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Can banks create their own money?

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Banks are commonly viewed as financial institutions that accept deposits from savers and lend them out as loans to borrowers. It is believed that by offering loans at a higher interest rate than what they need to pay depositors, banks make some profit for their shareholders.

The only problem with this description of banking is that it is almost entirely untrue. “Money Creation in the Modern Economy,” a 2014 paper from the Bank of England authored by Michael McLeay, Amar Radia, and Ryland Thomas, offers some fascinating details into how the modern banking system really works.

Making loans

According to the authors, banks don’t depend on deposits from savers to make loans. At some point, banks did function as financial intermediaries that channelled real savings from savers to borrowers. Today, however, banks can make loans by simply creating fresh money out of nowhere in their books.

When a borrower approaches a bank for a loan today, the bank creates a deposit account for the borrower with the loan amount already credited to it. Interestingly, this loan does not come from cash in the bank’s vault but is simply electronic money that the bank created out of nothing.

That’s just one interesting aspect of modern banking. Many other misconceptions about the banking system and monetary policy are exposed further in the paper.

Modern banking

In addition, the book Where does Money Come From? by Josh Ryan Collins, Tony Greenham, and Richard Werner dives into the intricacies of how modern banking really works.

“The Truth About Banks,” a 2016 IMF paper by Michael Kumhof and Zoltan Jakab, explores what uninhibited money creation by banks means for the stability of the financial system.

A better understanding of modern banks, especially the role that central banks play in propping them up, can explain many crucial events happening today, including the present push by governments towards a cashless world.

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Printable version | May 18, 2021 5:50:52 PM | https://www.thehindu.com/opinion/op-ed/can-banks-create-their-own-money/article18619665.ece

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