Question

Banks creation of Money: Myths or Reality

Answer 1

The major role of creation of money is of central banks. For example in United States, the role of creation of money is held by FED and in India; it’s the job of RBI.

Although banks do create money also. A major share of creation of money is done by banks and surely more than the government or reserve banks do. It’s known that banks can’t create the paper money. It is the job of central banks. But banks create money in the form of deposits. It is when banks hold public’s deposits and loan out some of them to the borrowers. Banks acts like the two way system here. Banks charges interests when they give loans to the borrowers. This interest rate is definitely more than any of the interest that they give on deposits. By this, banks create money.

Another way by which banks create money is against the mortgage that they take against the loans. They create money by giving the borrower the amount of loan equal or less than the value of mortgage. This involves the money creation also.

I’d say it depends on the perspective that it is myth or reality. If we are talking about the currency notes, then it is a myth that banks create money. But if we are not talking about currency notes in particular and the topic is general, then it is actually a reality that banks create money.