Banking 101 (Video Course)

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Before we discover how banks really work, and how money is created, first to clear up any confusion, we need to see what’s wrong about the way that most people think banks work.

Start Lesson (5 mins)
Banking 101

Most students and graduates get taught about something called the ‘money multiplier’. In this video we’ll show that it’s an inaccurate and outdated way of describing how the banking system works.

Start Lesson (8 mins)
3 B101

See how commercial banks can create money through the accounting process they use when they make loans, how banks make payments between each other using specially created central bank money, if the Bank of England really can control how much money is in the economy …and more.

Start Lesson (20 mins)
4 B101

What actually limits how much money the banks can create? Reserve ratios, Liquidity ratios, Capital Adequacy Ratios and/or the Basel accords? Explained in an easy to understand way.

Start Lesson (14 mins)
5 B101

You might hear some people say that “Banks don’t create money – they just create credit”. This response often comes from civil servants and people trying to deny that banks now create the nation’s entire money supply. So let us show you why the numbers that banks create are money, and not just ‘credit’.

Start Lesson (5 mins)
6 B101

Remember how new money is created when a bank makes a loan? Well, when someone repays the loan, the opposite process happens, and money is actually destroyed. It effectively disappears from the economy entirely. This video explains how.

Start Lesson (5 mins)

Stay in touch

  • Daithí

    And what if there aren’t enough Reserves for all of them. Presume there
    are 4 banks,£100 reserves,each owns £25. Since the Liquid Ratio is 0 so
    each bank went nuts and created £10’000 in credit. Let’s say the final
    result is Bank A owes £1000 to B, B owes £2000 to C, C owes £3000 to D, D
    owes £300 to A. In each case the differences are at least in hundreds
    and thousands in some. How can the £25 reserves cover the fictional
    money? Thank you. Great video by the way.

    • Simon

      The very act of creating credit, creates new money and new reserves. As long as all the banks keep in step with new lending, they can expect new deposits to flow back to them. Also they are only settling up with net amounts, so the reserve requirement is usually quite small, even if the amounts of new loans created are large.

      • GWHodgson

        No, new reserves are not created when banks create deposits. That’s why individual banks cannot create deposits willy-nilly. But as long as all banks create deposits at more or less the same rate there is no limit to how much can be created since net settlement balances hardly change.

        • Boxer

          Banks can give goverment bonds as collateral in exchange of reserves… so new reserves are created…

        • Simon

          Surely the bank’s account at the B of E increases, ie their reserves, if they receive more in deposits and debt repayments, versus loans and payments made to other banks ?

    • Ted Carron

      The banks go to the bank of England and borrow reserves which the BOE is always ready to supply in order to ‘stabilise’ financial markets.
      Which is weird really because 1st the BOE specifies a reserve requirement to control banks then it lends them the reserves they want so that banks can largely ignore those controls.

  • Daithí

    Where does the difference (their profit) between interests come from?
    Since the loan is repaid then the money is destroyed, so where does the
    money to cover the interest come from? Is it from M1? Thanks

    • GWHodgson

      All payments to banks – fees, charges, commission and borrowers’ interest – are taken by reducing customers’ deposits. All payments by banks – salaries and bonuses, suppliers’ invoices, shareholders’ dividends and depositors’ interest – are made by increasing customers’ deposits. The difference between payments to and payments by banks each year is their retained profits and constitutes a withdrawal of money from the economy, since deposits have shrunk by more than they have increased. In years when banks make losses, expenditure exceeds revenue and customers’ deposits overall increase, and therefore the money supply increases.

  • Kari Ilkkala

    Overall, the monetary system is broken, no doubt about it.

    However, the Banking 101 video, when describing how bank creates the money “out of thin air” by the means of loan agreement (asset) and deposit account (liability) gives totally misleading picture.

    The description is correct till that point, but does not explain what happens on the bank balance sheet when the customer withdraws / uses the money on his new deposit account.

    Loaned money sitting on depositors bank account has not left the bank, and this is the key detail: the bank has to have the money either as cash (in case the customer withdraws it) or eventually as central bank money on its central bank settlement account (in case customer pays someone using the funds on his deposit account). The numbers on customers deposit account becomes money only when they leave the bank.

    Let’s elaborate:

    Step 1 (as the video explains it): The bank enters the loan agreement as an receivable (asset), and credits customers deposit account with the loan principal (liability). The bank balance sheet grows accordingly.

