The deposit appears when the loan is made
Suppose a bank approves a $20,000 loan for a used van. It records a loan asset: the borrower’s promise to repay. At the same moment it credits the borrower’s deposit account by $20,000, creating a bank liability that the borrower can spend. The balance in that account did not have to be moved from another customer’s savings account first.
That is the point made by the Bank of England and the Bundesbank in their explanations of modern money creation. Commercial banks create deposit money when they lend. They do not create the van, the labor that made it, or new wealth for the borrower. The borrower receives purchasing power alongside an equal debt. Saying a bank “creates money” describes the new deposit, not a gift.
Two entries, two different promises
A loan is an asset to the bank because the borrower owes it principal and interest. A deposit is a liability because the bank owes the customer access to that balance. From the customer’s side, the signs reverse: the deposit is an asset and the debt is a liability. Looking at both sides prevents the magical version of the story in which the bank writes a number and has no obligation of its own.
The deposit can be used for ordinary purchases. If the borrower pays a van seller who uses the same bank, the bank changes which customer owns the deposit. If the seller banks elsewhere, the payment also has to be settled between banks, generally using central bank money. The lending bank may need to obtain or manage reserves and other funding to meet those payments. Creating a deposit does not free it from settlement.
This is why the phrase “banks lend out deposits” is misleading as an account of the instant a loan is originated. Existing deposits do matter to a bank’s funding and liquidity, but the new loan itself can create a new deposit. The bank then has to remain able to honor payments and withdrawals. These are different steps, and confusing them makes the process look either impossibly easy or impossibly constrained.
Why lending has limits
If deposits can be created, why not approve every loan? A bad loan may never be repaid. The bank still owes its depositors and payment counterparties, while the asset on its books has lost value. Shareholders’ capital absorbs losses only up to a point. Banks therefore assess borrowers and collateral, hold capital, and operate under regulation and supervision. The Bank of England also points to interest rates, demand for loans, and monetary policy as constraints on the amount of money created.
Funding matters too. When newly created deposits leave for other banks, the original bank has to settle those flows. It can attract deposits, borrow, sell assets, or use central bank facilities under their rules, but those routes have costs and limits. A bank with a cheap, stable base of deposits is in a different position from one that continually has to replace departing funds. Savers have a role even though a specific saver’s balance is not mechanically handed to a specific borrower.
Central bank reserves are another source of confusion. Banks use reserves for settlement and liquidity. Households usually use commercial bank deposits as their electronic money. The Bank of England’s account rejects the simple textbook story in which the central bank first supplies a fixed pile of reserves and commercial banks multiply it by a fixed ratio. Reserve needs and credit decisions interact through a wider financial system.
Spending and repayment change the total
When the van seller receives the payment, the deposit is still in the banking system, although it has moved to someone else. The borrower’s debt also remains. If the borrower repays principal from a deposit, the bank’s loan asset and a deposit liability both shrink. In that accounting sense, repayment destroys deposit money created by lending. The Bank of England gives this as the reverse of loan creation.
Interest is different from principal. It is a payment for the loan and becomes income to the bank, after costs and losses; it is not simply the cancellation of the entire loan balance. A default is different again: the bank writes down an asset it expected to collect. Neither interest nor default can be described accurately by saying the borrowed money merely vanishes. The effects depend on the transactions and on who holds the deposits at each stage.
A useful way to read the claim
“Bank lending creates money” is a statement about balance sheets and spendable deposits. It does not mean every bank can lend without restraint, that public authorities have no role, or that a society becomes richer whenever a debt is signed. The van still has to exist. Someone has to produce goods and services that borrowers purchase, and borrowers must usually earn income to repay.
A practical test is to ask three questions about any example: whose deposit rose, whose debt rose, and what happens when the deposit is spent or the debt repaid? Those questions keep the accounting concrete. They also show why the power to create deposits comes with credit risk, funding needs, and public rules rather than an unlimited supply of free money.