The money creation paradox
To understand the significance of the Swiss referendum on monetary reform, it helps to understand how the global banking system actually works. In the report below, first published in 2014, we challenge the misconception that commercial banks can create “free” money without restraint and explain how central banks already have ultimate control
Executive summary
Banks create money out of nothing, but an individual bank doesn’t. This is the money creation paradox, and it helps to explain many common misunderstandings about money and monetary policy.
While it is true that bank deposits, which these days dominate the money supply, are created in the process of banks making loans, it is not true that they can be created without restraint.
The key is to recognise that an individual bank, when it makes a loan, doesn’t usually retain the associated bank deposit. The borrower typically uses the loan to buy something from someone else, who will deposit the proceeds in their bank, which typically will be another bank. The lending bank, therefore, has to ensure that it can fund the loan.
So while banks as a whole create money ‘out of nothing’ by making loans which result in the corresponding deposits which contribute to the supply of money, every individual bank still has to compete to secure the deposits that are backing their loans, or else borrow the money, raise capital or sell other assets. At the same time, they also have to reconcile their profit goals with prudent levels of risk, capital and liquidity.
"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.
This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.
The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.
Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.
ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).