Common misconception regarding lending

There’s a very common societal misconception regarding how banks lend money that I think should be addressed. You ask the average person where banks get the money they lend from, they’ll say consumer deposits. In essence, many people believe that if you deposit $100 in the bank, the bank will take that same exact $100 and lend it to someone else and charge interest, and that simply is not true, and not how banks work.

The banking system CREATES money through loans. When you go to a bank and take out a loan for $10,000, if approved, the bank literally creates that money out of thin air. It did not exist beforehand. As you repay the loan in monthly installments, you are technically “destroying” money. One of the primary reasons why the Fed lowers interest rates is so that people are incentivized to borrow and money gets created and circulated within our economy. Customer deposits are a liability for the bank, and a certain portion of deposits are kept as reserves, but banks do NOT lend out customer money.

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