Banking For Dummies: Understanding How They Create Money

Have you ever asked yourself how do banks make money? If so, then you are not alone. Moreover, no, it is not as hard to understand as you think.

This article will take care of explaining you everything about this, so you can understand how they do so. This is banking for dummies, so I hope you enjoy it!

An Overview:

Did you know that banks create the majority of circulating money in our economies? Most people do not have a clue about this, but it is the reality. The money we see and have is created by banks, period.

However, how do they do it? In simple words: they create it whenever they make loans. According to statistics, banks create 97% of money, while the government simply makes a very small 3%. Surprising, right?

Overall, from this brief overview, you can take the following conclusions: banks are the principal moneymakers, the government is a minor player in this territory and loans are the ‘engine’ that makes this process possible.

How Does It Work?

Now, when we talk about money that banks create we are not talking about paper money, of course not, we are talking about numbers. The money they create come in the form of electronic deposit money.

When they make loans, banks are capable of using their accounting system to create money. To make you understand it better: these numbers are considered a liability. Your bank can give it to you, and the nice part here is that you can spend it with your debit card or online.

By giving you the chance to use those liabilities in a real economy, they create the perfect substitute for paper money. That is how banks operate, and as you can see it is not that hard to understand.

Therefore, the more loans a bank brings, the more money they create. Therefore, it is accurate to say that our economies are loan-fueled, because whenever someone takes them new money is created.

When you request a loan, you do not obtain the money directly, but instead the bank credits it to your bank account. This process creates new money.

As you can see there are no hard processes to nail nor complex terms to understand. Anyone can understand that most of the money created in the modern monetary system comes from loans created by banks.

Is it accurate to say that private banks create money out of thing? In essence, that is exactly what they do.

What Are The Consequences?

This method of creating money has negative consequences for our economies. For starters, they increase the amount of money, but is that any bad? Many people do not nail it, but with these practical examples, you will understand why it is bad:

  1. It pushes up the price of houses
  2. It causes inflation

These two points alone are more than enough to understand why this has consequences, and why we should start paying more attention to this issue.

In the case of US, government manages money through Central Banks, which can be independent of the state. Overall, the issue here is how banks create this big problem, by essentially creating new money out of nothing.

Moreover, this process of lending money, which is created out of nothing, creates debt. This is very bad for economies, because once the debt grows excessively much, that is when a financial crisis is prone to happen.

Bottom Line:

Now you have a clear idea on how banks create money, and the problems that such action brings to our economies. Yet, it is still a long way until people react to this reality and accept that we all are being fooled with this money-making process that is fueled by loans.


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