How Commercial Banks Create Money

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4. Creating commercial  bank money

Now lets look at how ‘commercial’ or high-street banks create the type of money that appears in your bank account.

Loans 

A customer, who we shall call Robert, walks into RBS and asks to borrow £10,000 to buy a new car. Robert signs a contract with the back confirming that he will repay £10,000 over a period of five years, plus interest. This legally enforceable contract represents a future income stream for the bank, and when the bank comes to draw up its balance sheet it will be included as an additional asset worth £10,000:

Robert, having committed to pay the bank £10,000, wants to receive his ‘loan’. So RBS opens up an account for him, and types in £10,000. This is recorded as a liability on RBS’s balance sheet as so:

Notice that no money was transferred or taken from any other account, the bank simply updated a computer database. A bank does not ‘lend money’ – to lend one must have money to lend in the first place. In reality a bank creates money – when it advances loans.

Buying Assets 

Banks also create money when they buy assets, be they real or financial. For example, say Barclays Bank wished to buy a £100 government bond from a pension fund. Initially Barclays balance sheet appears as so:

In order to buy a bond Barclays creates an account for the pension fund, and adds £100 to the balance. In exchange the bank receives a government bond worth £100. Because Barclays owns this asset it can be placed on its balance sheet of the bank:


For more details see:WDMCF2

Where Does Money Come From?

A guide to the UK Monetary and Banking System

Written By: Josh Ryan-Collins, Tony Greenham, Richard Werner & Andrew Jackson

 

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  • Ante Zivkovic

    Could you please elaborate on the bank buying assets part, please.

    Since home country debt carries 0% risk weight (Basel accords), does this mean the bank is not capital constrained from buying government bonds and what is the real constraint here?

    • Best_Reviews

      None. The bank can buy the whole country and just type a bunch of 0’s and now it owns it. And then buy the world. And on paper it will own the world. They are selling parts of the moon for years now. Lot of people made fortunes already.

      • Ante Zivkovic

        You can’t buy any entity by buying the debt it issues, left alone “buy the whole country”.

  • Daniele Angriman

    Question. Why do banks pay interest to us if they do not need our money to make loans?
    Please it’s important for me, thanks

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