<p>Repaying loans destroys deposits because matching deposit is created when loan is made so net amount of deposits increases. Paying interest does not create new deposit it just transfers a deposit from one account to another.</p>
<p>Interest is paid from a deposit account to deposit account (either whether you are borrower or lender, bank has its own deposit account). Hence amount of deposits does not change, party that earns \$10 interest has \$10 more deposits party that paid the interest has \$10 less deposits. Total amount of deposits is unchanged.</p>
<p>There also can't be a reference for something that is not happening. There are lot of good books on monetary theory and banking and none discusses interest payments themselves creating or destroying money. If you consider the absence of evidence from books like Walsh Monetary Theory and Policy or Economics Of Money Banking &amp; Financial Markets by Mishkin et all, as the evidence of absence then you can use them as a reference.</p>

CC BY-SA 4.0
2023-12-12T00:11:23.297Z
OK so let's assume I take a `$100` loan at  10% from bank A, and never withdraw the associated deposit they create (also `$100`).  Next year I pay 10% on the loan with my deposit - now I have `$90` in deposits, the loan is still `$100`, and the bank has increased it's equity through interest income on the loan.  How then does this not reduce the amount of deposits in the system?
Solaxun
CC BY-SA 4.0
2023-12-12T06:24:02.720Z
@Solaxun because of fundamental accounting equation A=L+E bank equity cannot increase without either liability decreasing or assets increasing. In case of interest payment cash assets of a bank increase. Bank also has a deposit account(s)  - account from which it pays its employees, pays for office supplies and so on. When you pay 10 dollar interest you move it from your deposit account to deposit account of a bank. If you want to confirm this go take small loan, bank will give you number for its deposit account where you make interest payments (or in case of automatic withdrawal you will see
1muflon1
CC BY-SA 4.0
2023-12-12T06:28:38.207Z
The bank account number every time your money is deducted). In accounting this is recorded as cash, but nowadays in 21st century cash on balance sheet does not mean just actual physical cash somewhere in vault but it includes money on your own business deposit account and cash equivalents. Hence what happens (eventually since there are other intermediate steps especially on the equity side) is that  when you pay 10 dollars in interest, yes you increase bank equity (iff they retain the earnings and not pay them as dividends) but you also increase bank’s account balance by 10 so value of deposit
1muflon1
CC BY-SA 4.0
2023-12-12T06:34:24.527Z
Across economy is exactly the same as it was before interest payment. In an alternative case when full revenue is payed out as divided it increases account value of owner. In any case unless something else happens paying interest is just transfer of money from one account to another.
1muflon1
CC BY-SA 4.0
2023-12-12T21:17:32.183Z
A=L+SE still holds in my example - it balances through E (specifically RE from the interest income). The bank account number you send the funds to (which assumes the funds come from a different bank, which differs from my example) is for payment processing purposes but doesn't necessarily indicate how the bank will record the funds on their books.  How certain are you that the receipt will be marked as deposits?  I think they would receive cash (if from outside the bank) - so really reserves, and then mark up equity via retained earnings to balance it out.  No new deposits created.
Solaxun
CC BY-SA 4.0
2023-12-12T21:22:24.720Z
I think the crux of our disagreement is around how the actual accounting for that interest received works from the bank's perspective.  Assuming again the money comes from outside the bank, I think the bank receives reserves as payment, but no deposit is created.  They just get more reserves and mark up retained earnings (assuming they don't pay it out).
Solaxun
CC BY-SA 4.0
2023-12-12T21:56:48.180Z
@Solaxun 1. reserves account is a separate account that banks use as a reserve, banks don't generally pay employees from reserve or receive profits on their reserve account, they can move the extra cash to the reserve account from their regular business account (in fact actually bank will have separate accounts just for employees separate account just for interest revenue and so on). 2. reserve account is tantamount for all practical purposes to deposit accounts reserves are part of money supply so amount of money stays constant you have 10 extra money as reserves and 10 less as deposits.
1muflon1
CC BY-SA 4.0
2023-12-12T21:57:57.557Z
3.No they do not mark up retained earning. They first use temporary accounts https://www.accountingcoach.com/blog/what-is-a-temporary-account to record revenues and expenses, retained earnings can be mark up down the line but there are at least 1 separate account movements before you get to retained earnings (from revenue account it goes to NI account or however they label it and then it may go to retained earnings or dividends). Also accounting is not on topic on this site, if you are interested in accounting details I would recommend asking about it to some accounting dedicated site,
