $100 purchase.

The two sides disagree less than the arguments suggest. The Bank of England accepts that price, profit and policy limit lending, and Selgin accepts that a loan creates a deposit when it is made. The choice of model still matters. Bank of England staff economists Zoltan Jakab and Michael Kumhof built models of both kinds and found that banks which lend by creating deposits change lending faster and by more after a shock than banks that only pass on savings, which fits how volatile real bank balance sheets are.¹⁹ Those are simulations in staff working papers, not official Bank of England views.

Evidence from inside a bank and from history

The accounting can be checked directly, and one economist did. In August 2013, Richard Werner took out a €200,000 loan from Raiffeisenbank Wildenberg, a small cooperative bank in Bavaria, and watched its books while the loan was made. The funds reached his account without anyone checking reserves or moving money from other customers. He published the result in 2014 under the title “Can banks individually create money out of nothing?”²⁰ It is one bank on one day, and Werner noted that other same-day transactions made the balance sheet harder to read, but it matches what every central bank describes.

History shows why the limits matter. Moritz Schularick and Alan Taylor assembled data on 14 countries from 1870 to 2008 and found that rapid growth in bank credit was a strong predictor of later financial crises.²¹ Drechsler, Savov and Schnabl argue in a 2026 working paper that in the 1970s, Regulation Q caps on deposit rates meant each Fed tightening pushed deposits out of banks, lending contracted, and those credit crunches helped cause stagflation.²² In both cases, credit could expand far faster than the economy and then contract hard when funding dried up.

Why a bank’s IOU works as money and yours doesn’t

If a bank creates money by writing down that it owes you, why can’t you? You can write the IOU. You cannot get Costco, your landlord or the IRS to accept it as $100.

A bank deposit is a promise to pay dollars on demand, at par, and people accept it as dollars because of the machinery behind it. Banks settle with each other in central bank reserves. Deposits are insured up to $250,000 per depositor, per insured bank, per ownership category.²³ Banks operate under capital and liquidity rules, supervision, and a resolution process when they fail. A useful way to picture the hierarchy:

• The Federal Reserve creates the final settlement money: currency and reserves.
• Commercial banks create deposits that promise conversion into that money one for one.
• Everyone else creates IOUs, bonds, credit and fund shares that can be close to money but trade on the issuer’s credit.

The US tried something closer to open issuance during the free banking era before the Civil War, when state-chartered banks printed their own notes. Notes traded below face value depending on the issuer’s credit and how far away it was. Gary Gorton’s study of Philadelphia note-price lists found Indiana bank notes averaging 4% to 27% below face value depending on the year, with the worst at 75%.²⁴ A deposit at a regulated bank today trades at exactly $1 because the system is built so that you don’t have to judge each issuer.

Silicon Valley Bank: funding after the loan

SVB had no trouble creating deposits. Its problem was keeping them. At the end of 2022, about 94% of its deposits were uninsured, against 41% for its peer group of large banks.²⁵ It had put much of its deposit funding into long-dated bonds, and its held-to-maturity portfolio was worth $15.1 billion less than its cost at year-end 2022 as rates rose.²⁶

On March 9, 2023, depositors withdrew more than $40 billion, and management expected more than $100 billion more the next day, about 85% of the deposit base.²⁵ Regulators closed the bank on March 10. On March 12 the Treasury, Fed and FDIC invoked a systemic risk exception to cover all SVB depositors, and the Fed opened the Bank Term Funding Program to lend to other banks against Treasuries and agency securities valued at par.²⁷

SVB’s deposits funded a balance sheet of loans and long-dated bonds. When the funding ran, the bank could not turn those assets into reserves fast enough to pay depositors.

What this means for DIY investors

Reading bank stocks

Once deposits are seen as funding, the metrics that matter for a bank stock make sense. A base of small, insured, rarely-moved retail deposits is a valuable franchise. Watch:

• Deposit beta, the share of Fed rate increases a bank passes on to depositors. For all US banks, the cumulative beta in the 2022-2024 cycle reached 0.51 by the second quarter of 2024, per the St. Louis Fed, meaning banks passed on about half of the increase.²⁸ A low beta means cheap funding; a rising one means competition.
• Uninsured deposit share, the money most likely to leave fast. The FDIC estimated $8.69 trillion of uninsured deposits across US banks at mid-2026.²⁹
• Net interest margin, the spread between what a bank earns on assets and pays for funding: 3.32% for the industry in the second quarter of 2026, per the FDIC.²⁹
• Duration of the bond book and reliance on wholesale funding. SVB failed on both.

