Unveiling Illusion: Money creation by banks and economic impact

In today’s digital age, most assume money exists as physical cash or government-issued currency. Yet, the reality is startling: 97% of money creation by banks occurs as digital deposits, crafted out of thin air. This revelation, highlighted in a recent X thread by @Finance_Nerd_ on 22 July 2025, exposes how banks generate money through loans, wielding immense power over our economy. As we delve into this financial illusion, the implications reveal a system that shapes wealth distribution, housing markets, and global stability.

Your money isn’t real.

97% of it is just numbers in a bank’s computer created out of thin air.

Banks don’t lend you money, they create it when you take a loan.

And when you repay it, that money disappears.

This is the greatest illusion in modern finance. Let me explain... pic.twitter.com/4LdpJ7fcZv

— Finance Nerd (@Finance_Nerd_) July 22, 2025

The thread of X posts above features compelling images of the Federal Reserve building alongside stacks of cash, symbolising the nexus of institutional authority and monetary creation. It argues that when you take a loan, banks don’t redistribute existing funds; they create new money by crediting your account, a process that reverses upon repayment. This mechanism, rooted in fractional reserve banking, has ignited calls for public oversight, a debate that resonates amid ongoing economic challenges.

Mechanics of money creation

Banks operate under a fractional reserve system, holding only a small percentage of deposits—around 10%—as reserves, as dictated by central bank rules. This enables money creation by banks, where a £2,000 deposit might lead to a £1,800 loan, generating a new deposit and expanding the money supply, per the Bank of England’s 2014 report, "Money Creation in the Modern Economy". The process is entirely digital, with no physical cash transferred.

When loans are repaid, the created money vanishes, leaving banks with interest as profit. This power to drive money creation by banks gives them control over credit allocation, often favouring real estate and large corporations over small businesses, shaping economic priorities.

In India, the Reserve Bank of India (RBI) plays a pivotal role in this system. As the central bank, the RBI oversees commercial banks, which create money through lending under its regulatory framework, as detailed on its website. The RBI sets the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), currently at 6.50%, requiring banks to hold a portion of deposits, allowing the rest to be lent out and thus fueling money creation.

Link to wealth inequality

Money creation by banks significantly influences wealth distribution, inflating asset prices like houses and stocks faster than wages or savings. The X thread notes this fuels rising inequality, supported by 2025 World Bank data showing the top 1% owning nearly 50% of global wealth.

The 2008 financial crisis exemplifies this, with excessive lending for mortgages creating a housing bubble, resulting in $14 trillion in global losses, according to the International Monetary Fund. Bailout funds, such as the US’s $700 billion, largely benefited the financial sector, widening the rich-poor gap.

In India, the RBI’s policies have historically directed bank lending towards agriculture and small trade, as noted in Wikipedia’s 2025 update, yet real estate and speculative investments often dominate. This mirrors global trends, where money creation by banks disproportionately benefits asset owners, leaving middle-class families struggling with soaring property prices.

Economic cycles, debt dependency

The cycle of money creation by banks contributes to economic booms and busts, with excessive lending inflating asset prices and encouraging debt. When banks reduce credit during recessions, the money supply shrinks, deepening crises, a pattern linked to the 2008 collapse.

The Bank of England confirms that each pound in circulation matches an equal debt amount, suggesting growth relies on money creation by banks. While productivity and government spending offer alternatives, the current system’s debt dependency remains a vulnerability.

The RBI influences this cycle through tools like the repo rate and open market operations, as outlined in Unacademy’s 2022 analysis. By adjusting liquidity, the RBI aims to stabilise the economy, but commercial banks’ lending decisions still drive money creation, perpetuating debt reliance in India’s financial landscape.

Role of bailouts, government oversight

When money creation by banks leads to failures, taxpayers often bail them out, as seen in the 2008 crisis with trillions injected globally. This raises questions about control, with benefits rarely reaching ordinary citizens.

Central banks set frameworks, but private banks dominate money creation by banks, as per the Bank of England’s insights. The thread’s call for public oversight reflects a need for accountability, though government influence varies by nation.

In India, the RBI acts as a lender of last resort and custodian of international currency, per its 2025 data, stepping in during crises to protect depositors. However, its reliance on commercial banks for money creation limits government control, echoing the global pattern where private institutions hold significant power.

Proposals for fairer system

To counter these issues, the thread suggests public control over money creation by banks, redirecting loans to productive businesses. This aligns with sovereign money models, potentially reducing inequality, as hinted by a 2020 SpringerOpen study.

Implementing this requires regulatory shifts and public backing, as seen in Switzerland’s 2018 referendum. The debate evolves with digital currencies, offering new avenues for reform.

For India, the RBI could explore tightening CRR or prioritising lending to small businesses, as suggested by its mandate under the RBI Act, 1934, to support economic growth. Such reforms could rebalance money creation by banks, ensuring broader societal benefits.

Rethinking money creation

The @Finance_Nerd_ thread unveils how money creation by banks shapes our economy, driving inequality and instability. Supported by economic data, including the RBI’s role in India, this system demands scrutiny and potential reform.

As of 23 July 2025, exploring public control remains vital, particularly in diverse economies like India’s.