    Step 2 (which the video omits): The customers withdraws the borrowed money. The banks liability is reduced accordingly. This is not possible without an balancing entry on the asset side of the balance sheet, too. The cash the customer withdraws from his deposit account (liability) comes from the banks cash account (asset). The banks balance sheet is subtracted.

    In other words, for the customer to be able to actually withdraw the money from the bank, the bank has to have it. The entry of the receivable as an asset did not create the money in such a way that the customer can actually withdraw it from the bank. All that happened with the new loan was the banks balance sheet got bigger.

    This is Bookkeeping 101. I would very much like to hear the PositiveMoney team explaining how this part of the basic bookkeeping matches with their Banking 101. I’m not saying the banking and monetary systems aren’t broken, all I’m saying is that what ever the agenda, stick to the facts.


    • Simon

      The videos do explain the process in terms of the customers account, and the way banks settle up between themselves at the end of the day (they have to use base money in their accounts at the Bank of England for settling up). If all the banks increase their lending together, then new money will be created, and they can expect new deposits to return to them. The money supply more than doubled in the UK between 1997 and 2007, as the commercial banks increased their lending. The money disappears when a loan is repaid, because money is taken from the economy usually to repay it. The videos show the multiplier effect to be outdated in the UK at least. Expanding lending will increase a banks balance sheet on both sides, loan repayments will reduce it. It is true that the bank will probably try to lend out loan repayments again. it is better not to get too hung up on the accounting side of things, and actually look at the growth (or not) of the money supply, which has increased by more than 100 times since 1960 in the UK. How did all that money get created ?

      • GWHodgson

        A further point is that when a bank creates a deposit it doesn’t disappear when the customer spends it. It gets taken on by another bank. It stays in the system. But the deposit does disappear when a borrower repays a loan. The overall level of deposits in the system falls. If the borrower repays the loan by depositing cash, it is true that the cash holdings of the bank increase to replace the loan paid off, but that cash had to have come from somebody else who withdrew it from their bank, reducing its holdings of cash and their deposits. So the end result is that the level of cash in the system has not changed, but the levels of loans and deposits have shrunk.

    • Boxer

      if a customer redraws his deposit and the bank A doesnt have the reserves to settle the transaction then the bank A borrows it from some other Bank B who has them… In bookkeeping, Bank A reduces the deposits and increases the loans due to Bank B… Bank B on the other side reduces its reserves and increases its assets (loan to bank A)… neither Bank A or B balance sheet total amount changed… this in terms of bookkeeping…

      As for step 2 , no reserves are needed to complete such a transaction… as you already know you credit an asset and debit a deposit to repay your loan… its irrelevant if reserves are there…

      The whole system haults when banks prefer to sit on their reserves rather than lend them… this is what happened to the greek, portugal and ireland banks… in those cases the system didnt collapse because the ECB provided the neccesary reserves… so the banks who didnt have the reserves to settle the deposit flight borrowed from ECB (with new reserve creation) instead from other banks… In that particular case the money supply didnt change… only the reserves in the ECB…

  • Ettore

    Please Is there anybody going to explain to me how these explanation is possible matching with the MEMMT theory

    Thank you


    • GWHodgson

      In brief, the monetary aspects of Mosler’s MMT differ from this explanation in their treatment of the central bank, which they regard as being an internal part of government. So for them, government spends by issuing reserves to banks who credit the intended recipients’ deposits. And government withdraws reserves from banks by requiring taxpayers to surrender some of their deposits which the banks match by surrendering reserves to government. In other words, for them the role of taxation is to control the money supply, not to finance government. The explanation of the processes in these videos does not contradict the MMT interpretation but it is also consistent with banking reality that government has a stock of reserves at the central bank from which it makes payments and to which its revenues are credited.

  • Kari Ilkkala

    I have approached the PositiveMoney team directly, challenging them to explain the obvious mistakes their presentation contains.

    While the team appears to have a good cause, their message contains critical errors. To my great disappointment, the team does not see it worth their time to respond in any way. Don’t they have the knowledge, or don’t they have the balls?

    • GWHodgson

      See responses to your post below

  • Robert

    Can Kari kindly please clear-up for me something in his illustration which doesn’t seem to me to add-up (perhaps because I haven’t fully understood his train of thought)?

    In step 2 of his description of the money-creation phase he writes “The cash the customer withdraws from his deposit account (liability) comes from the banks cash account (asset)”. So, that money leaves the bank – right?