1muflon1
CC BY-SA 4.0
2023-12-12T22:01:26.290Z
for economic purposes important fact is that paying interest does not change amount of money, some accountant can explain more details about GAAP or ISFR accounting procedures for banks, but it should boil down to pretty much what I said with possibly slightly different naming conventions
1muflon1
CC BY-SA 4.0
2023-12-12T22:11:00.123Z
"How certain are you that the receipt will be marked as deposits?" <- it does not matter what name of the account is given to it in an accounting book. It can be marked account no 678 in account book and thats it, but it will be some deposit account so its a deposit. Deposits are not deposits just because of a name if you deposit your money at bank account its still deposit even if bank decides to internally call it money balance instead of deposit, like free lunches or healthcare benefits are part of total compensation economically even if the company calls it free gifts
1muflon1
CC BY-SA 4.0
2023-12-16T22:27:37.377Z
OK I agree that they may have an operational account separate from the reserve account, but I *do* think it matters if that is considered a deposit or not for e.g. determining M2.  "Money stays constant 10 extra reserve 10 less deposit" - I disagree with this point.  Reserves would not increase system-wide, they would remain unchanged.  However deposits would go down. Assume I take a 100 loan from Bank A, and move my money to Bank B.  Now Bank A has 100 More loan, and  100 less reserve.  Bank B has 100 more deposits and reserve.  When I pay interest of 10, it goes from B back to A and ...
Solaxun
CC BY-SA 4.0
2023-12-16T22:31:30.240Z
Now B has 90 deposits/reserves, and Bank A has 10 reserves (note 10 of deposits are *not* created because the customer no longer has a claim on those reserves - they were used for interest payment).  Overall there is still 100 reserves, they just moved around.
Solaxun
CC BY-SA 4.0
2023-12-16T22:39:28.030Z
@Solaxun 1. the operational account as you call it is a deposit account by definition and considered part of M2 2. In your example its impossible to not default on loan, you have to get 10 dollars from somewhere else, if there is 10% interest and you borrow 110 you need to repay 100 + 10 extra that has to come from somewhere else and cannot be part of that movement of reserves you describe.
1muflon1
CC BY-SA 4.0
2023-12-10T12:35:43.387Z
2023-12-10T12:35:43.387Z
1muflon1
<p>You're quite correct that loans create new deposits and repaying loans destroys deposits. This is not true for the interest paid on loans.</p>
<p>Interest paid to the bank on top of the principal loan you took out is broad money already in the banking system (on its liability side). It probably was originally created by a bank loan itself somewhere else in the economy because north of 90% of all broad money is created in this way - but for the process of a specific loan repayment, it represents income to that specific bank rather than a loan redemption.</p>
<p>The bank will have an <a href="https://www.hsbc.com/-/files/hsbc/investors/hsbc-results/2022/annual/pdfs/hsbc-holdings-plc/230221-financial-statements-ara-2022.pdf" rel="nofollow noreferrer">income statement</a> which details all the sources of income and expenses for a given time period. Below is HSBC bank's consolidated income statement for 2022.</p>
<p><a href="https://i.sstatic.net/v2UK0.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/v2UK0.png" alt="HSBC's 2022 consolidated income statement" /></a></p>
<p>The loan principals are not on here since they don't represent income to the bank. Interest income was \$55Bn in 2022 with \$22Bn of interest expense paid out to customer savings. This interest spread represented around 67% of HSBCs net operating income in 2022.</p>
<p>The bank doesn't have a deposit account in the same way customers do where they place all their income. Customer deposit accounts represent liabilities to the bank. Bank deposit reserve accounts with the central bank represent assets of the bank. Banks track and manage their operating income and expenses and reflect them in their income statement. It would be misleading to think of the process of revenue accounting as placing income (and other revenues) into an &quot;account&quot; owned by the bank since this would be seen as a financial asset of the bank. Income is not accounted for as a financial asset. It is reflected ultimately in the bank's retained earnings on the equity side of the balance sheet.</p>
<p>The bank will also have a balance sheet statement (below) detailing all their stocks of assets and all their liabilities and equity. The bank's shareholder equity is the difference between total assets and liabilities such that</p>
<p>assets = liabilities + equity</p>
<p>This is a core accounting identity.</p>
<p><a href="https://i.sstatic.net/ZdDFY.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/ZdDFY.png" alt="Consolidated 2022 balance sheet" /></a></p>
<p>Income is a flow and assets, liabilities and equity are stocks.</p>

