Can banks individually create money out of nothing? — The th (2024)

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Author

Listed:

  • Werner, Richard A.

Abstract

This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air".

Suggested Citation

  • Werner, Richard A., 2014."Can banks individually create money out of nothing? — The theories and the empirical evidence,"International Review of Financial Analysis, Elsevier, vol. 36(C), pages 1-19.

    • Handle: RePEc:eee:finana:v:36:y:2014:i:c:p:1-19
    DOI: 10.1016/j.irfa.2014.07.015

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    References listed on IDEAS

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    More about this item

    Keywords

    Bank credit; Credit creation; Financial intermediation; Fractional reserve banking; Money creation;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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    Can banks individually create money out of nothing? — The th (2024)

    FAQs

    Can banks individually create money out of nothing? — The th? ›

    According to the fractional reserve

    fractional reserve
    Fractional-reserve banking is the system of banking in all countries worldwide, under which banks that take deposits from the public keep only part of their deposit liabilities in liquid assets as a reserve, typically lending the remainder to borrowers.
    https://en.wikipedia.org › wiki › Fractional-reserve_banking
    theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money
    creating money
    Money creation, or money issuance, is the process by which the money supply of a country, or an economic or monetary region, is increased. In most modern economies, money is created by both central banks and commercial banks.
    https://en.wikipedia.org › wiki › Money_creation
     through systemic interaction.

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    Can a bank just take money out of your account? ›

    Generally, a bank may take money from your deposit account to make a payment on a separate debt that you owe to the bank, such as a car loan, if you are not paying that loan on time and the terms of your contract(s) with the bank allow it. This is called the right of offset.

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    Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.

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    How do private banks make money? Private banks make their money via various fees, interest, and investment.

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    At the moment of deposit, the funds become the property of the depository bank. Thus, as a depositor, you are in essence a creditor of the bank. Once the bank accepts your deposit, it agrees to refund the same amount, or any part thereof, on demand.

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