On 25 September 2026 the European Central Bank reported that the euro area’s broad money supply, M3, had grown 3.5% in the year to August, a touch faster than July’s 3.4%. Loans to households were up 3.1% and loans to firms 4.2%. Three days earlier, the Federal Reserve had put US M2 at 23,342.8 billion dollars for August, roughly 5.7% more than a year before.
Most of that money is not printed notes but bank balances, and that is where the question of how banks create money starts. When a commercial bank grants a loan, it credits the borrower’s account with a new deposit, and that deposit is money the borrower can spend. Nobody’s savings were handed over.
Lesson five of our money and economics path comes after the lesson on inflation and purchasing power. Rules are those in force as of October 2026, and nothing here is investment advice.
Most of the money you hold is a promise from your bank
Money comes in three forms in a modern economy, and only one of them is something you can hold in your hand. Banknotes are issued by the central bank. Reserves are balances that commercial banks keep in their own accounts at the central bank; you and I cannot open one. Deposits are what you see in your banking app: a debt your bank owes you.
The first two are central bank money. The third is commercial bank money, and it is by far the largest. The European Central Bank’s own explainer puts it plainly: “Commercial bank money makes up most of the money that people actually use.” The Bank of England measured the UK split in December 2013: deposits made up 97% of broad money, currency the remaining 3%.
The euro area looks similar today. At the end of August 2026 cash was roughly 9% of broad money M3, according to the ECB data portal (seasonally adjusted, provisional); the dollar figures are in the table further down.
If you have read our lesson on what money is, you know the three jobs money does. A bank deposit does all three, which is why we treat it as money even though it is a private promise. The reason it works is that the promise is convertible: you can turn a deposit into cash at par, or send it to another bank and have it arrive as one euro for one euro. That convertibility rests on the central bank, as the lesson on fiat money and central banks explains.
The textbook story: deposit first, loan second
Many economics courses still teach a tidy sequence. A saver deposits 1,000 dollars. The bank keeps a fraction as reserves, say 10%, and lends out the other 900. The borrower spends it, the seller deposits it at another bank, which keeps 90 and lends 810, and so on. Add up the rounds and the original 1,000 has turned into as much as 10,000 of deposits. The ratio 1 divided by the reserve requirement is called the money multiplier.
That arithmetic sits behind the phrase “fractional reserve banking”, and it does describe something real: in a system with a binding reserve requirement and a central bank that strictly rations reserves, the multiplier marks a ceiling on deposits. That is why it found its way into textbooks.
The central banks that run the system say it is not how money is made today. In a 2014 Quarterly Bulletin article, “Money creation in the modern economy”, three Bank of England economists wrote that “the act of lending creates deposits”, the reverse of the textbook order. Their verdict on the multiplier was blunt: “it is not an accurate description of how money is created in reality.”
They rejected the opposite caricature too. Banks do not simply act as intermediaries passing savers’ deposits to borrowers, and they do not “multiply up” central bank money. Their key sentence on reserves: “In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available.”
The ECB’s public explainer gives the same account: “if a commercial bank grants you a loan to buy a car, they create money in this way.” Post-Keynesian economists had argued for decades that money is created inside the banking system, and the Bank of England article cites that literature. The news in 2014 was a central bank saying it in plain terms.
How banks create money with a loan: the balance sheet in four steps
What follows is an illustration, not a real bank: the names and numbers are invented and kept round so the two sides of the balance sheet are easy to follow.
In our example, Bank A starts with 1,000,000 euros of assets: 100,000 in reserves at the central bank and 900,000 of existing loans. On the other side it owes 900,000 euros of deposits to its customers and has 100,000 of equity, the shareholders’ stake. Anna asks for a 20,000 euro car loan.
- The loan is approved. Bank A adds a new asset, “loan to Anna, 20,000”, and a new liability, “deposit of Anna, 20,000”. Both sides of the balance sheet grow by 20,000. Broad money in the economy has just risen by 20,000 euros. Bank A’s reserves have not moved.
