A €10,000 loan in two entries
Suppose a bank grants a customer a €10,000 loan. A loan receivable appears among the bank's assets: under the contract, the customer owes principal and interest. A €10,000 deposit appears among its liabilities in the customer's account. The customer has received money available to spend and a debt for the same principal.
The customer's net wealth has not automatically risen by €10,000 at the moment of drawdown, because the new debt stands against the new deposit. The quantity of bank deposits in the economy has nevertheless increased. This is why central banks explain that commercial-bank lending creates most modern money.
What happens when the borrower spends it
If the customer pays a seller at the same bank, the bank reduces the buyer's deposit and increases the seller's. This internal transfer does not change its total deposits. If the seller banks elsewhere, the deposit moves to the other institution and the two banks must settle the payment, normally using central-bank reserves.
The bank losing the deposit must therefore manage liquidity and funding. It can attract other deposits, borrow in markets, sell liquid assets or, if eligible, obtain central-bank liquidity. Creating the deposit with the loan does not make all later payments costless for the bank.
- loan approval: a loan asset and new deposit arise
- payment within one bank: names attached to deposits change
- payment to another bank: interbank settlement becomes necessary
Repaying principal extinguishes created money
When the borrower repays principal from a bank deposit, the bank reduces both its loan receivable and the deposit used for repayment. In this simplified operation, part of the bank money created earlier disappears. New lending and repayments happen continuously, so total deposits reflect their combined effect and other balance-sheet transactions.
Interest must be distinguished from principal. Interest received is bank revenue used for expenses, losses, taxes and any profit; it does not cancel loan principal in the same accounting manner. When the bank later spends income on wages or services, money returns to deposits held by the non-bank sector.
What the mechanism does—and does not—say
It does not mean that a bank can credit arbitrary sums to anybody without consequence. A loan can default, payments can drain reserves and losses can destroy equity. The bank must price risk, fund itself, meet regulation and find a customer willing and able to repay.
Bitcoin is not created by lending under its protocol. Someone can nevertheless lend existing bitcoin or create a contractual claim denominated in BTC. A fixed protocol supply therefore does not eliminate credit or debt claims; it separates creation of base units from a bank's decision to lend.