<p>Fantastic question! Fractional Reserve Banking is a fascinating topic :) </p>

<p>So, the bank never created the money out of thin air. To be clear, the loan money DOES come ENTIRELY from the depositor. This below example should be clear: </p>

<p>If I put <code>$100k</code> into a bank...what do I get back? I get back a checking account...I effectively get an "IOU" back from the bank. So, now the bank has <code>$100k</code> in cash, but still owes me <code>$100k</code> (i.e. its <a href="https://www.investopedia.com/terms/a/accountspayable.asp" rel="nofollow noreferrer">Account Payable</a>). It keeps <code>10%</code> in cash, because it assumes I'll never withdraw more than <code>$10k</code> in a short period of time. But now it can use the other 90% for longer-term assets, which have a higher yield. They're borrowing short &amp; lending long. </p>

<p>Thus, the bank can only lend out <code>$90k</code> to Merry...not the full $100k. It needs to keep a fraction of its payables as reserves (i.e. cash) -- hence the term "Fractional Reserve Banking." </p>

<p>Now Merry has <code>$90k</code> in cash. She could go put that into another bank - they keep 10%, and lend out the remaining $81k. Ad infinitum. </p>

<p>This is fine as long as I am fine having an IOU from the bank for my full <code>$100k</code>. If everybody in the system demanded back their FULL IOU...then the situation I described above would reverse itself &amp; contract. If I was the ONLY member at the bank, and I decided to buy a $100k Porsche...I would be calling in the loan I gave to my bank. My bank would then have to call in its loan it gave to Merry. And Merry to her bank, etc. </p>

CC BY-SA 4.0
2022-01-14T20:42:19.227Z
Comments are not for extended discussion; this conversation has been [moved to chat](https://chat.stackexchange.com/rooms/133213/discussion-on-answer-by-davis-clute-banks-are-allowed-to-print-money-out-of-thin).
1muflon1
CC BY-SA 4.0
2020-03-31T07:45:43.260Z
2020-03-31T07:45:43.260Z
David
<p>Very good question.</p>

<p>Let's break it down:</p>

<blockquote>
  <p>A bank give a Merry loan of 100,000$</p>
</blockquote>

<p>Concretely, the bank records an asset of 100,000 (the loan) and a liability of 100,000$ (the amount recorded in Merry's deposit account).</p>

<p>Note that at this point, the liability is what appears on your internet banking statements as 'money' and those liabilities to you from banks are today what is traded in exchange for goods and services. In this sense the liability is 'money',  and it is why people consider this money to have been synthesized commercially <em>ex nihilo</em>. This is essentially correct. Banks are licensed to create this money from nothing.</p>

<blockquote>
  <p>Merry buys a house with this money. </p>
</blockquote>

<p>Analyse it in detail: Merry finds a supplier, who implicitly trusts the bank, who probably has an account at another bank (though not necessarily), and agrees to accept payment in the form of a bank liability. Merry initiates a bank transfer from MerryBank to SupplierBank. MerryBank decreases its liability to Merry by 100,000, keeping only the asset, but adds a new liability to SupplierBank. SupplierBank records an asset of 100,000 (MerryBank's liability to SupplierBank) and a liability to Supplier of $100,000. </p>

<blockquote>
  <p>For a period of 1 year, Merry has paid back 10,000 to the bank. </p>
</blockquote>

<p>Yes, in 99% of cases in the form of bank transfers from other newly created debt from other banks. These become assets in the books of MerryBank (liabilities from SomeOtherBank) and the loan asset is reduced. So while MerryBank gains a 10k asset from SomeOtherBank it actually cancels 10k of loan asset, so its position has not changed - only its risk position.</p>

<blockquote>
  <p>Afterward Merry's finance condition worsen and she no longer can pay
  her debt. So in theory, if all the bank borrowers end up in the same
  situation as Merry did, the bank is going to bankrupt.</p>
</blockquote>

<p>No. The bank still has an asset of 90,000$ and will use debt collectors to take Merry's property. The bank will then cancel the 90,000 loan asset and record a property asset at market value.</p>

<blockquote>
  <p>But if the bank never had the loan money in the first place,</p>
</blockquote>

