Say ten people deposit £100 with a bank. The bank then has £1,000. Another person comes along and asks for a loan. The bank lends them £100. Now eleven people believe they have £100. Thus the amount of money in question is no longer £1,000, but £1,100.
The effect is magnified several times over, particularly as banks lend out far more money than they have been given. This sort of system – under which banks need own only a percentage of the money that they lend – is known as “fractional reserve lending”.
If your bank gives you a loan, they will “transfer” the money into your account, giving you “credit” and meaning that a new account balance appears on your bank statement. But they have not taken this money directly from someone else’s account. The money did not exist until they added the figure to your account balance.
As Martin Woolf of the Financial Times puts it, “The essence of the contemporary monetary system is the creation of money out of nothing by private banks”.
Remember what the word “credit” means. To “credit” someone’s story is to trust it. Something is “credible” if it is believable. The word derives from the Latin credere, to believe. The word “creed” has the same root. You have credit – you believe the money is yours.
This does not mean that the banks don’t need the money you give them. There have often been legal limits on how much banks are allowed to lend in proportion to what they take from customers, although there were very few limits in place by the time of the crash of 2008. In 2013, the UK government introduced a higher limit on the amount that banks must hold. The bigger borrowers, who are corporations and sometimes governments, want to know that the bank is a safe bet – or as a safe as anything can be in the banking world.