Banks Don’t Lend Money .. Do They?

Banks don’t lend money

Do They?

Previously published here from Mickanomics

Hat-tip – CJ Stone:

Professor Hyman Minsky once wrote “Banking is not money lending; to lend, a money lender must have money. The fundamental banking activity is accepting, that is, guaranteeing that some party is creditworthy. A bank, by accepting a debt instrument, agrees to make specified payments if the debtor will not or cannot”.

“Banking is not money lending”? Surely some mistake! Why would an economist as famous as Professor Minsky make such an outrageous sounding statement?… Well the answer is that its perfectly true. Crazy though it sounds, banks don’t lend money at all. To understand why this is the case we must understand some technicalities about money.

Most people imagine that money is simply a system of government-created
tokens (physical or electronic) that get passed form person to person as trade is carried out. Money of this kind does indeed exist, so called “central bank money” is of this type. However the vast majority of the money we spend day today is a second type, technically known as “broad money” or “cheque book money” which can best be described as “spendable bank IOUs”. The concept of a spendable IOU may sound rather strange, and in order to explain it, we must first consider some characteristics of an ordinary IOU, the kind you or I might use…

Say that Mick wanted to borrow £10 from Jim. Jim could give Mick a £10 note in return for a piece of paper with “I.O.U. £10, signed.. Mick” written on it. The IOU would then have some value to Jim as a legal record of the loan. At some later time Mick would repay the loan. At this point Jim should no longer keep the IOU because Mick would no longer owe Jim any money. The IOU has now done its job and may be disposed of. To summarise, the lifecycle of an ordinary IOU is as follows:


  • Creation (out of nothing. It did not exist previously)
  • It now has value as a legal record of the loan.
  • It expires (back out of existence) when the loan is repaid.

Note that even though the IOU has value during stage 2, it is not easily spendable. If Jim went into a grocery shop and said “I’d like to have £10 worth of food, here’s an IOU from Mick, he’ll pay you back later”, the shopkeeper would almost certainly refuse. This is because the shopkeeper has no idea if Mick is creditworthy, the shopkeeper would be worried he may never receive £10 from Mick. Now imagine for a moment that it could somehow be arranged to have a guarantee from a famous high street bank, that Mick would indeed pay £10 to the holder of the IOU. Then the shopkeepers fears would be allayed and he would have no reason not to accept Mick’s IOU as payment for food. To summarise, a bank guarantee could convert a non-spendable IOU into a spendable IOU.


So far this has all been hypothetical, but to see a non-spendable IOU get converted into a spendable one in the real world, look no further than the process of getting a “bank loan”. The term “bank loan” is in fact highly misleading. What is actually going on is not lending at all, it is in fact an IOU swapping arrangement. If Mick went to borrow £1000 from a bank, the first thing that would happen is that the bank would asses Mick’s creditworthiness. Assuming it was good enough, then the bank would ask Mick to sign a “loan agreement” which is essentially an IOU from Mick to the bank. What the bank would give Mick would generally not be “central bank money”, but instead its own IOUs (i.e. cheque book money). And just like ordinary IOUs, bank IOUs do not have to be obtained from anybody else. They are just created on the spot. No “lending” is going on. In order to “lend”, the bank would have had to have been in possession of the money beforehand, and they were not.

So there you have the layman’s explanation. But some people are still not convinced. Many people have heard a different explanation of the money creation process at university or from textbooks and so assume that this explanation is somehow wrong. But let me assure you that it is the textbook explanation that is wrong. I do realise that “extraordinary claims require extraordinary evidence”. So here goes…

The first thing to say is that the explanation given here is indeed a simplification of the money creation process as it occurs in the real world. The full details of which are so complex and so frequently changing that they are not taught to undergraduate students as part of economics degrees. What students are often taught instead is a toy model of reality. A not-actually-true teaching aid. The idea of using a not-actually-true teaching aid is not unique to economics, in the field of chemistry a similar thing occurs with regard the behaviour of electrons around atomic nuclei. The real world behaviour is too complex for undergraduate students, so they are taught a not-actually-true story of “electron shells”. Its in virtually all the textbooks.