<p>Yes. Fractional reserve requirements for loans <a href="https://federalreserve.gov/monetarypolicy/reservereq.htm" rel="nofollow noreferrer">was/is often 0%</a>. Also, the asset (for example) at SupplierBank is then used <em>as reserves to issue further debt</em>. Two banks in a fractional reserve system act as feedback-loop amplifiers, so if the reserve requirement was 10%, that does not mean that the money multiplier would be 10 times, but depending on flow rates and dynamic systems calculations you can end up with hundreds of thousands times the base reserve. Incidentally, this was the keystone to the financial crisis.</p>

<blockquote>
  <p>every penny received from borrowers is a pure profit. Even if Merry returned
  only 10% of her loan, the Bank still profits 10,000 because the given
  100,000$ to Merry were not bank's money in the first place.</p>
</blockquote>

<p>No. See above. The asset position is unchanged. </p>

<blockquote>
  <p>This leads me to the question: Why do banks put interest on top of
  this fraud? And what prevents banks from putting huge amount of money
  to some people's account (for example to the Bank's CEO )? This black
  magic is not quite clear to me.</p>
</blockquote>

<p>Interest rate is primarily determined by interbank lending rates to cover reserve and capital requirements. </p>

<p>I don't know if it applies to the rest of the world, but the main source of income for banks where I live is actually transaction fees. </p>

<p>As for CEO payments, auditors. But in general CEOs reward themselves by issuing debt (bonds) to cover stock buybacks, to boost stock price, to which their bonuses are tied. Calling this kind of activity fraud is to some extent true, as outside the US a lot of this kind of thing is regulated.</p>

<p>Banks could be pure digital banks that have a employees in the hundreds. Typically they are dinosaur institutions that employ in the 10s or 100s of thousands of people. The banks use fees and interest to cover the cost of employees mainly. Incidentally, this is one reason why governments chose to assist banks in 2008. Directly and indirectly they employ a big chunk of the economy, a consequence of Western deindustrialization and financialization.</p>

CC BY-SA 4.0
2020-03-31T16:57:28.433Z
Very comprehensive explanation, kudos.
I wonder which institution follow and regulate banks balancesheets. Is this information (bank's equity) stored on some centralized system (Central bank) for example?
Hairi
CC BY-SA 4.0
2020-03-31T20:24:35.357Z
@Hairi good question, I think the short answer is nobody really. Otherwise they would not need auditor firms to do occassional risk assessment audits. Also bank core systems tend to be very old. COBOL on fragile systems in very secure places, for example
Frank
CC BY-SA 4.0
2020-03-31T07:54:53.223Z
2020-03-31T13:27:59.017Z
2020-03-31T13:27:59.017Z
Frank
<p>Today it is wide spread notion that the commercial banks cat create a money out of thin air. Simply by typing numbers on computer. Every time a bank gives a load to a borrower, the loan money do not come from other people deposits (at least not entirely but fractionally) but they are simply created out of nothing. This form of banking is called <a href="https://en.wikipedia.org/wiki/Fractional-reserve_banking" rel="nofollow noreferrer">Fractional reserve banking</a> . </p>

<p>The problem I have with this concept is the following: A bank give a Merry loan of 100,000\$. Merry buys a house with this money. For a period of 1 year, Merry has paid back 10,000$ to the bank. Afterward Merry's finance condition worsen and she no longer can pay her debt. So in theory, if all the bank borrowers end up in the same situation as Merry did, the bank is going to bankrupt.</p>

<p>But if the bank never had the load money in the first place, every penny received from borrowers is a pure profit. Even if Merry returned only 10% of her loan, the Bank still profits 10,000$ because the given 100,000\$ to Merry were not bank's money in the first place.</p>

<p>This leads me to the question: Why do banks put interest on top of this fraud? And what prevents banks from putting huge amount of money to some people's account (for example to the Bank's CEO )? This black magic is not quite clear to me.    </p>

CC BY-SA 4.0
2020-03-31T08:39:54.407Z
Hairi suggest you post this on Money and Personal Finance. This economics stack only has a few members and is ridden with ideology. The Money and Personal Finance is actually frequented by people from the finance sector who can talk to you about banking back office operations.
Frank
CC BY-SA 4.0
2020-03-31T09:34:53.073Z
Hi! Ideologue and otherwise foolish person here: seems to me interest is an unnecessary obfuscation here. If I (the bank) get 20 dollars from someone (depositors), lend you the 20 dollars, you hand it back to me, and I go tell my creditors that I am bankrupt and will not be repaying them then yes, indeed, I made some money. This is not magic, or surprising in my opinion. We probably should have written a better contact at the start that does not let me so this, or perhaps even without an explicit clause this is illegal.
Giskard
CC BY-SA 4.0
2020-03-31T12:20:55.683Z
Be advised that the US reserve requirement is 0% for all institution categories. Prior to this month banks had to have reserves of either 0, 3 or 10 % depending. However even then independent banks managed their own reserve requirement by product category (eg 0% for mortgages or commercial loans) https://www.federalreserve.gov/monetarypolicy/reservereq.htm @Giskard - your scenario cannot apply because no deposit is ever transferred.
Frank
CC BY-SA 4.0
2020-03-31T20:30:19.197Z
Why was this question closed? Just because it is duplicated, why close it?
Frank
<banking><debt>
Banks are allowed to print money out of thin air. Black magic or what?
Hairi
# Banks are allowed to print money out of thin air. Black magic or what?

