How Banks Create Money: What Really Happens With a Loan

What the Story Claims

The story begins with an approved loan of €50,000. That money, it says, did not exist five minutes earlier. The bank types a number into a computer and risks nothing. Yet it demands €70,000 back, and the €20,000 of interest was never created. So there is always more debt than money, and someone has to lose in the end.

The first sentence is true. The conclusions drawn from it are not. This study goes through the claims one by one. It then uses our own interest rate series to work out what a loan in Germany has cost since 2003.

Yes: A Loan Creates New Money

The Deutsche Bundesbank says so plainly in its Monthly Report of April 2017, as does the Bank of England in its Quarterly Bulletin 2014 Q1. When a bank grants a loan, it credits the amount to the customer’s account. Two entries arise at the same time: the bank’s claim on the customer and the customer’s deposit at the bank. That deposit is money the customer can pay with. It does not come from other customers’ deposits. When the loan is repaid, the money disappears again.

That is why most of the money supply consists of bank deposits, not cash. It is no secret, and it is not a trick that laws made legal after the fact. Banking systems with a central bank have worked this way for a long time. London goldsmiths in the 17th century, who issued more receipts than they had gold in their vaults, were an early forerunner. The Bank of England was founded in 1694 to lend money to the English state for its war against France.

No: Out of Thin Air and Without Limit

This money creation is not unlimited. If the customer transfers the new money to someone who banks elsewhere, the bank has to hand over central bank money, which it must obtain and pay for. It has to hold a minimum reserve, 1% of deposits in the euro area since 2012. It needs capital in proportion to its loans under the Basel rules, which apply in the EU as a regulation. And it needs customers who want a loan at the rate it asks and are likely to repay it.

The bank also risks more than a few bytes. If a customer does not pay, the bank loses its claim, while the customer’s money has long been spent. The loss hits the bank’s capital. That is why it checks income and collateral, and why it charges interest above its own costs.

The Interest Fallacy

The strongest claim is that only the loan amount is created, not the interest. Therefore, it says, the total of all debts can never be repaid. The argument confuses a stock with a flow. The interest customers pay does not stay inside the bank. The bank uses it to pay salaries, rent, taxes, interest to savers and dividends to its owners. The money flows back into the economy, where it can be earned again.

The same euro can make many payments in a single year. So the money supply never has to be as large as all debts plus future interest. Loans default when incomes collapse or a purchase turns out to be a mistake. There is no arithmetic rule that forces someone to be left without a chair.

What a Loan Really Costs

It is true that a loan can be expensive. How expensive depends mainly on timing. Since 2003, the rate on new housing loans in Germany has ranged between about 1% and just over 5%. In August 2026 it stood at 4.00%, the overnight deposit rate at 0.51% and the ECB deposit rate at 2.25%. On average since 2003, the mortgage rate was 2.65 percentage points above the overnight deposit rate. Banks pay their costs, defaults and capital out of this spread.

For the loan in the story, this means: €50,000, fully repaid over ten years, cost €3,059 in interest when taken out in January 2021 at 1.19%. In January 2003 at 5.32% it was €14,582, and in January 2026 at 3.76% about €10,065. Total repayments of about €70,000 only arise at a rate of just over 7%. The mortgage rate has not been that high at any point since 2003. Consumer installment loans often cost that much, but they are not part of our data.

Does Inflation Melt Debt Away?

This claim is true only under one condition. A fixed-rate loan becomes cheaper in real terms when inflation turns out higher than the agreed rate. The borrower then repays with money that buys less than at the start. If inflation stays below the rate, the loan keeps costing money in real terms.

In our data, the mortgage rate was below inflation in 49 of 284 months, all between 2017 and 2023, with a low of minus 8.3 points in October 2022. For fixed-rate loans the picture is mixed. A loan taken out in January 2008 at 5.22% cost 3.83% a year in real terms, with average inflation of 1.39%. A loan from January 2016 at 1.98% came out at minus 0.87% in real terms, and one from January 2021 at 1.19% at minus 3.12% so far. Banks know this mechanism. When they expect more inflation, they charge higher rates.

Leverage: When Tenants Pay the Loan

The last part of the story separates consumer debt from debt for assets. This much is true: a loan for a car or a vacation is repaid from the borrower’s own income. A rented apartment or a business, by contrast, can earn its own income. Tax law in Germany also treats the two differently. Interest on a rented property counts as an income-related expense, and a business deducts its interest as an operating expense. Interest on an owner-occupied home or on consumer loans does not reduce taxes.

That does not make leverage a sure thing. It raises the return on the equity invested only as long as the asset earns more after all costs than the loan costs. If the rate is higher, leverage lowers the return, and if the value falls, the loss hits the equity first. Rents also often do not cover the full payment. One example: a purchase price of €300,000, 10% purchase costs, €60,000 of equity, a 4% rate and 2% repayment lead to a payment of €1,350 a month. With €1,000 of net rent and 20% running costs, income covers only 59% of it in the first year. The investment loan calculator works through such assumptions year by year.

What the Data Shows

Three claims in the story hold up. Banks create new money when they lend. A loan can cost a lot over its term: between about €3,000 and €14,600 of interest on €50,000 over ten years. And loans for rented property or a business are taxed differently from consumer loans.

Three claims do not hold up. Banks put their own capital at risk with every loan, not just a few bytes. The fact that interest is not created does not make debt unpayable, because interest flows back into the economy as income. And inflation erodes debt only when it is higher than the agreed rate. In our data, that was the case in 49 of 284 months.