š How do banks make money?
1/ You visit the loan officer at the bank to request a loan.
2/ The loan officer asks you for papers and documents.
You submit the mortgage and other required documents.
3/ After analyzing your application, the bank offers you different plans and conditions.
4/ You agree to one of the plans, and the bank provides you with loan agreements based on the agreed upon plan.
5/ When you receive the loan agreements or contract papers, you sign them. Suppose the loan amount is $100,000.
6/ The moment you sign the loan agreement for $100,000, that document becomes a bond or a promise from you to repay $100,000 plus interest in the future.
In essence, that paper turns into the financial market.
The core business of a bank revolves around buying and selling securities.
7/ The bank buys the bond/guarantee/promissory note from you for $100,000 today.
You are the issuer/seller/borrower, while the bank is the buyer/lender/creditor.
When the bank buys this security from you, it takes action.
8/ First, when the bank owns the bond, it becomes an asset for the bank.
Therefore, the bank adds the $100,000 in bonds along with its assets on the balance sheet.
For the balance sheet to remain in balance, when assets increase by $100,000, there must also be a $100,000 increase in liabilities/equity.
Assets = Liability + Equity.
9/ Here, bank deposits are considered obligations of the bank, as it is obligated to pay them.
Then, the bank recently added $100,000 to your bank account.
10/ This newly created deposit is just a digital entry, not originating from any other account.
It was created at that moment by the bank.
This process is known as credit creation, and is a routine practice for commercial banks every time they issue a loan.
Nearly 97% of money exists as credit, while only 3% is cash/coin, which we commonly refer to as money.
Banks, especially commercial banks, do not lend money.
Instead, they create money out of nothing with every loan, whether it's $500 to an individual or $100 million to a company.
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