Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Basics of Banking: Loans Create a Lot More Than Deposits

International Trust Bank, Denver 1956
The Denver Post | Getty Images

When someone says "loans create deposits," usually that means at least that the marginal impact of new lending will be to create a new asset and a new liability for the banking system. But in our system it's actually a bit more complicated than that.

A bank makes a loan to a borrowing customer. This simultaneously, creates a credit and a liability for both the bank and the borrower. The borrower is credited with a deposit in his account and incurs a liability for the amount of the loan. The bank now has an asset equal to the amount of the loan and a liability equal to the deposit. All four of these accounting entries represent an increase in their respective categories: the bank's assets and liabilities have grown, and so has the borrower's.

It's worth noting that at least two more types of liabilities are also created at this moment: a reserve requirement is created and a capital requirement is created. These aren't standard financial liabilities. They are regulatory liabilities.

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