THE MONEY MULTIPLIER ISN'T WHAT MOST PEOPLE THINK IT IS
You may have learned that banks take €100 of deposits, keep €10 in reserve, lend €90, and somehow turn the original €100 into €1,000.
That story is useful for learning the basic idea of fractional-reserve banking.
But there is a problem.
It is not a very good description of how modern banks actually create money.
The reality is much stranger.
THE CLASSIC TEXTBOOK STORY
Imagine a bank receives:
€1,000
And suppose the required reserve ratio is:
10%
The textbook model says the bank keeps:
€100
and can lend:
€900
The €900 is then spent.
Someone else receives that €900 and deposits it into another bank.
That bank keeps:
€90
and lends:
€810
Then:
€810 becomes another deposit.
The next bank keeps:
€81
and lends:
€729
And the process continues.
Eventually, the original €1,000 can theoretically support:
€10,000 of deposits
under the simplified model.
The formula is:
The famous formula is:
Money multiplier = 1 ÷ reserve ratio
With a 10% reserve ratio:
1 ÷ 0.10 = 10
So:
€1,000 × 10 = €10,000
It looks perfectly logical.
But modern banking doesn't work by simply repeating this chain.
THE BIG MISCONCEPTION
The textbook story makes it sound as if:
Deposits come first
↓
Banks receive deposits
↓
Banks lend some of those deposits
↓
Loans create additional deposits
But in modern banking, the relationship is often reversed.
When a commercial bank approves a loan, it can simultaneously create:
An asset for the bank
and
A deposit for the borrower.
The Bank of England explains this directly: when a bank makes a loan, it credits the borrower's account with a new deposit. That deposit is newly created money.
IMAGINE YOU GET A €200,000 MORTGAGE
You walk into a bank.
The bank approves your:
€200,000 mortgage.
The bank doesn't necessarily take €200,000 of someone else's savings and physically hand it to you.
Instead, its balance sheet changes.
BANK'S ASSETS
+€200,000 loan
You owe the bank €200,000.
BANK'S LIABILITIES
+€200,000 deposit
You now have €200,000 in your bank account.
The bank has created a new deposit at the same time as creating the loan.
Loan created → deposit created.
That is the modern money-creation mechanism.
SO WHERE DID THE €200,000 COME FROM?
This is the strange part.
It wasn't necessarily sitting in another customer's savings account waiting to be lent.
The bank created a deposit when it made the loan.
The Bank of England describes commercial bank deposits as the main form of money in the modern economy and says most of them are created by commercial banks making loans.
The borrower can then use that deposit to:
Buy a house
Pay a company
Buy a car
Pay employees
Purchase goods
The recipient of the payment now has a bank deposit.
The money has moved through the economy.
BUT BANKS CAN'T CREATE UNLIMITED MONEY
This doesn't mean a bank can simply type:
€1,000,000,000
into someone's account.
There are serious constraints.
A bank has to consider:
The Bank of England explicitly notes that banks cannot create money without limit because profitability, regulation and other constraints restrict lending.
THEN WHAT ABOUT RESERVES?
This is where the old money-multiplier story becomes particularly confusing.
Commercial banks hold reserves at the central bank.
These are central-bank money.
They are used for things such as settling payments between banks.
But reserves aren't simply the pile of money that banks must mechanically multiply into loans.
The Bank of England explains that, in modern monetary systems, banks' lending decisions generally come first, while the demand for reserves generated by the banking system is accommodated through the central-bank system.
THINK ABOUT A PAYMENT
You borrow:
€100,000
from Bank A.
Bank A creates your:
€100,000 deposit.
You use it to buy a house.
The seller banks with:
Bank B.
Now Bank A needs to settle the payment with Bank B.
That can require a transfer of central-bank reserves between the two banks.
So reserves are extremely important.
But notice the sequence:
Loan
↓
Deposit
↓
Payment
↓
Interbank settlement
The reserves help banks settle payments.
They aren't necessarily what mechanically created the original loan.
THIS IS WHY THE WORD "MULTIPLIER" CAN BE MISLEADING
The traditional model suggests:
Central bank reserves
↓
Banks multiply reserves
↓
Loans and deposits
But modern banking is better described as:
Demand for credit + profitable lending opportunities
↓
Bank creates loan
↓
Bank creates deposit
↓
Payments move deposits between banks
↓
Banks manage the resulting reserve/liquidity needs
The Bank of England has explicitly described the traditional money-multiplier approach as an inaccurate description of modern money creation, while noting that it remains useful as a simplified textbook model.
