How is money really made by banks? [Banking 101 Part 3] (2024)

But there’s a small complication. What happens if Robert goes and spends the new bank-created money with a shop that has a bank account with a different bank, say Lloyds? If this happens, then Lloyds will want to see £10,000 of real money from Barclays. Barclays would then need to transfer £10,000 of central bank reserves to Lloyds to settle the transaction. Note that from the point of view of Lloyds, receiving a transfer of £10,000 in central bank reserves into its account at the Bank of England is just as good as Barclays pulling up in a truck and dropping off £10,000 in cash, although it’s much more convenient for the banks to have the electronic central bank reserves than to have to carry around all that cash. This process of banks making payments between themselves is called inter-bank settlement, and it’s really important to understand it, because it’s crucial to the way that banks have been able to gain control of the entire money supply. First, let’s look at the simplest example of inter-bank settlement, with just two banks and two customers. Robert, when he receives his loan, goes straight to a DIY store and spends £10,000 on everything he needs. He gets to the checkout and pays using his visa debit card. Here’s a simplified version of what happens behind the scenes: First, the DIY Store’s debit card machine automatically contacts Visa and say “Please charge £10,000 to this card number: xxxxxx”. Visa’s computer systems then dial up Barclay’s computer systems and say “Robert’s trying to spend £10,000 on his debit card. Is that ok?” Barclays’ computer system checks the balance of the account and says “Yes”. Barclays computer system then reduces the balance of Robert’s account by £10,000. Now, Visa’s computer system contacts the Lloyds, and says “I’m sending you £10,000 for the DIY Store’s account”. Lloyds then updates the balance of the DIY Store by £10,000. However, importantly, when the owners of the DIY store log into their internet banking, they see two figures. One says “Account balance”, and the other says “Available now”. For the next couple of days after Robert has come into the shop, the Account balance will be £10,000 higher than the Available Now balance. The £10,000 that Robert spend isn’t available to the DIY Store for them to spend just yet. Why? Well, behind the scenes, Barclays needs to settle with Lloyds. When Lloyds gets the message that someone has spent £10,000 in the DIY store, it updates their account balance, and then calls Barclays to say “Send me the money…”. Barclays could settle with Lloyds by delivering the £10,000 in cash, but in reality this is just a hassle for both banks. They’d have to find somewhere to store all the cash, and a van with security to transport it. So instead, Barclays will settle by making a £10,000 transfer from its reserve account at the Bank of England, to Lloyds reserve account at the Bank of England. Once Lloyds gets the £10,000 in its account at the Bank of England, then it will update the Available Balance in the DIY Store’s account.