Module 14 · How the economy works
Where money comes from: banks, central banks and loans
Why most money is a bank deposit, how a loan creates new money and repayment removes it, and what limits how much banks can create.
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In this lesson
- Explain that most money is bank deposits, and that cash and bank reserves come from the central bank
- Show with a bank's balance sheet how a loan creates a deposit and repayment removes it
- Name what limits money creation by banks
- Read the size and growth of the money supply
Eva wants a €20,000 car loan. The clerk taps a few keys, and a minute later €20,000 appears in her account. Where did that money come from? Did the bank take it from another customer?
Most money is a bank deposit
Money is not mostly paper. In August 2026, banknotes and coins in the euro area were about €1.6 trillion. Total broad money was about €17.6 trillion (European Central Bank data). So cash was about 9%. The rest was mainly bank deposits.
The is the total amount of money in an economy: cash plus bank deposits and close substitutes. There are two kinds of money:
- Central bank money: banknotes and coins, and the that commercial banks hold in accounts at the . Banks use reserves to pay each other.
- Commercial bank money: the deposits in your current account, created by banks.
How a loan creates money
by banks works like this. When a bank grants a loan, it does not hand over another customer’s deposit. It types a new number into the borrower’s account. The loan is an for the bank, because the borrower owes it money. The deposit is a , because the bank owes it to the borrower. Both rise by the same amount, and the money supply grows.
So money is created when loans are granted and destroyed when they are repaid. A payment only moves money from one account to another.
What limits money creation
Banks cannot create money without limit. Five things hold them back:
- Borrowers: someone must want the loan at the interest rate offered.
- Risk: a bank loses if the loan is not repaid, so it lends only to borrowers it expects to repay.
- Profit: a loan must earn more than it costs to fund.
- Capital rules: regulators require banks to hold their own funds to absorb losses, so a bank cannot expand without limit.
- The price of reserves: the central bank sets the interest rate on reserves, which affects the cost of every loan.
The central bank also creates reserves and cash. It does so when it lends to banks, when it buys bonds (a later lesson) and when banks swap reserves for banknotes for their customers.
Over many years, money growth far above the growth of output goes with high inflation. In the euro area, broad money grew 3.5% in the year to August 2026.
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