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    Hello everybody!

    I learnt at University that banks lend the money deposited and hold a small portion of these deposits within their vault to meet customers' withdrawals, while the rest of the deposits can be loaned out to the public (as not part of the reserve requirement). And all of that makes sense considering the fractional-reserve banking system.

    I have recently read an article by the Bank of England regarding money creation. The article states that banks do not act as simple intermediaries only receiving deposits and lending them to the public but, in reality, banks actually create money through lending. The money multiplier model is then not to be taken as the main way through which money is created. It is rather the act of lending that creates deposits. In fact, when a bank makes a loan, it credits the lender's bank account with a bank deposit of the size of the loan. At that moment, new money is created. There are of course restrictions that limits how much banks can lend.

    What the article says is much different to what I have learnt.

    I get the impression that, under the “loans create deposits” model, there are no risks of not meeting customers withdrawals, as the deposits are not lent out to the public. Are deposits kept as vault cash? Do then capital and reserve requirements still apply under these circumstances? If banks do not lend deposits out, what would be the purpose of keeping reserve requirements?

    Thank you.
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Updated: January 29, 2016

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