(Asked by: username_0 on 2020-03-31)

Today it is wide spread notion that the commercial banks cat create a money out of thin air. Simply by typing numbers on computer. Every time a bank gives a load to a borrower, the loan money do not come from other people deposits (at least not entirely but fractionally) but they are simply created out of nothing. This form of banking is called [Fractional reserve banking](https://en.wikipedia.org/wiki/Fractional-reserve_banking) .

The problem I have with this concept is the following: A bank give a Merry loan of 100,000\$. Merry buys a house with this money. For a period of 1 year, Merry has paid back 10,000$ to the bank. Afterward Merry's finance condition worsen and she no longer can pay her debt. So in theory, if all the bank borrowers end up in the same situation as Merry did, the bank is going to bankrupt.

But if the bank never had the load money in the first place, every penny received from borrowers is a pure profit. Even if Merry returned only 10% of her loan, the Bank still profits 10,000$ because the given 100,000\$ to Merry were not bank's money in the first place.

This leads me to the question: Why do banks put interest on top of this fraud? And what prevents banks from putting huge amount of money to some people's account (for example to the Bank's CEO )? This black magic is not quite clear to me.

**Tags:** banking, debt

> **Comments:**
> **username_1**: username_0 suggest you post this on Money and Personal Finance. This economics stack only has a few members and is ridden with ideology. The Money and Personal Finance is actually frequented by people from the finance sector who can talk to you about banking back office operations.  
> **username_2**: Hi! Ideologue and otherwise foolish person here: seems to me interest is an unnecessary obfuscation here. If I (the bank) get 20 dollars from someone (depositors), lend you the 20 dollars, you hand it back to me, and I go tell my creditors that I am bankrupt and will not be repaying them then yes, indeed, I made some money. This is not magic, or surprising in my opinion. We probably should have written a better contact at the start that does not let me so this, or perhaps even without an explicit clause this is illegal.  
> **username_1**: Be advised that the US reserve requirement is 0% for all institution categories. Prior to this month banks had to have reserves of either 0, 3 or 10 % depending. However even then independent banks managed their own reserve requirement by product category (eg 0% for mortgages or commercial loans) https://www.federalreserve.gov/monetarypolicy/reservereq.htm @username_2 - your scenario cannot apply because no deposit is ever transferred.  
> **username_1**: Why was this question closed? Just because it is duplicated, why close it?  

---

## 2 answers

### Answer by username_1 on 2020-03-31. Score: 3 | Accepted answer

Very good question.

Let's break it down:

> A bank give a Merry loan of 100,000$

Concretely, the bank records an asset of 100,000 (the loan) and a liability of 100,000$ (the amount recorded in Merry's deposit account).

Note that at this point, the liability is what appears on your internet banking statements as 'money' and those liabilities to you from banks are today what is traded in exchange for goods and services. In this sense the liability is 'money', and it is why people consider this money to have been synthesized commercially *ex nihilo*. This is essentially correct. Banks are licensed to create this money from nothing.

> Merry buys a house with this money.

Analyse it in detail: Merry finds a supplier, who implicitly trusts the bank, who probably has an account at another bank (though not necessarily), and agrees to accept payment in the form of a bank liability. Merry initiates a bank transfer from MerryBank to SupplierBank. MerryBank decreases its liability to Merry by 100,000, keeping only the asset, but adds a new liability to SupplierBank. SupplierBank records an asset of 100,000 (MerryBank's liability to SupplierBank) and a liability to Supplier of $100,000.

> For a period of 1 year, Merry has paid back 10,000 to the bank.