CC BY-SA 4.0
2023-12-11T12:30:27.723Z
the banks do have accounts where people pay interest rate they don't just track it via balance sheet. Everyone who ever had to pay a mortgage knows that.
csilvia
CC BY-SA 4.0
2023-12-11T14:52:30.857Z
@csilvia I don't believe that to be correct. My point is bank's do not put interest income in a deposit account just like customers do. The interest income does not represent an increase in the bank assets. It is reflected in the equity section of the bank's balance sheet with the new "retained earnings" coming from the income statement and cash flow accounts.  A bank "account" is usually considered asset or liability which interest income is neither for the bank.
Jamie Smith
CC BY-SA 4.0
2023-12-11T15:11:35.913Z
it is correct in double entry bookkeeping every account has to have counterbalance, you can't just put something on an equity account. Also retained earnings is account that is used only at the end of the year. Bank puts cash from interest on its account which increases its assets and credits some interest revenue account (which is on equity and liability side but is neither equity or liab), eventually at the end of the year all revenue and loss accounts are netted and only then retained earnings and dividends accounts are created where net income is transferred, hence why the rev and loss
csilvia
CC BY-SA 4.0
2023-12-11T15:19:59.763Z
are not on balance sheet and are known as temporary accounts because their balance is 0 at the start and end of each accounting period. This is literally accounting 101. Every time any firm gets cash revenue it has to increase firms assets.
csilvia
CC BY-SA 4.0
2023-12-11T10:11:39.777Z
2023-12-11T15:06:19.857Z
2023-12-11T15:06:19.857Z
Jamie Smith
<p>It's pretty well understood (and documented) that when a bank loan <em>principal</em> is repaid, deposits are destroyed.  What about the effect of <em>interest</em> payments?  Intuitively, I would expect paying interest on bank loans also destroys deposits. The mechanics are somewhat different than when repaying principal - where both the loan/deposit pair decrease and the banking sector overall shrinks.  Instead what I would expect to happen when paying interest is for the banking sector to overall be unchanged from an asset perspective, but with more equity - deposits go down but reserves (and loans) stay the same.</p>
<p>Similar question for interest on deposits - wouldn't that increase the money supply? Deposits increase but reserves stay unchanged.</p>
<p>References appreciated.</p>

<monetary-policy><banking>
Repaying loan principal destroys deposits - but what about making interest payments?
Solaxun
# Repaying loan principal destroys deposits - but what about making interest payments?

(Asked by: username_0 on 2023-12-10)

It's pretty well understood (and documented) that when a bank loan *principal* is repaid, deposits are destroyed. What about the effect of *interest* payments? Intuitively, I would expect paying interest on bank loans also destroys deposits. The mechanics are somewhat different than when repaying principal - where both the loan/deposit pair decrease and the banking sector overall shrinks. Instead what I would expect to happen when paying interest is for the banking sector to overall be unchanged from an asset perspective, but with more equity - deposits go down but reserves (and loans) stay the same.

Similar question for interest on deposits - wouldn't that increase the money supply? Deposits increase but reserves stay unchanged.

References appreciated.

**Tags:** monetary-policy, banking


---

## 2 answers

### Answer by username_1 on 2023-12-10. Score: 0

Repaying loans destroys deposits because matching deposit is created when loan is made so net amount of deposits increases. Paying interest does not create new deposit it just transfers a deposit from one account to another.

Interest is paid from a deposit account to deposit account (either whether you are borrower or lender, bank has its own deposit account). Hence amount of deposits does not change, party that earns \$10 interest has \$10 more deposits party that paid the interest has \$10 less deposits. Total amount of deposits is unchanged.

