The short answer
When a commercial bank makes a loan, it credits the borrower's account with a new deposit. The loan and the deposit are created together on the bank's balance sheet. In that accounting sense, the bank creates money "out of thin air."[1]
But "out of thin air" can suggest that the process is unlimited, costless, or disconnected from the real economy. It is none of those things. The new deposit is matched by a loan asset, and the bank must bear the credit risk, fund the balance sheet, hold capital, and satisfy liquidity and regulatory requirements.
The balance-sheet view
| Bank assets | Bank liabilities |
|---|---|
| Loan to borrower: +$100,000 | New deposit: +$100,000 |
The bank has not taken $100,000 from another depositor. It has expanded its balance sheet. The borrower can spend the deposit, and the recipient's bank will receive reserves in settlement. The banking system as a whole obtains the reserves it needs from the central bank's operating framework.
Why the phrase is both right and misleading
It is right because the deposit did not exist before the loan. It was created by a bookkeeping entry, backed by the borrower's promise to repay.
It is misleading if it implies that banks can create money without limit. Lending is constrained by:
- The availability of creditworthy borrowers.
- The bank's capital and liquidity.
- Regulation and supervision.
- The expected return on the loan.
- The central bank's policy rate and financial conditions.
A bank that creates too many bad loans will suffer losses and may fail. The constraint is economic and institutional, not a fixed pile of reserves.[2]
What the evidence shows
Survey and empirical work on bank lending supports the "loans create deposits" view. Werner's study of individual bank lending found that banks create credit when they grant loans, rather than intermediating existing deposits.[3] The Bank of England's 2014 primer made the same point for the UK system.
The bottom line
Banks create money when they lend. That is a real power, and it has real consequences. But it is not magic, and it is not unlimited. The interesting questions are about the constraints, the incentives, and the effects on the economy.
Sources
- McLeay, Michael; Radia, Amar; Thomas, Ryland. Money creation in the modern economy. Bank of England Quarterly Bulletin. 2014. View source Accessed Nov 11, 2026.
- Jakab, Zoltán; Kumhof, Michael. Banks are not intermediaries of loanable funds — and why this matters. Bank of England Working Paper 529. 2015. View source Accessed Nov 11, 2026.
- Werner, Richard A.. Can banks individually create money out of nothing? The theories and the empirical evidence. International Review of Financial Analysis. 2014. View source Accessed Nov 11, 2026.