- Anna buys the car. The dealer banks at Bank B, so Anna’s deposit at Bank A falls by 20,000 and the dealer’s deposit at Bank B rises by 20,000. To settle, Bank A transfers 20,000 euros of reserves to Bank B at the central bank. Money in the economy has not changed; it has changed banks.
- Bank A refills its reserves. It can use what it holds, borrow from other banks, attract new deposits, or borrow from the central bank against collateral. Each option has a price, and that price is tied to the central bank’s policy rate. This funding cost, not a stock of savings, is what the loan really costs the bank.
- Anna repays over five years. Each repayment reduces her deposit and the loan by the same amount, and the money disappears. The interest she pays is income for the bank, which ends up in its equity if the bank makes a profit.
Step 4 is the part people forget. The Bank of England notes that just as lending creates money, repaying loans destroys it; its own example is a consumer who pays off a month of credit card spending in full, wiping out the deposits those purchases created. Broad money grows only when new lending runs ahead of repayments.
Some economists call this “fountain pen money”, created at the stroke of a banker’s pen; the Bank of England article points to James Tobin’s 1963 discussion of the term. Today it is a keystroke. The bank needs no gold, cash or someone else’s savings in a drawer to make the entry. It does need to settle the payments that follow, hold enough capital and liquidity, and earn more on the loan than it costs to fund.
What stops banks creating as much as they like
If a keystroke creates money, why don’t banks lend without end? The Bank of England article sorts the brakes into three sets: the banks’ own limits (profit, risk and regulation), the behaviour of borrowers and savers, and monetary policy.
Profit, risk and competition
A loan has to pay. Bank A loses reserves the moment Anna spends at another bank, and replaces them at a cost close to the policy rate. Cut lending rates to win business and each loan earns less; lend to weaker borrowers and more loans go bad, eating into equity. A bank that grows its lending much faster than its rivals loses reserves to them every day and must pay up to win deposits back.
Capital rules: a cushion, not a vault
The Basel III framework, published by the Basel Committee on Banking Supervision in December 2010 and finalised in December 2017, sets the minimum capital banks must hold. In the United States the Federal Reserve writes it into its capital rule, 12 CFR 217.10: a common equity tier 1 ratio of 4.5%, a tier 1 ratio of 6% and a total capital ratio of 8% of risk-weighted assets, plus a leverage ratio of 4%. The largest banks (advanced approaches and Category III firms) also face a supplementary leverage ratio of 3%. The next section of the rule, 217.11, adds a buffer of 2.5% of risk-weighted assets on top of those minimums (for the biggest banks, a stress capital buffer of at least 2.5%); a bank that dips into it faces limits on dividends and bonuses.
Two misunderstandings sit in that sentence. Capital is not cash set aside: it is the part of a bank’s funding that comes from shareholders and retained profits, which absorbs losses before depositors take any. And “risk-weighted” means a loan counts according to its risk: a well-secured mortgage counts for less than an unsecured business loan, so capital rules shape which loans banks prefer. Every new loan raises risk-weighted assets, so every new loan needs more capital behind it.
Liquidity rules
The Liquidity Coverage Ratio, published by the Basel Committee in January 2013 and fully in force since 1 January 2019, asks banks to hold enough high-quality liquid assets to survive 30 days of stressed outflows, at a minimum ratio of 100%. A second standard, the Net Stable Funding Ratio, asks them to fund long-term loans with stable money rather than overnight borrowing. Both make fast credit growth more expensive.
Borrowers and the central bank’s rate
Lending needs a borrower. Households and firms borrow when they expect the loan to pay for itself, and they repay early when they have spare cash, which destroys money. The Bank of England calls monetary policy the ultimate constraint: when the central bank raises its rate, loans cost more, fewer people want them and money growth slows. As the inflation lesson showed, central banks aim at an inflation target, and they get there by steering the price of credit, not the quantity of reserves.