    In step 1 of his description of the money ‘disappearance’ phase he writes: ” The customer deposits money on his/her account with the intent to settle his/her debt. When the amount on the customers account increases, so does the banks liability and the amount on banks cash account (asset). The banks balance sheet grows accordingly”. So, the same amount of money is back with the bank again – right?

    In step 2 he writes: “The customer informs the bank that he/she would like to settle the debt. The bank debits the customer deposit account, decreasing the banks liability, and credits the loan (i.e. the receivable in the assets). The banks balance sheet gets subtracted”. To me, by “crediting” the loan-repayment to “the receivables in the assets” (which were increased in step 1) Kari can only mean that receivables are reduced in this step by the same amount – ie the amount of the repayment – (because otherwise the balance-sheet would no longer balance) – right?

    He then writes: ” the cash is now in the banks cash account (asset) ready to be extended as credit to someone else”. This throws me completely! How can the cash now be in the bank’s cash account and able to be loaned to someone else when (as I understand him to be saying) it was deducted from that account in step 2? And if it’s still there (ie wasn’t deducted) then how could the balance-sheet be in balance in step 2 as he states?

    I’m not btw seeking to either defend or attack PM’s position against Kari’s critique, but to point out what seems to me (unless I’ve misunderstood him) to be a fatal flaw in that critique.

  • Kari Ilkkala


    I have now tried to answer Robert twice about the concerns he has about my money creation and destruction critique.

    When I post, I get a message that the post is waiting for moderation. Then my posting vanishes. How often does the moderators review and publish the postings? This way, any meaningful discussion appears to be impossible.

    • Mira Tekelova

      Hi Kari,

      There is no moderation for your posts – they should go live immediately. Not sure what happened, might have been some temporary problem or a problem with internet connection? As this post was published now, it seems to be working for you now. Please let us know in case there’s still some problem – Thanks!

  • LindaG

    One of the pieces of the puzzle the video series helped me to better understand is that of interbank settlement.

    I hadn’t taken into account before the fact that **before banks actually move any reserves to other banks**, they go through the automatic process of cancelling out the deposit totals that have gone out with the deposit totals that have come in (in relation to each bank), and only once the “net difference” in liabilities (deposits) has been determined, do actual transfers of reserves between banks’ accounts at the Central Bank occur (automatically).

    I had been trying to understand banking by using a model of how one account is handled (from loan/deposit creation through settlement of payment with another bank). That helped me with several steps in the banking process, and even helped me to learn about a bank’s capacity to borrow later (after loans/deposits had been created) the reserves it may need to settle payment between banks. I also developed a better understanding of what “deposit” means, which can be confusing due to other meanings of the word, “deposit” – basically, in this usage, a deposit means a bank’s liability, or promise to pay, an IOU (for whatever amount is created via the loan creation).

    But, by definition, without a model involving **multiple transfers of deposits** (in which a “cancelling out” process occurs before any reserves are transferred), I wouldn’t be able to understand the fact that the transfer of deposits themselves suffices for the bulk of final payments for the bulk of transactions occuring during a day – because it’s the “net difference/change in liabilities” that finally brings in the need for a transfer of reserves.

    In fact, due to this information, I can better understand that all transactions among deposit accounts WITHIN a bank will ALWAYS net to zero change in liabilities, so deposits are clearly sufficient in and of themselves for final payment in those cases, with absolutely no backing by reserves needed.

    So I can better understand now that that only leaves transfers of reserves between banks that need to be accounted for, and then, only the net change in liabilities for which transfers of deposits alone won’t suffice for final payment. (That also helps me to better understand that reserves are only used by banks for the purpose of the settlement of payments between themselves and/or dealings with the Central Bank – for example, purchasing/selling of Treasuries. By the same token, I can see that deposit accounts are what is used for all initial payments among banks’ customers – deposits are “our” money, while reserves are “banks’” money.)

    And banks have most of the reserves they need among their own assets for that relatively small amount of difference that requires payment settlement via reserves. And when they don’t, I can then see better how interbank borrowing (or, as a “last resort,” borrowing from the CB) comes into play, and why such borrowing is needed for just a single day (or thereabouts) at a time. That’s because a similar process happens all over again the next day (or a few hours later).
    Do I have the above about right?

    I appreciate that the site also points to how a real world occurrence can upset the stability of that daily dynamic among banks: If Banks Can Create Money, How Come Northern Rock Went Bust?

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