THE FED HAS STUDIED THIS TOO
This isn't simply a theoretical disagreement.
Federal Reserve research comparing the textbook multiplier with actual data found that the relationship between reserves and deposits was much more complicated than the simple multiplier model suggested.
During the financial crisis, for example, U.S. reserve balances increased dramatically while deposits did not increase in the simple textbook proportion predicted by the multiplier.
That is a major clue.
If reserves automatically created loans through a fixed multiplier, the relationship should have been much more mechanical.
It wasn't.
WHAT HAPPENS WHEN YOU REPAY THE LOAN?
Here's another strange part.
Suppose the bank originally creates:
€200,000 loan
and:
€200,000 deposit.
Years later, you repay the €200,000 principal.
The loan on the bank's balance sheet falls.
And the deposit money associated with repayment is effectively destroyed as the bank's balance sheet contracts.
The Bank of England explains that when bank-created loans are repaid, the corresponding electronic money is deleted.
So:
Bank lending can create money.
And:
Loan repayment can destroy money.
THIS IS WHY BANKS CREATE MONEY — NOT WEALTH
This distinction is crucial.
Suppose a bank gives you:
€100,000
in new credit.
You now have:
€100,000 deposit
but also:
€100,000 debt.
Your money increased.
Your net wealth did not automatically increase by €100,000.
You received an asset:
Deposit
and a liability:
Loan
The bank has also created an asset:
Your loan
and a liability:
Your deposit
Money creation is therefore not the same thing as wealth creation.
The Bank of England makes exactly this distinction: banks create money through lending, but that does not mean they create wealth simply by creating deposits.
THEN WHY DO ECONOMICS TEXTBOOKS TEACH THE MULTIPLIER?
Because it can be useful.
The simple model helps students understand relationships between:
Reserves
Deposits
Lending
Banking
The monetary system
It is a simplified model.
The problem occurs when someone treats that simplified model as a literal description of how every modern bank loan is created.
The Federal Reserve research itself notes that the simple multiplier is a theoretical relationship and can diverge substantially from actual data.
THE CENTRAL BANK STILL MATTERS ENORMOUSLY
None of this means central banks are irrelevant.
Quite the opposite.
Central banks influence money and credit conditions through:
The Bank of England says monetary policy affects money creation through the interest-rate environment and can also directly affect broad money through asset purchases such as quantitative easing.
So the central bank doesn't need to simply say:
"Here are €100 of reserves. Go create €1,000."
It can influence the economic environment in which banks decide whether lending is attractive and borrowers decide whether taking loans makes sense.
THE MONEY MULTIPLIER ISN'T COMPLETELY "FAKE"
This is an important nuance.
The textbook multiplier isn't useless.
It is a model.
Under particular assumptions, the relationship:
1 ÷ reserve ratio
can illustrate how a banking system could theoretically expand deposits through repeated lending and redepositing.
But modern banking doesn't operate as a simple machine where:
€1 of reserves automatically produces €10 of deposits.
Real banks make lending decisions first, subject to profitability, capital, liquidity, regulation and borrower demand.
THE REAL MONEY-CREATION LOOP
A more realistic simplified picture is:
Customer wants a loan
↓
Bank evaluates the borrower
↓
Bank decides whether lending is profitable and permitted
↓
Bank creates a loan
↓
Bank creates a matching deposit
↓
Customer spends the deposit
↓
Money moves between bank accounts
↓
Banks settle payments using central-bank money
↓
Bank manages capital, liquidity and reserves
↓
Loan is eventually repaid
↓
Deposit money can disappear
That is much closer to how modern commercial banking works.
AND THAT CHANGES HOW YOU THINK ABOUT MONEY
If you believe the simple multiplier story, you might imagine banks are basically:
middlemen for existing money.
But modern commercial banks are also creators of deposit money through lending.
The Bank of England states that commercial banks create most of the money used by households and businesses in this way.
That is one of the most important concepts in modern finance.
MAACAT PERSPECTIVE
The phrase "money multiplier" makes banking sound like a simple mathematical machine.
Put in:
€1
Get out:
€10
But real banking isn't a vending machine.
Banks don't simply wait for deposits, multiply them by a fixed number and hand out loans.
They decide whether to lend.
They create deposits when they make loans.
Those deposits move through the banking system.
Central-bank reserves settle payments between banks.
And when loans are repaid, money can disappear again.
So the better question isn't:
"How many euros can a bank multiply from one euro of reserves?"
It's:
"How does a modern bank create, move and eventually destroy deposit money?"
That's where the real story begins.
