Money creation in the modern economy

The Bank of England explains that most money in a modern economy is created when commercial banks make loans. A new loan creates a matching deposit in the borrower’s account; banks are not simply lending out money previously deposited by savers, and the process is not a mechanical multiplication of central-bank reserves. When borrowers repay principal, that bank-created money is extinguished.

Banks cannot create money without limit. Lending is constrained by profitability, capital and liquidity requirements, the demand and creditworthiness of borrowers, and monetary policy. The article also explains how central banks influence money creation through interest rates and, in unusual conditions, through asset purchases such as quantitative easing.