How banks lend you money created from thin air

The false belief of fractional reserve banking

Author

Boago Sephutho
June 18, 2025

Good morning! Let’s get into it.

People believe that banks keep our money and save it to lend to others at a higher interest rate than the one they pay us.

I don’t believe that. I think they create money out of thin air to lend that money.

Let's break down both views:

View 1: Banks lend out your savings

Financial Services Money GIF by Pudgy Penguins

Gif by pudgypenguins on Giphy

This is the traditional belief:

  • You deposit P100 into the bank.

  • The bank keeps a portion (say 10%) as reserves.

  • Then it lends out the remaining P90 to someone else.

  • That borrower spends the P90, and eventually it gets deposited into another bank account.

  • That new bank repeats the process.

This is called the fractional reserve banking model, and it's what most people are taught. But it's not the whole picture anymore.

View 2: Banks create money when they lend

This is a more accurate, modern view:

  • Banks don’t wait to collect deposits before they lend.

  • Instead, when you apply for a loan (e.g., P100,000), they create that money on the spot by typing it into your account, from nothing.

  • That loan becomes a new deposit in the economy.

  • This is how most of the money supply is created — through credit issuance, not central banks printing money or people depositing savings.

This view is confirmed by institutions like:

  • The Bank of England: "Money creation in the modern economy"

  • The Bank for International Settlements

  • Even the South African Reserve Bank has explained this publicly.

So what’s the truth?

  • Your deposits aren't directly lent out. They're part of the bank’s liabilities (money they owe you).

  • The money they lend is newly created by increasing the borrower’s account.

  • The bank profits from the interest spread: borrowing at a lower rate (your savings) and lending at a higher rate.

Why this matters:

Understanding this changes how you think about:

  • Inflation

  • Government debt

  • Banking crises

  • Central banks’ role

  • And whether banks are “safe”

The technical term is:

Credit Creation

(or more specifically, Bank Credit Creation or Money Creation by Commercial Banks)

In Botswana, this process is recognized and regulated by the Bank of Botswana (BoB), and while they may use slightly different phrasing in official documents, it generally falls under terms like:

  • Monetary Policy Operations

  • Credit Expansion

  • Money Supply Growth

  • Domestic Credit by Commercial Banks

How the Bank of Botswana explains it:

In BoB publications (like the Monetary Policy Statements or Banking Supervision Annual Reports), they describe the money creation process through terms such as:

  • "Domestic credit growth" refers to how much credit banks are extending.

  • "Broad money (M2) expansion" — which grows as banks issue loans.

  • "Deposit money banks creating purchasing power" — a phrase sometimes used in policy education.

Summary in local context:

In Botswana, commercial banks don’t just move existing money around — they create purchasing power through credit when they issue loans. This is part of what BoB manages under its monetary policy framework to control inflation, liquidity, and overall economic stability.

References

1. “Domestic credit growth” & “Money supply (M2) expansion”

The Monetary Policy Report – April 2025 notes:

These terms—"commercial bank credit growth" and "money supply (M2) expansion"—are exactly how BoB refers to the process of banks creating new money via lending.

2. “Credit developments” & “credit-to-GDP ratio”

The Monetary Policy Statement 2025 states:

  • “In general, credit growth continues to be supportive of economic activity.” It also analyzes the credit-to-GDP ratio to monitor how much banks are lending relative to national output. bis.org+2bankofbotswana.bw+2bis.org+2

This emphasizes credit creation’s direct role in boosting the monetary base and broader supply.

3. “Domestic credit” in Annual Reports

In BoB’s Annual Report 2023, under “Domestic Credit”:

  • It shows annual growth in commercial bank credit, reinforcing that banks—through lending—are a key driver of credit creation domestically. bankofbotswana.bw

Summary of Terms Used in Botswana

  • Commercial bank credit growth / Domestic credit growth

  • Money supply (M2) expansion

  • Credit-to-GDP ratio