Yes, in 99% of cases in the form of bank transfers from other newly created debt from other banks. These become assets in the books of MerryBank (liabilities from SomeOtherBank) and the loan asset is reduced. So while MerryBank gains a 10k asset from SomeOtherBank it actually cancels 10k of loan asset, so its position has not changed - only its risk position.

> Afterward Merry's finance condition worsen and she no longer can pay
> her debt. So in theory, if all the bank borrowers end up in the same
> situation as Merry did, the bank is going to bankrupt.

No. The bank still has an asset of 90,000$ and will use debt collectors to take Merry's property. The bank will then cancel the 90,000 loan asset and record a property asset at market value.

> But if the bank never had the loan money in the first place,

Yes. Fractional reserve requirements for loans [was/is often 0%](https://federalreserve.gov/monetarypolicy/reservereq.htm). Also, the asset (for example) at SupplierBank is then used *as reserves to issue further debt*. Two banks in a fractional reserve system act as feedback-loop amplifiers, so if the reserve requirement was 10%, that does not mean that the money multiplier would be 10 times, but depending on flow rates and dynamic systems calculations you can end up with hundreds of thousands times the base reserve. Incidentally, this was the keystone to the financial crisis.

> every penny received from borrowers is a pure profit. Even if Merry returned
> only 10% of her loan, the Bank still profits 10,000 because the given
> 100,000$ to Merry were not bank's money in the first place.

No. See above. The asset position is unchanged.

> This leads me to the question: Why do banks put interest on top of
> this fraud? And what prevents banks from putting huge amount of money
> to some people's account (for example to the Bank's CEO )? This black
> magic is not quite clear to me.

Interest rate is primarily determined by interbank lending rates to cover reserve and capital requirements.

I don't know if it applies to the rest of the world, but the main source of income for banks where I live is actually transaction fees.

As for CEO payments, auditors. But in general CEOs reward themselves by issuing debt (bonds) to cover stock buybacks, to boost stock price, to which their bonuses are tied. Calling this kind of activity fraud is to some extent true, as outside the US a lot of this kind of thing is regulated.

Banks could be pure digital banks that have a employees in the hundreds. Typically they are dinosaur institutions that employ in the 10s or 100s of thousands of people. The banks use fees and interest to cover the cost of employees mainly. Incidentally, this is one reason why governments chose to assist banks in 2008. Directly and indirectly they employ a big chunk of the economy, a consequence of Western deindustrialization and financialization.

> **Comments:**
> **username_0**: Very comprehensive explanation, kudos. I wonder which institution follow and regulate banks balancesheets. Is this information (bank's equity) stored on some centralized system (Central bank) for example?  
> **username_1**: @username_0 good question, I think the short answer is nobody really. Otherwise they would not need auditor firms to do occassional risk assessment audits. Also bank core systems tend to be very old. COBOL on fragile systems in very secure places, for example  

---

### Answer by username_3 on 2020-03-31. Score: 1

Fantastic question! Fractional Reserve Banking is a fascinating topic :)

So, the bank never created the money out of thin air. To be clear, the loan money DOES come ENTIRELY from the depositor. This below example should be clear:

If I put `$100k` into a bank...what do I get back? I get back a checking account...I effectively get an "IOU" back from the bank. So, now the bank has `$100k` in cash, but still owes me `$100k` (i.e. its [Account Payable](https://www.investopedia.com/terms/a/accountspayable.asp)). It keeps `10%` in cash, because it assumes I'll never withdraw more than `$10k` in a short period of time. But now it can use the other 90% for longer-term assets, which have a higher yield. They're borrowing short & lending long.

Thus, the bank can only lend out `$90k` to Merry...not the full $100k. It needs to keep a fraction of its payables as reserves (i.e. cash) -- hence the term "Fractional Reserve Banking."

Now Merry has `$90k` in cash. She could go put that into another bank - they keep 10%, and lend out the remaining $81k. Ad infinitum.

This is fine as long as I am fine having an IOU from the bank for my full `$100k`. If everybody in the system demanded back their FULL IOU...then the situation I described above would reverse itself & contract. If I was the ONLY member at the bank, and I decided to buy a $100k Porsche...I would be calling in the loan I gave to my bank. My bank would then have to call in its loan it gave to Merry. And Merry to her bank, etc.

> **Comments:**
> **username_4**: Comments are not for extended discussion; this conversation has been [moved to chat](https://chat.stackexchange.com/rooms/133213/discussion-on-answer-by-davis-clute-banks-are-allowed-to-print-money-out-of-thin).  

---