Reserve requirements: 1% in the euro area, zero in the United States
The textbook multiplier rests on a reserve requirement. Euro-area banks must hold 1% of a defined reserve base, mainly customer deposits and short-term debt securities, on their accounts at their national central bank. The ratio was 2% when the euro was launched on 1 January 1999 and was cut to 1% from the maintenance period that began on 18 January 2012, according to the Deutsche Bundesbank. Each bank deducts a flat allowance of 100,000 euros. From the maintenance period that began on 20 September 2023, required reserves have earned 0% interest.
American banks face no requirement at all. The Federal Reserve announced on 15 March 2020 that it was cutting reserve requirement ratios to zero percent, effective 26 March 2020; its reserve requirements page says this “eliminated reserve requirements for all depository institutions”. Its press release tied the cut to “the shift to an ample reserves regime”, in which banks hold plenty of reserves and the interest rate, not their quantity, is the tool. On 14 October 2026 US banks held about 3.02 trillion dollars of reserve balances at the Fed, according to the H.4.1 release, without any rule obliging them to.
The Bank of England wrote in 2014 that it had no formal reserve requirements (only small non-interest-bearing cash ratio deposits, which serve another purpose), so the textbook process was “less relevant for UK banks”.
Banks still keep reserves, because they settle payments to each other with them and because regulators require liquid assets. But the quantity of reserves follows lending; it does not cap it. The Bank of England article describes the multiplier as running in reverse: looser policy raises lending and deposits, and that raises banks’ demand for reserves, which the central bank meets.
M0, M1, M2, M3: the same money measured at four distances
Monetary aggregates measure money at growing distance from cash, and each central bank sets its own definitions: an M2 in Frankfurt is not an M2 in Washington.
The narrowest measure is the monetary base, sometimes still called M0: currency in circulation plus banks’ reserves at the central bank, all of it central bank money. In the euro area, the ECB’s M1 combines currency in circulation and overnight deposits; M2 adds short-term deposits other than overnight ones, such as savings with a notice period; M3 adds marketable instruments, assets that are close to deposits but traded. In the United States, the Fed’s H.6 release defines M1 as currency plus demand deposits and other liquid deposits, savings deposits included; M2 adds small time deposits of under 100,000 dollars and retail money market fund balances. The UK publishes its own broad measure, M4ex.
| Measure | Euro area (ECB) | United States (Fed) | Date |
|---|---|---|---|
| Currency in circulation | about 1.62 trillion euros | about 2.49 trillion dollars | Euro: end of August 2026 (ECB data portal); US: 14 October 2026 (H.4.1) |
| Bank reserves at the central bank | not shown here | about 3.02 trillion dollars | 14 October 2026 (H.4.1) |
| M1 | about 11.29 trillion euros (+2.9% in a year) | about 19.99 trillion dollars | August 2026 |
| M2 | about 16.45 trillion euros | about 23.34 trillion dollars (about +5.7% in a year) | August 2026 |
| M3 | about 17.65 trillion euros (+3.5% in a year) | not published | August 2026 |
The gap between the first row and the others is bank money. Most of the growth reported each month in M2 or M3 is the net result of new loans minus repayments, plus banks’ purchases of securities, which create deposits in the same way.
Banks settle among themselves in central bank money
Go back to step 2 of the example: Anna’s euros left Bank A and reached Bank B. Commercial bank money moved between two different balance sheets, so something had to settle the debt between the banks. That something is central bank money.
Euro payments between banks settle in T2, the Eurosystem’s real-time gross settlement system, which went live in March 2023 and replaced TARGET2. Each payment settles individually and with finality on the banks’ accounts at the central bank. The ECB says that every eight days T2 processes payments worth close to the euro area’s entire annual GDP. In the United States the equivalent is the Fedwire Funds Service, run by the Federal Reserve Banks.
