Bank Reserve Deposits – How Money is ‘Really’ Created. More than 97% of all the money in the economy exists as bank deposits – and banks create these deposits simply by making loans. Every time someone takes out a loan, new money is created.
Even among bankers, economists, and policymakers, there is no common understanding of how new money is created. This is a problem because attempts at banking reform are more likely to fail.
We define money as anything widely accepted as payment, particularly by the government as payment of tax. The UK’s national currency exists in three main forms, the second two of which exist in electronic form: cash and commercial bank money.
There are several conflicting ways of describing what banks do, but the simplest version is that banks take money from savers and lend it out to borrowers.
More sophisticated versions of fractional reserve banking recognise that banks can lend out many times more than the amount of cash and reserves they hold at the Bank of England.
Banks create new money whenever they extend credit, buy existing assets or make payments on their own account, and their ability to do this is only very weakly linked to the amount of reserves they hold at the central bank.
The power of commercial banks to create new money has many important implications for economic prosperity and financial stability. Capital adequacy requirements are ineffective in preventing credit booms and their associated asset price bubbles, credit is rationed by banks, and fiscal policy does not directly affect money creation.
The basic analysis of Where Does Money Come From? is neither radical nor new, but many naturally resist the notion that private banks can really create money.
Out of the all the money in the UK, only 3% is in actual physical money reserve. The other 97% owned by the banking system is money from debts and loans the banks control in digital transactions daily, the vast amount through the digital central bank reserves. Local money initiatives are now being explored where money is spent within local areas, an example of this is the “Brixton Pound”