There also can't be a reference for something that is not happening. There are lot of good books on monetary theory and banking and none discusses interest payments themselves creating or destroying money. If you consider the absence of evidence from books like Walsh Monetary Theory and Policy or Economics Of Money Banking & Financial Markets by Mishkin et all, as the evidence of absence then you can use them as a reference.

> **Comments:**
> **username_0**: OK so let's assume I take a `$100` loan at  10% from bank A, and never withdraw the associated deposit they create (also `$100`).  Next year I pay 10% on the loan with my deposit - now I have `$90` in deposits, the loan is still `$100`, and the bank has increased it's equity through interest income on the loan.  How then does this not reduce the amount of deposits in the system?  
> **username_1**: @username_0 because of fundamental accounting equation A=L+E bank equity cannot increase without either liability decreasing or assets increasing. In case of interest payment cash assets of a bank increase. Bank also has a deposit account(s)  - account from which it pays its employees, pays for office supplies and so on. When you pay 10 dollar interest you move it from your deposit account to deposit account of a bank. If you want to confirm this go take small loan, bank will give you number for its deposit account where you make interest payments (or in case of automatic withdrawal you will see  
> **username_1**: The bank account number every time your money is deducted). In accounting this is recorded as cash, but nowadays in 21st century cash on balance sheet does not mean just actual physical cash somewhere in vault but it includes money on your own business deposit account and cash equivalents. Hence what happens (eventually since there are other intermediate steps especially on the equity side) is that  when you pay 10 dollars in interest, yes you increase bank equity (iff they retain the earnings and not pay them as dividends) but you also increase bank’s account balance by 10 so value of deposit  
> **username_1**: Across economy is exactly the same as it was before interest payment. In an alternative case when full revenue is payed out as divided it increases account value of owner. In any case unless something else happens paying interest is just transfer of money from one account to another.  
> **username_0**: A=L+SE still holds in my example - it balances through E (specifically RE from the interest income). The bank account number you send the funds to (which assumes the funds come from a different bank, which differs from my example) is for payment processing purposes but doesn't necessarily indicate how the bank will record the funds on their books.  How certain are you that the receipt will be marked as deposits?  I think they would receive cash (if from outside the bank) - so really reserves, and then mark up equity via retained earnings to balance it out.  No new deposits created.  
> **username_0**: I think the crux of our disagreement is around how the actual accounting for that interest received works from the bank's perspective.  Assuming again the money comes from outside the bank, I think the bank receives reserves as payment, but no deposit is created.  They just get more reserves and mark up retained earnings (assuming they don't pay it out).  
> **username_1**: @username_0 1. reserves account is a separate account that banks use as a reserve, banks don't generally pay employees from reserve or receive profits on their reserve account, they can move the extra cash to the reserve account from their regular business account (in fact actually bank will have separate accounts just for employees separate account just for interest revenue and so on). 2. reserve account is tantamount for all practical purposes to deposit accounts reserves are part of money supply so amount of money stays constant you have 10 extra money as reserves and 10 less as deposits.  
> **username_1**: 3.No they do not mark up retained earning. They first use temporary accounts https://www.accountingcoach.com/blog/what-is-a-temporary-account to record revenues and expenses, retained earnings can be mark up down the line but there are at least 1 separate account movements before you get to retained earnings (from revenue account it goes to NI account or however they label it and then it may go to retained earnings or dividends). Also accounting is not on topic on this site, if you are interested in accounting details I would recommend asking about it to some accounting dedicated site,  
> **username_1**: for economic purposes important fact is that paying interest does not change amount of money, some accountant can explain more details about GAAP or ISFR accounting procedures for banks, but it should boil down to pretty much what I said with possibly slightly different naming conventions  
> **username_1**: "How certain are you that the receipt will be marked as deposits?" <- it does not matter what name of the account is given to it in an accounting book. It can be marked account no 678 in account book and thats it, but it will be some deposit account so its a deposit. Deposits are not deposits just because of a name if you deposit your money at bank account its still deposit even if bank decides to internally call it money balance instead of deposit, like free lunches or healthcare benefits are part of total compensation economically even if the company calls it free gifts  
> **username_0**: OK I agree that they may have an operational account separate from the reserve account, but I *do* think it matters if that is considered a deposit or not for e.g. determining M2.  "Money stays constant 10 extra reserve 10 less deposit" - I disagree with this point.  Reserves would not increase system-wide, they would remain unchanged.  However deposits would go down. Assume I take a 100 loan from Bank A, and move my money to Bank B.  Now Bank A has 100 More loan, and  100 less reserve.  Bank B has 100 more deposits and reserve.  When I pay interest of 10, it goes from B back to A and ...  
> **username_0**: Now B has 90 deposits/reserves, and Bank A has 10 reserves (note 10 of deposits are *not* created because the customer no longer has a claim on those reserves - they were used for interest payment).  Overall there is still 100 reserves, they just moved around.  
> **username_1**: @username_0 1. the operational account as you call it is a deposit account by definition and considered part of M2 2. In your example its impossible to not default on loan, you have to get 10 dollars from somewhere else, if there is 10% interest and you borrow 110 you need to repay 100 + 10 extra that has to come from somewhere else and cannot be part of that movement of reserves you describe.  