This is why reserves matter even with no requirement: every payment a customer sends to another bank drains them. Settlement in central bank money also gives what economists call the singleness of money. A euro at your bank and a euro at mine are worth the same because both convert at par into the same central bank asset. If a bank cannot honour that conversion, deposit guarantees take over, up to a limit.
Deposit guarantees cap the risk at 100,000 euros, 250,000 dollars or 120,000 pounds
Because deposits are the bank’s debt, they carry the bank’s risk. Governments cap that risk for ordinary savers through deposit guarantee schemes funded by the banks.
In the United States, deposit insurance “covers $250,000 per depositor, per FDIC-insured bank, for each account ownership category”, according to the Federal Deposit Insurance Corporation. The FDIC’s deposit insurance page lists what it does not cover: crypto assets are on that list, with stocks, bonds and mutual funds.
Across the European Union the guarantee is 100,000 euros per depositor and per bank. France’s Fonds de garantie des dépôts et de résolution pays within seven working days of the accounts becoming unavailable and separately guarantees securities up to 70,000 euros. Italy’s Fondo Interbancario di Tutela dei Depositi pays within seven working days of the bank’s compulsory liquidation order taking effect.
The UK raised its limit on 1 December 2025. The Financial Services Compensation Scheme now protects up to 120,000 pounds per eligible person per authorised firm, up from 85,000. Temporary high balances, such as house sale proceeds, are covered up to 1.4 million pounds for up to six months. Banks of one group that share a banking licence count as one firm, so several brands can share a single limit.
| Scheme | Limit | Covers | Source and date |
|---|---|---|---|
| FDIC (United States) | 250,000 dollars per depositor, per ownership category, per bank | Deposits at insured banks; not crypto assets, stocks or funds | FDIC, October 2026 |
| FGDR (France) | 100,000 euros per customer per bank | Current and savings accounts, Livret A, LDDS, LEP; paid in 7 working days | FGDR, October 2026 |
| FITD (Italy) | 100,000 euros per depositor per bank | Current accounts, deposit accounts, certificates of deposit; paid in 7 working days | FITD, October 2026 |
| FSCS (United Kingdom) | 120,000 pounds per person per authorised firm | Bank, building society and credit union deposits; limit raised on 1 December 2025 | FSCS, October 2026 |
A stablecoin balance or a coin held on an exchange is not a bank deposit, so these schemes do not protect it.
Silicon Valley Bank lost over 40 billion dollars of deposits in one day
California gave a sharp lesson in what a deposit is in March 2023. Silicon Valley Bank had about 209 billion dollars of assets and 175.4 billion of deposits at the end of 2022, according to the FDIC. Its depositors were mainly start-ups and venture funds, and about 94% of its deposits were uninsured at year-end 2022, according to the Federal Reserve’s later review. Much of the money had gone into long-dated bonds, which lost value as interest rates rose.
On 8 March 2023 the bank’s parent announced that it had sold 21 billion dollars of securities at a loss of 1.8 billion dollars after tax and planned to raise 2.25 billion of capital. The next day, 9 March, SVB “lost over $40 billion in deposits”, the Fed’s review of 28 April 2023 found, and management expected more than 100 billion dollars of further withdrawals on 10 March. The actual and expected outflows together came to roughly 85% of the bank’s deposit base, the Fed said, in a run “fueled by social media”.
On 10 March California’s banking regulator closed SVB and appointed the FDIC as receiver. On 12 March the Treasury, the Fed and the FDIC announced that all depositors, insured and uninsured, would be protected, and the Fed opened the Bank Term Funding Program, lending to banks for up to a year against Treasuries and other high-quality collateral valued at par.
A bank funds long loans and bonds with deposits that customers can move at a click. No bank holds enough reserves to repay every depositor at once, and none is meant to: that is the trade-off behind credit creation. A liquidity rule built around 30 days of stress could not cope with a run measured in hours. What stopped the panic from spreading were backstops: deposit insurance, central bank lending and a government decision. A crypto lender has none of them.