Reading the Fed

Quantitative easing creates reserves, and reserves are not loans. The 62-fold rise in reserves from 2008 to 2014 did not produce a matching rise in lending or broad money, because banks were never waiting on reserves to lend. Treat any forecast that turns a Fed balance-sheet number into a lending or inflation number by multiplication with suspicion. How rates affect lending and prices is covered in Does the Fed Really Set Interest Rates? and Do Higher Interest Rates Cause Inflation?

Where you keep your own cash

The deposits channel is visible in your own accounts. When the Fed raised rates in 2022, many checking and savings rates barely moved while Treasury bills and money market funds paid far more. Commercial bank deposits fell from $18.13 trillion in April 2022 to $17.23 trillion in April 2023 on the Fed’s seasonally adjusted monthly series.⁴ Money market fund assets stand at $7.94 trillion as of September 23, 2026, per the Investment Company Institute.³⁰ A bank paying you well below the T-bill rate is earning a spread on your inertia. Compare options in Where to Park Your Cash and SGOV vs. HYSA, and keep insured balances under the FDIC limit per ownership category.

Credit growth and inflation

A new bank loan adds money, but where the money goes decides what happens next. Credit can pay for a new factory, bid up house prices, refinance an older loan or sit in an account. There is no fixed ratio from bank lending to consumer prices. Fast credit growth relative to the economy does have a long record as a warning sign for banking crises, per Schularick and Taylor, which is a reason to pay attention when bank balance sheets grow quickly.

Key takeaways

• When a bank makes a loan, it creates a matching deposit. It does not hand the borrower another customer’s savings.
• The new money comes with an equal new debt, so no one is richer at the moment of lending.
• When the borrower spends, the deposit and reserves usually move to another bank, and the lender must replace that funding. Banks compete for deposits because they are the cheapest funding available.
• Profit, capital, liquidity rules, borrower demand and interest rates limit lending. The reserve ratio does not: it has been zero in the US since March 2020.
• Repaying a loan destroys the money its creation added.
• For investors: judge banks by their funding (deposit beta, uninsured share, margin, bond duration), and don’t read Fed reserve creation as a forecast of lending.

Frequently asked questions

Does my bank lend out the money I deposit?

Not directly. Your deposit is a record of what the bank owes you. When the bank makes a loan, it creates a new deposit for the borrower. Your deposit does help fund the bank as a whole, which is why the bank wants to keep it, but there is no link between your dollars and a particular borrower.

Can banks create unlimited money?

No. Each loan has to be profitable, uses up regulatory capital, and creates a deposit that will likely leave for another bank and must be refunded. Liquidity rules, borrower demand and the central bank’s interest rate also limit lending.

Is fractional reserve banking real?

Banks hold far less in reserves than they owe depositors, so in that sense yes. The textbook version, where a reserve ratio determines how much money banks can create, does not describe the US system. The reserve requirement has been 0% since March 26, 2020.

What happens to money when a loan is repaid?

The repaid principal disappears. The bank reduces both the loan asset and the borrower’s deposit by the same amount, so the money supply shrinks. Interest payments are different: they move to the bank as income and are spent or paid out from there.

Does quantitative easing cause inflation by boosting bank lending?

Not through a mechanical multiplier. QE adds reserves, and US reserves grew about 62 times from 2008 to 2014 while broad money grew 47%. QE can affect inflation through lower long-term rates, asset prices and, when the Fed buys bonds from non-banks, the deposits created in those purchases, but it does not force banks to lend.

If my bank created the money, is my deposit safe?

Deposits at FDIC-insured banks are covered up to $250,000 per depositor, per bank, per ownership category. Money above that depends on the bank’s health, which is why SVB’s uninsured depositors ran. Treasury bills and government money market funds are the usual alternatives for large balances.

Related guides

• Does the Fed Really Set Interest Rates?
• Do Higher Interest Rates Cause Inflation?
• Where to Park Your Cash
• SPAXX vs. HYSA
• Best Fidelity Core Position: SPAXX vs. FZFXX vs. FCASH vs. FDIC Sweep
• Emergency Fund Sizing: 3, 6, 12, or 24 Months?
• Should Married Couples Have Joint Accounts? (FDIC ownership categories)

