Money is the means or mechanism of payment par excellence in the developed and modern world, however many people do not know how money is really created, in some cases statements are heard that governments “print” bills (without fully explaining this process). In this article, we will explain how FIAT money is created through the existence of central bank money and commercial bank money.

The Central Bank is the monetary authority that governs the economy of a country, which is why it is he who has the power to issue the bills and coins of national circulation. However, “at the time of execution”, it is not only the Central Bank that issues money, but also commercial banks are able to issue “additional” money.

How does the Central Bank create money?

In order to be able to create money, the Central Bank must acquire assets, which is what gives it monetary support. Keep in mind that a banknote or a currency is the representation of the debt that a government acquires with the user, in such a way that, if the government wishes to print money, it must back it up. This process is what is called, creation of a monetary base, which consists in increasing the assets of the Central Bank, for this purpose, there are several ways to implement it:

Increase the amount of gold and currencies in your possession. Increase the amount of credits that the Central Bank grants to commercial banks that require liquidity, for this case, there are various interest rates, which will depend on the degree of difficulty that each bank has to finance itself in other markets. Buy public debt through open market operations. And another alternative is to increase the credits granted by the Central Bank to the public sector.

How does commercial banking create money?

Commercial or private banking through bank deposits, when making new bank loans, is the way she can create money. It means that commercial banks do not create banknotes or paper money, because it is owned by the Central Bank. It is through electronic money, that you can see in the ATMs, in your bank statements issued by the bank, or you see it through the web pages of your bank. In such a way that today, a very high percentage of that money, it is estimated that 97% of bank deposits, constitute the support of the economy of the country and only the remaining percentage, 3%, constitutes the counting physical money and sonante, that we can see and touch.

Commercial banking also creates money, through the accounting records they make when they grant bank loans. These numbers constitute an obligation and a commitment on the part of the bank towards the users or clients, which can be honored by means of credit or debit cards, or through internet banking. Through these electronic payment commitments, commercial banking can create a real money substitute.

How does the Central Bank create money?

In order to be able to create money, the Central Bank must acquire assets, which is what gives it monetary support. Keep in mind that a banknote or a currency is the representation of the debt that a government acquires with the user, in such a way that, if the government wishes to print money, it must back it up. This process is what is called, creation of a monetary base, which consists in increasing the assets of the Central Bank, for this purpose, there are several ways to implement it:

-Increase the amount of gold and currencies in your possession.

-Increase the amount of credits that the Central Bank grants to commercial banks that require liquidity, for this case, there are various interest rates, which will depend on the degree of difficulty that each bank has to finance itself in other markets.

-Buy public debt through open market operations.

-Increase the credits granted by the Central Bank to the public sector.

How does commercial banking create money?

Commercial or private banking can create money through bank deposits when making new loans, commercial banking does not create banknotes or paper money, since these are owned by the Central Bank, however commercial banking creates electronic money, which is You can see on the screens / vouchers of the ATMs, in the account statements issued by the bank and through the website or online banking. Currently, a high percentage of that money (it is estimated that 97% of bank deposits) constitute the support of a country’s economy, while the remaining percentage (3%) constitutes physical money (which can be see and touch).

Commercial banking also creates money through the accounting records they make when they grant bank loans. These numbers constitute an obligation and a commitment on the part of the bank towards the users or clients, which can be honored by means of credit / debit cards or through Internet banking. Through these electronic payment commitments, commercial banks can create a real “substitute” for money.

In conclusión

Money can be created through the following ways: The central bank, circulates a certain amount of legal money in the form of bills and coins. The banking system (commercial banks), when granting loans, makes that legal money multiply. It is important to note that all commercial banks own money from the central bank (they have an account at the central bank), which can be “lent” to other people, businesses or companies by converting it into “commercial money,” although the backup rate It varies in each country, we can say that on average, with a single dollar of «central bank money», a commercial bank can lend approx. Up to 10 dollars to other people, businesses or companies (in some cases it may be more), this “additional” money is called “commercial money.”

If you want to know the second way in which FIAT money (open market operations) is created, you can visit the following link.

What do you think about this topic? Did you know the participation of commercial banks in the creation of money?

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