Bitcoin, stablecoins and tokenised deposits answer the same question differently
Bitcoin: issuance fixed by the rules every node enforces
In Bitcoin, new coins appear only as the block reward to miners. The Bitcoin Core code starts the reward at 50 BTC and halves it every 210,000 blocks; since block 840,000 it has been 3.125 BTC. The same code sets a sanity ceiling of 21 million BTC, and actual supply will end slightly below it. Our glossary entry on the Bitcoin halving gives the schedule. Satoshi Nakamoto’s white paper describes new coins as analogous to gold miners adding gold to circulation, and imagines a future in which fees replace the subsidy and the system becomes “completely inflation free”.
There is no loan in the protocol and so no deposit created by lending. Credit does exist around Bitcoin: exchanges and lenders take coins and lend them, and DeFi protocols run loans backed by collateral, as our DeFi guide explains. Those are claims on existing coins, and they carry the same run risk as a bank, without the deposit guarantee or a lender of last resort. The basics of the network are in our guide to Bitcoin.
Regulated stablecoins: claims backed one to one
A stablecoin issuer takes in dollars or euros and issues tokens against them. Under the US GENIUS Act, Public Law 119-27, signed on 18 July 2025, a permitted issuer must maintain “identifiable reserves” on “an at least 1 to 1 basis”, in cash, deposits, short Treasury bills and similar assets, and may not pay holders “any form of interest or yield” for simply holding the coin. The text of the Act gave regulators one year to write the implementing rules and takes effect on the earlier of 18 months after enactment, which is 18 January 2027, or 120 days after the final rules. The rules are written by federal banking regulators such as the Office of the Comptroller of the Currency and the FDIC, together with the Treasury.
European law takes a similar line. MiCA treats a stablecoin that references one official currency as an e-money token: it is issued at par and redeemable at par at any time, without a fee. Article 50 bars the issuer from granting interest, and extends the ban to crypto-asset service providers, counting any benefit tied to how long a holder keeps the token as interest. Our MiCA guide covers the details, and our stablecoin lesson covers how coins such as USDC work in practice.
So a fully reserved stablecoin issuer does not create money by lending; it holds money and issues a claim on it. Any credit creation happens at the banks where the reserves sit. The Bank for International Settlements judged in its Annual Economic Report of June 2025 that stablecoins “perform poorly” against the three tests a monetary system needs: singleness, elasticity and integrity. Elasticity is the point here: bank money can grow with the economy’s demand for credit, a fully reserved coin cannot.
Tokenised deposits: bank money on a new ledger
A tokenised deposit is an ordinary deposit recorded on a blockchain-style ledger. It remains a liability of the bank, so the bank still creates it by lending, it still sits inside the capital and liquidity rules, and it settles between banks in central bank money. The BIS report says tokenised commercial bank money “could build on the proven two-tier system” of central and commercial banks. Older forms of digital bank money and e-money, and the experiments that led up to Bitcoin, are the subject of our next lesson on digital money before Bitcoin.
Switzerland voted on ending bank money creation, and 75.7% said no
Only one country has put the question to its voters. On 10 June 2018 the Swiss voted on the “Vollgeld” or sovereign money initiative, which would have given the Swiss National Bank sole power to create money, electronic money included, and required sight deposits at banks to be fully backed by central bank money.
The proposal lost heavily. According to the Federal Chancellery’s open-data results, 442,387 voters said yes and 1,379,540 said no, a 75.7% rejection, with turnout of about 34.6%. Not one canton backed it. A post-vote survey reported by swissinfo found that 58% of respondents had found it hard to understand what the vote was about.
The Swiss National Bank opposed the initiative. The vote settled nothing about the economics, but it showed that who creates money is a political choice that voters can be asked to make.
The ECB’s money figures for September are due in the coming weeks, and the GENIUS Act takes effect no later than 18 January 2027, whatever the pace of the final rules. Token supply schedules, the crypto counterpart of monetary policy, come in a later lesson.
