Banks Create Money, Someone Goes Into Debt

In a previous post we saw that governments can create money without borrowing or taxing first. But they're not the only money creators - banks do it too, just in a fundamentally different way.

When you borrow £50,000 from a bank to start a business, the bank doesn't check if it has that money sitting in a vault. It simply types numbers into your account. New money, created on the spot.

But here's the crucial difference from government money creation: The bank simultaneously creates a matching liability - your debt. Two entries in the ledger:

• Credit: £50,000 in your business account (money created)
• Debit: £50,000 you owe the bank (debt created)

When the government creates money, there's no matching private debt. When banks create money, there always is. Every pound of bank-created money is also a pound of someone's debt.

You and the wider economy benefit from this new money - you can hire people, buy equipment, start trading. Economic activity increases. But unlike government spending, this money is temporary. When you repay the loan, that money disappears from the economy. The bank deletes both entries: your debt and the deposits.

This creates a treadmill effect. To maintain money supply, someone always needs to be borrowing and since banks create the principal but not the interest, borrowers must compete for existing money to pay interest, creating pressure for continuous credit expansion (assuming Government spending remains flat). If everyone tried to pay down debt simultaneously or banks just stop lending, the money supply would contract, spending would collapse, and we'd face an economic crisis - unless the government increased deficit spending to compensate. This is exactly what happened in 2008 - reckless lending created unsustainable debt levels, defaults triggered panic, banks stopped lending, money supply crashed, recession followed.

There’s another problem. Banks only create money when they expect to profit. This means they fund whatever generates financial returns, not necessarily what's actually good for society. So while banks sometimes fund productive business investment, they also fuel housing bubbles that price families out of homes. If this sounds familiar then perhaps it's very similar to the problem with GDP - measuring activity rather than value. Banks will happily fund planned obsolescence that creates waste, but won't touch a community bus service or river cleanup. Profitable doesn't mean useful, just like high GDP doesn't mean we're thriving. This isn't blaming banks - they're operating exactly as their institutional role requires. The problem is relying solely on profit-driven lending for society's essential needs.

For a functional economy, we need both types of money creation:

• Government money: Public services, long-term infrastructure, climate action, anything vital but unprofitable
• Bank money: Business investment, entrepreneurship, responding to market signals

But neoliberalism has convinced us that only one type matters. The logic goes: if we just let markets allocate resources through profit signals, we'll get optimal outcomes. Deregulate banking, maximise private investment, trust that the pursuit of profit will deliver what society needs. The invisible hand will provide.

Except it demonstrably hasn't. We've got record private debt, a housing crisis, crumbling infrastructure, rivers full of sewage, and a climate emergency. Meanwhile banks funnel money into financial speculation and asset bubbles because that's what's profitable - not because it's useful.

The assumption that "profitable = good for society" is as flawed as thinking "high GDP = we're doing well." Both mistake measurement for meaning, activity for value.

This imbalance didn't happen by accident - it's the result of specific rules and institutional arrangements introduced over the past forty years. In future posts, we'll examine exactly what those rules are, who put them in place, and who profits from keeping them there (probably, or I may move on to something completely different!)