Banks are not intermediaries of loanable funds - and why this matters

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 29 May 2015

Working Paper No. 529
By Zoltan Jakab and Michael Kumhof 

In the intermediation of loanable funds model of banking, banks accept deposits of pre-existing real resources from savers and then lend them to borrowers. In the real world, banks provide financing through money creation. That is they create deposits of new money through lending, and in doing so are mainly constrained by profitability and solvency considerations. This paper contrasts simple intermediation and financing models of banking. Compared to otherwise identical intermediation models, and following identical shocks, financing models predict changes in bank lending that are far larger, happen much faster, and have much greater effects on the real economy.

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