---

### Answer by username_2 on 2023-12-11. Score: -3

You're quite correct that loans create new deposits and repaying loans destroys deposits. This is not true for the interest paid on loans.

Interest paid to the bank on top of the principal loan you took out is broad money already in the banking system (on its liability side). It probably was originally created by a bank loan itself somewhere else in the economy because north of 90% of all broad money is created in this way - but for the process of a specific loan repayment, it represents income to that specific bank rather than a loan redemption.

The bank will have an [income statement](https://www.hsbc.com/-/files/hsbc/investors/hsbc-results/2022/annual/pdfs/hsbc-holdings-plc/230221-financial-statements-ara-2022.pdf) which details all the sources of income and expenses for a given time period. Below is HSBC bank's consolidated income statement for 2022.

[![HSBC's 2022 consolidated income statement](https://i.sstatic.net/v2UK0.png)](https://i.sstatic.net/v2UK0.png)

The loan principals are not on here since they don't represent income to the bank. Interest income was \$55Bn in 2022 with \$22Bn of interest expense paid out to customer savings. This interest spread represented around 67% of HSBCs net operating income in 2022.

The bank doesn't have a deposit account in the same way customers do where they place all their income. Customer deposit accounts represent liabilities to the bank. Bank deposit reserve accounts with the central bank represent assets of the bank. Banks track and manage their operating income and expenses and reflect them in their income statement. It would be misleading to think of the process of revenue accounting as placing income (and other revenues) into an "account" owned by the bank since this would be seen as a financial asset of the bank. Income is not accounted for as a financial asset. It is reflected ultimately in the bank's retained earnings on the equity side of the balance sheet.

The bank will also have a balance sheet statement (below) detailing all their stocks of assets and all their liabilities and equity. The bank's shareholder equity is the difference between total assets and liabilities such that

assets = liabilities + equity

This is a core accounting identity.

[![Consolidated 2022 balance sheet](https://i.sstatic.net/ZdDFY.png)](https://i.sstatic.net/ZdDFY.png)

Income is a flow and assets, liabilities and equity are stocks.

> **Comments:**
> **username_3**: the banks do have accounts where people pay interest rate they don't just track it via balance sheet. Everyone who ever had to pay a mortgage knows that.  
> **username_2**: @username_3 I don't believe that to be correct. My point is bank's do not put interest income in a deposit account just like customers do. The interest income does not represent an increase in the bank assets. It is reflected in the equity section of the bank's balance sheet with the new "retained earnings" coming from the income statement and cash flow accounts.  A bank "account" is usually considered asset or liability which interest income is neither for the bank.  
> **username_3**: it is correct in double entry bookkeeping every account has to have counterbalance, you can't just put something on an equity account. Also retained earnings is account that is used only at the end of the year. Bank puts cash from interest on its account which increases its assets and credits some interest revenue account (which is on equity and liability side but is neither equity or liab), eventually at the end of the year all revenue and loss accounts are netted and only then retained earnings and dividends accounts are created where net income is transferred, hence why the rev and loss  
> **username_3**: are not on balance sheet and are known as temporary accounts because their balance is 0 at the start and end of each accounting period. This is literally accounting 101. Every time any firm gets cash revenue it has to increase firms assets.  

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