Physical cash (banknotes and coins) is a small and shrinking fraction of the money in most economies. The far larger portion is commercial bank money: digital deposit balances that exist only as entries in banks' accounting systems, which is why economists call it 'broad money' as opposed to the narrower monetary base issued directly by a central bank.
Central banks including the Bank of England have published explanations clarifying that commercial banks create most new money not by lending out existing deposits, but through double-entry bookkeeping: approving a loan simultaneously creates a new asset (the loan) and a new liability (the borrower's deposit). This is sometimes described as 'loans create deposits' rather than the older textbook picture of banks simply channeling pre-existing savings to borrowers.
This system means the money supply expands and contracts with the volume and pace of bank lending, moderated by capital requirements, reserve rules and central bank policy rates, rather than by a fixed physical quantity. It also means your bank balance is legally a claim on the bank, not a separate, ring-fenced asset, which is precisely why deposit insurance schemes exist to protect depositors if a bank fails.
Explain more simply
When you check your bank balance, you are not looking at stored cash with your name on it. You are looking at an entry in the bank's private ledger that says how much it owes you.
Most of that money was not printed by a central bank at all, it was created the moment someone else took out a loan. When a bank approves a mortgage, it does not hand over savers' cash; it creates a new deposit for the borrower and a matching loan on its books.
Real-world analogy
A bank balance is like an IOU written in the bank's own notebook. It is useful and widely trusted, but it is a promise, not the underlying thing itself, which is why the notebook's owner matters.
Key facts
- Most money in circulation exists only as digital bank deposits, not physical cash.
- Commercial banks create new deposits when they issue loans, expanding the money supply.
- A bank balance is legally a claim on the bank, which is why deposit insurance exists.
Common misconception
“Banks simply lend out the deposits that savers put in.”
Central bank research, including from the Bank of England, describes the opposite sequence for most lending: approving a loan creates a new deposit at the same moment, rather than transferring pre-existing savings from one customer to another.[1]
Go deeper
This mechanism is bounded, not unlimited: banks are constrained by capital adequacy rules, liquidity requirements, and the need to remain profitable and solvent, and central banks can influence lending volume through interest rates and reserve policy. But within those bounds, the quantity of bank deposits is an outcome of lending decisions made by thousands of separate institutions, not a single centrally metered stock.
This is part of why 'the money supply' is not one number: economists track several aggregates (such as M0, M1, M2) that include different combinations of physical cash, checking deposits and savings-type deposits, precisely because 'money' spans a spectrum from instantly spendable to more slowly convertible claims.
Quick check
Answer every question correctly (100%) to complete this lesson.
1.What happens, in most cases, when a commercial bank approves a new loan?
2.Legally, what is a bank account balance?
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Extra exam questions
Every question here counts towards your accuracy, XP and rank. No guessing: every answer is explained.
Quick check
Answer every question correctly (100%) to complete this lesson.
1.When you check your bank app, what does the number in your account actually represent?
2.Under fractional reserve banking, what happens to most of the money you deposit?
3.When a bank issues a new loan, what typically happens to the money supply?
4.What is 'counterparty risk' in the context of holding money in a bank account?
5.Why can a bank run occur even at a fundamentally solvent bank?
6.What is the main purpose of deposit insurance schemes (e.g. covering deposits up to a set limit)?
7.Which of these is an example of 'digital balances' relying on trust in an intermediary?
8.What distinguishes 'base money' (central bank reserves and cash) from the broader money supply?
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Sources
- Bitcoin: A Peer-to-Peer Electronic Cash System (2008), Satoshi Nakamoto
The original nine-page proposal. Describes proof of work, timestamping and the incentive model.