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The True History of Banking
Part 1 – The Hidden Power Behind Banks: The Ability to Create Money

The story of banking is often told incorrectly. Most people are taught a simple explanation: banks take deposits from savers and lend those funds to borrowers. In this narrative, banks are merely intermediaries—middlemen connecting those who have money with those who need it. It sounds reasonable, tidy, and harmless. Yet the deeper history of banking reveals something far more significant.

Banks do not simply move money. They create it.
Understanding this point is the true starting line for any honest history of banking. Without recognizing how money is created, it is impossible to understand financial crises, economic growth, or the immense influence banks hold over societies.

The history of banking is therefore not merely about vaults, interest rates, or paper currency. It is about the evolution of a unique institutional privilege: the ability to create purchasing power through credit.

And that story has been misunderstood for generations.
The Three Competing Theories of Banking

For much of the modern academic era, economists have debated how banks actually operate. According to the source material, there are three major theories explaining banking.

The first—and still dominant in many textbooks—is the financial intermediation theory. This theory claims that banks gather deposits from savers and then lend those deposits to borrowers. In other words, banks are simply conduits moving existing money around the economy.

This explanation is widely accepted because it appears intuitive. People deposit money, banks lend it, and the bank earns a margin. But according to deeper research into banking operations, this description is fundamentally incorrect.

The second theory is known as the fractional reserve theory. In this model, banks still act as intermediaries, but when multiple banks interact, new money is supposedly created through a multiplier effect tied to reserves.

For decades, students of economics were taught this model. It introduced the idea that banks could expand the money supply, but it still framed banks as dependent on deposits and reserves.
However, there is a third theory—one that had existed historically but was largely dismissed for years.

This is the credit creation theory of banking.
According to this theory, banks are fundamentally different from other financial institutions. They possess a special legal and accounting privilege: they can create new money when they issue loans.

This is not a metaphor. It is not a theoretical abstraction. It is a practical accounting reality.

When a bank grants a loan, it does not transfer money from someone else’s account. Instead, the bank creates a new deposit in the borrower’s account, thereby increasing the money supply.
This means the borrower receives money that did not previously exist.

Money Created “Out of Nothing”
The implications of this discovery are profound.
When a loan is issued, no other depositor loses funds. No pile of existing cash is moved. Instead, the bank expands its balance sheet: a loan appears as an asset, and a new deposit appears as a liability.

This process effectively creates purchasing power out of nothing.
In technical language, the money is created ex nihilo—out of nothing.

For many people, this idea sounds extraordinary, even implausible. Yet it is confirmed by examining the accounting practices of banks. When non-bank institutions issue loans, they must transfer existing funds from somewhere on their balance sheet. Banks, however, simply create the deposit simultaneously with the loan.

That is the defining difference between banks and other financial institutions.

This unique ability explains why banks hold such influence within economic systems. They are not just financial intermediaries—they are the primary creators of money in modern economies.

Why This Was Hidden in Plain Sight
One of the striking insights from the source material is how long this understanding was overlooked or dismissed.

For decades, mainstream economic models excluded banks entirely from their explanations of how economies function. In many academic frameworks, banks were treated as peripheral institutions rather than central drivers of economic activity.
Yet in everyday life, people intuitively recognize the importance of banks. When asked who they owe money to, the answer is almost always the same: a bank.

The disconnect between real-world experience and academic theory had significant consequences. Because economists misunderstood banking, they struggled to explain financial crises and economic cycles.

The financial crisis of 2008 exposed this gap dramatically. Analysts who relied on models without banking dynamics found themselves unable to explain what was happening when major financial institutions began to collapse.

Understanding that banks create money changes the entire analytical framework.

It reveals why credit booms can inflate asset bubbles. It explains why financial crises occur when lending collapses. And it clarifies why banking policy has such far-reaching effects on society.

The Banking License: A Public Privilege
If banks can create money, an obvious question arises: why are they allowed to do so?

The answer lies in law and regulation.

Banks operate under licenses granted by governments. These licenses give them the legal authority to expand their balance sheets in ways other institutions cannot.
In essence, banks are granted a public privilege: the power to create money through lending.

Because of this privilege, the activities of banks affect everyone—not just their customers. Every loan issued increases the total money supply and influences economic conditions.

This is why the allocation of bank credit matters so profoundly. Where banks direct new lending determines whether an economy grows productively or experiences instability.

If banks finance productive enterprises—businesses building goods, services, and innovation—the result can be genuine economic expansion.

But if banks primarily lend for speculative asset purchases, the consequences can be very different.

The Seeds of Boom and Bust
One of the key insights from the source material is that banking crises often arise from the type of credit banks create.
When banks channel large amounts of credit into asset purchases—such as real estate or financial markets—prices rise rapidly. This creates bubbles that eventually collapse, leading to recurring financial crises.

In some countries, a large majority of bank lending goes toward such asset transactions. This pattern produces cycles of boom and bust that appear almost inevitable under the current system.
However, the same mechanism that produces instability can also produce prosperity.

If credit creation is directed toward productive investment—new technologies, businesses, and infrastructure—it can drive sustained economic growth without inflation or financial crises.
This dual nature of banking is central to understanding its history.
Banks are capable of generating extraordinary prosperity. But they can also generate systemic risk when credit is misallocated.

The Real Beginning of Banking History
Many histories of banking begin with goldsmiths, vaults, or ancient coinage. While those developments are important, the deeper story begins with the realization that money can be created through credit.

Throughout history, banking systems evolved around this insight—sometimes openly, sometimes quietly.

In later centuries, institutions such as the Bank of England formalized banking rules and laws that enabled this system to function at scale.

But the core principle remained constant: banking is fundamentally about credit creation.

This principle is the key to understanding why banks became the most powerful economic institutions in modern societies.

A Different Way to View the Economy
Once we recognize that banks create money, the structure of the economy looks very different.

Economic growth becomes closely tied to credit expansion. Political systems become intertwined with banking structures. Financial crises become understandable as contractions in credit.
It also becomes clear why control over banking institutions can shape entire nations.

The source material emphasizes that the number of banks and how credit is distributed can influence how centralized or decentralized a society becomes. When credit is concentrated in a few institutions, economic power becomes concentrated as well.

This insight leads directly into the next stage of banking history: how banking systems evolved from early private institutions into centralized financial structures that shape national economies.

What Comes Next in the Story
Part 1 has established the foundation: the hidden reality that banks create money and that this power lies at the heart of modern economic systems.

But the historical story is only beginning.
In the next part of this series, we will explore how early banking systems developed, how governments became intertwined with banking institutions, and how the control of credit gradually became one of the most powerful forces in shaping nations and economies.

Because once money can be created through credit, the question inevitably follows:

Who decides where that credit goes?