Sources

1. McLeay, Radia and Thomas, “Money creation in the modern economy,” Bank of England Quarterly Bulletin, 2014 Q1. bankofengland.co.uk
2. Deutsche Bundesbank, “The role of banks, non-banks and the central bank in the money creation process,” Monthly Report, April 2017. bundesbank.de (PDF)
3. Bank for International Settlements, Annual Economic Report 2023, Chapter III, “Blueprint for the future monetary system.” bis.org (PDF)
4. Federal Reserve, H.8 Assets and Liabilities of Commercial Banks in the United States, release of September 25, 2026 (week of September 16), and monthly seasonally adjusted deposits (DPSACBM027SBOG). federalreserve.gov
5. Achugamonu, Schmidt-Eisenlohr and Seay, “Assessing Bank Resilience to a Funding Shock,” FEDS Notes, February 17, 2026. federalreserve.gov
6. Drechsler, Savov and Schnabl, “The Deposits Channel of Monetary Policy,” Quarterly Journal of Economics 132(4), 2017; magnitudes from NBER Working Paper 22152 (revised January 2017). nber.org
7. Blickle, Parlatore and Saunders, “Deposit Specialization and Lending Behavior,” Federal Reserve Bank of New York Staff Report 1175, December 2025. newyorkfed.org
8. Basel Committee on Banking Supervision, Basel III framework. bis.org
9. Basel Committee on Banking Supervision, “Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools,” January 2013. bis.org
10. James Tobin, “Commercial Banks as Creators of ‘Money,’” Cowles Foundation Discussion Paper 159, 1963. cowles.yale.edu (PDF)
11. Federal Reserve Bank of St. Louis, FRED series TOTRESNS (total reserves), M2SL (M2) and CURRSL (currency), August 2008, August 2014 and August 2026. fred.stlouisfed.org
12. Carpenter and Demiralp, “Money, reserves, and the transmission of monetary policy: Does the money multiplier exist?” Journal of Macroeconomics 34(1), 2012. federalreserve.gov
13. Federal Reserve Board, “Reserve Requirements.” federalreserve.gov
14. Ihrig, Weinbach and Wolla, “Teaching the Linkage Between Banks and the Fed: R.I.P. Money Multiplier,” Page One Economics, Federal Reserve Bank of St. Louis, September 2021. stlouisfed.org
15. Marriner Eccles, testimony, Banking Act of 1935, hearings before the House Committee on Banking and Currency on H.R. 5357, March 1935 (hearing transcript), and his summary of statements at the March 4-20, 1935 hearings (FRASER).
16. Paul Krugman, “Banking Mysticism,” The Conscience of a Liberal, New York Times, March 27, 2012, and “Tobin-Brainard 1963,” April 1, 2012.
17. George Selgin, “Banks Are Intermediaries of Loanable Funds,” Cato Working Paper No. 80, 2024. cato.org
18. Borio and Disyatat, “Global imbalances and the financial crisis: Link or no link?” BIS Working Paper 346, May 2011. bis.org
19. Jakab and Kumhof, “Banks are not intermediaries of loanable funds, and why this matters,” Bank of England Staff Working Paper 529, 2015; and “…facts, theory and evidence,” Staff Working Paper 761, 2018 (revised 2019). bankofengland.co.uk
20. Richard A. Werner, “Can banks individually create money out of nothing? The theories and the empirical evidence,” International Review of Financial Analysis 36, 2014. sciencedirect.com
21. Schularick and Taylor, “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008,” American Economic Review 102(2), 2012. aeaweb.org
22. Drechsler, Savov and Schnabl, “Credit Crunches and the Great Stagflation,” NBER Working Paper 35057, 2026. nber.org
23. FDIC, “Understanding Deposit Insurance.” fdic.gov
24. Gary Gorton, “Pricing free bank notes,” Journal of Monetary Economics 44(1), 1999. sciencedirect.com
25. Board of Governors of the Federal Reserve System, “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank,” April 28, 2023. federalreserve.gov (PDF)
26. SVB Financial Group, Form 10-K for fiscal year 2022 (held-to-maturity securities: fair value $76.2 billion, amortized cost $91.3 billion). sec.gov
27. Federal Reserve Board press release, March 12, 2023, and joint statement by Treasury, the Federal Reserve and the FDIC, March 12, 2023. federalreserve.gov
28. Federal Reserve Bank of St. Louis, “Higher Deposit Costs Continue to Challenge Banks,” On the Economy, September 2024. stlouisfed.org
29. FDIC Quarterly Banking Profile, Second Quarter 2026. fdic.gov (PDF)
30. Investment Company Institute, Money Market Fund Assets, week ended September 23, 2026. ici.org

Author disclosure

Educational content, not investment advice. Banking figures are dated snapshots from the sources listed; verify current numbers before acting. Summitward has no affiliation with any bank or institution named here.