The standard not-actually-true method for teaching students about the workings of our monetary system is an explanation called the “money multiplier model” in which banks appear to lend out money that has been deposited with them. When some economists finish their degrees and subsequently go on to specialise in the monetary system and finally learn the full details of the process, they occasionally have some choice words to say about the undergraduate textbook model:

  • “The way monetary economics and banking is taught in many, maybe most, universities is very misleading”. Professor David Miles, Monetary Policy Committee, Bank of England.
  • “It amounts to misinstruction”. Professor Charles Goodhart CBE, FBA, ex Monetary Policy Committee, Bank of England.
  • “The textbook treatment of money in the transmission mechanism can be rejected”. Michael Kumhof, Deputy Division Chief, Modelling Unit, Research Department, International Monetary Fund.
  • “Textbooks assume that money is exogenous.” … “In the United Kingdom, money is endogenous” Mervyn King, Governor of the Bank of England.

Notice the extremely high calibre of the economists being quoted. These are all economists that specialise in the workings of our monetary system.

Is this issue controversial? Well yes and no (but mainly no)… let me explain. the issue is only controversial in as much as non-experts (that have just learned the textbook story) may say things that contradict the experts that have a detailed knowledge of the system in reality. But amongst the experts, it is not controversial at all.

I shall finish with a quote form Professor Victoria Chick, Emeritus Professor of Economics, University College London: “Banks do not lend money. It may feel like it when you get a ‘loan’, but that’s not what they are doing. They don’t have a pot of money which they are passing on. What they are doing is accepting your IOU… they simply write up your account”.

So there you have it, banks do not lend money. And if you want to argue against this on academic grounds, please only quote economists that specialise in the monetary system.

7 thoughts on “Banks Don’t Lend Money .. Do They?

  1. You don’t need to go as far as a bank loan to convert a non-spendable IOU into a spendable IOU.

    That’s what a cheque is (or rather was since the good old cheque is in decline).

    It is written on a bank’s paper and in the good old days it could be endorsed (or left ‘open’), which allowed that IOU to circulate as payment for trade debts.

    That made the cheque ‘money’.


  2. This also helps explain the folly of Osbornes’ reliance on ‘pushing on a string’ monetary approaches to boost demand rather than injecting spending power directly through fiscal means.
    A neat little non-technical book that explains the endogeneity of money concisely is ‘Where does Money Come From? by Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson published by the New Economics Foundation


  3. And for all the detail on how to get out of this situation visit They’ve even drafted the Bill. The present reality is that Cameron says we have to get the banks lending again. That’s the last thing we need – you can’t get out of debt by creating more debt through our current system (i.e letting banks create money out of nothing). We need full reserve banking where only the Bank of England can create money, on a debt-free basis. It actually isn’t rocket science’


  4. …and isn’t it nice work if you can get it. You create money out of nothing, and we all have to pay it back to you …with interest! Ever wondered how they pay for all the Champagne? There isn’t enough money in the system to pay back all the debt!


    • Of course there is. Simplest example possible: I owe you $1, you owe Lisa $1. I work for Lisa and she gives $1; I pay you, you pay Lisa. There, one dollar paid back two dollars in loans.

      The “check book money”, the money that disappears when the loan is paid back, is not the paper note, but my debt to you, or your debt to Lisa, which can be treated as a money.

      You’re also assuming that no money ever leaves the bank and no losses are ever taken by the bank.

      Money leaves the bank as dividends to shareholders, as bonuses to bank officers and so on. They don’t just stick it down some hole; they buy yachts, foie gras and champagne and whatever else these scumfucks buy. That money is then used to pay back money lent by the champagne maker etc.

      If the bank makes bad loans, the asset column(money owed to the bank + deposits + the banks own capital) becomes smaller than the liability column(money owed by the bank, that is savings accounts, checkings accounts and so on). If the regulatory agencies are functioning; they now step in and close the bank; losses taken by the bank gets taken out of the bank’s capital and there are no losses to depositors that have to be re-imbursed by the tax payer.

      If the regulatory agency is not awake (I suspect more often “in on the fraud” than not paying attention), losses may affect tax payers (through FDIC Insurance bail-outs and other unsavoury means).

      If the bank is never shut down by regulators; it will crash and burn in a bank-run stretching around the block.

      Whenever a loan fails; either a loan to the bank or a loan from the bank, debt is destroyed. It’s not paid back, it just goes away.


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