32 responses to “Loan repayments destroy credit money. Right? Wrong. They don’t.

  1. OK. I take out a loan for 10K to buy and car and pay the vendor. The vendor now a 10K deposit, a bank liability. I still have a 10K loan to repay, which is a bank asset. Assume I repay the loan over 3 years. Ignoring
    interest, my deposits will decline by 10K relative to what they otherwise would have been. The loan is now gone. Yes, the vendor still has the 10K in deposits which are, say, still circulating. But my deposits declined by 10K because of the loan repayment. So overall, bank assets and liabilities are unchanged after the loan is repaid relative to what they would have been if the car had never been purchased. So overall, money was first created by the loan (and it went to the vendor) and then the same amount of money was destroyed as I paid back the loan. So I don’t quite get the “remains in circulation” argument from an overall perspective. Now, of course, I have the car. But I also have had to reduce consumption on other goods to have the money to repay the loan. So, on a “real goods” basis, it seems to be a wash also. Since Mr. Keen and yourself are more knowledgeable than I am, I’m probably missing something. Any thoughts appreciated. . .

  2. I believe that you (and Keen) are wrong. There are 2 types of money — base money (currency and bank reserves), and credit money created by banks. Banks loans are not typically made and repaid in currency. Rather, when the loan is made, the money outside the banking system is increased by crediting a checking account (in exchange for IOU). When the loan is repaid, the checking account balance of the borrower is decreased (cancelling the IOU). In neither case is the base money supply affected.

    If the loan is made and repaid in cash, then the money supply is unaffected, although the loan may move money into circulation, and the repayment may remove money from circulation.

    If, as in your example, the loan is made by creating new bank credit money, and repaid in currency, then the flow is as follows:

    1. New credit money created (outside banking system)
    2. Credit money destroyed (replaced by base money) as currency withdrawn from bank (lowering demand deposit balance).
    3. Currency transferred to banking system to repay loan.


    1. New credit money created (outside banking system)
    2. Hoarded currency (outside banking system) delivered to banking system to repay loan.
    with the net result that new credit money has indeed been created, but this has been balanced by a reduction in currency held outside the banking system. So no new money is left outside the banking system following repayment of the loan. The accounting is a little more complicated, but basically irrelevant as this is never done in practice.

  3. Peter,

    Obviously money is not destroyed when your £10k loan is repaid because as part of the repayment process, you introduce £10k to the economy from nowhere, or to be more exact, from the central bank. That’s the £10k of base money used to repay the loan.

    Put that another way, if the £10k of base money existed somewhere in the economy PRIOR to the £10k loan being made, and the debtor manages to get hold of that £10k of base money somehow or other, and uses it to repay the loan, then the money supply DOES DECLINE by £10k when the loan is repaid: the £10k created by the commercial bank disappears.

  4. The situation would end up exactly the same if I bought the car from the vendor with cash. He would then put the £10k of cash into the bank which they would hold in their reserves. They would then credit the vendor with £10k of bank created credit money.

    If a civil servant is paid directly from government his salary cheque will be in BoE (state) money. The banks will put that money into their reserves and create credit money to show in the civil servant’s account.

    So, the banks create money all the time in this way. If they consider their reserves are excessive they will purchase gilts. They are quite adept at managing on the minimum level of reserves knowing they can always acquire reserves if needed. Consequently it appears that the amount of money in the economy consists of nearly all bank credit money. (Which the Positive Money group seem to have noticed).

    So just paying off a debt to the bank won’t in itself destroy any bank credit money. That only happens when the account holder makes a withdrawal in cash or if there is a financial transaction involving government or another bank which insists that the payment should be made from the bank’s reserves.

  5. “So just paying off a debt to the bank won’t in itself destroy any bank credit money.”

    It destroys the credit money created by that loan. It won’t destroy ‘credit money’ created by government fiat payments – all of which create credit money when they happen.

    What happens when government pays anybody is that the ‘money’ ends up in two places. It is a liability at the Bank of England, *and* a liability at the commercial bank, with the commercial bank holding the corresponding offset deposit at the Bank of England – which we call ‘Bank Reserves’.

    The relationship between a commercial bank and the Bank of England is a simple currency peg. The commercial bank is required to ‘convert’ the Bank of England liabilities into its own liabilities and back again to maintain parity of the commercial bank liabilities with Sterling.

    To get hold of £10k of government notes, you had to previously withdraw that from a bank. That previously deleted £10k of credit money and £10k of bank reserves as you took up the liability directly with the Bank of England, rather than via an intermediary.

    Bank notes don’t arrive out of thin air. They are receipts for a deposit at the Bank of England. That’s why they say ‘I promise to pay the bearer’ on them. And you have to obtain them – from a bank.

    Paying your £10K in notes in just executes a swap in the system. The Bank Reserves are created and the corresponding ‘credit money’ deposit created. The deposit is then written out against the loan deleting the two. The Reserves then match the other credit money deposit held elsewhere and you drop out of the middle. Which is how all debts are settled everywhere – you swap a debt you owe for a debt you own.

    The point Steve was making was a different one, which I think is to do with the fact that current commercial banks are actually ‘narrow banks’ in the sense that the sovereign money believers mean – i.e. they are actually fully funded. Which is correct, surprising to a lot of people who haven’t picked up on the subtleties of MMT bank descriptions, and which is why the ‘sovereign money’ changes won’t actually change anything.

    I believe Steve has changed the way he expresses it now, since the idea can be misinterpreted – as this piece demonstrates!

    As an aside sovereign money proposals boil down to putting interest rates up to get less lending and more saving and then offset that by injecting more money via government with tax cuts or spending increases. Which is nothing new – hence the need to dress it up with lots of mumbo-jumbo so it sounds more impressive.

    • Neil,
      Thanks for your comments. You’ve said “The relationship between a commercial bank and the Bank of England is a simple currency peg. ”

      That’s the way I see it too. Commercial bank money is essentially a parallel currency. Its not the same currency though so we have to be careful when looking at the double entries. The two currencies can’t be mixed.

      This is the situation prior to the loan repayment. (assets, liabilities)
      Commercial Bank Liabilities (Credit Money)
      Purchaser (0, 10) Vendor ( 10, 0) Comm Bank (10,10)
      Central Bank Liabilities (BoE Money)
      Purchaser (10,0) Cent Bank (0,10)

      After the loan repayment:
      Commercial Bank Liabilities (Credit Money)
      Purchaser (0, 0) Vendor ( 10, 0) Comm Bank (0,10)
      Central Bank Liabilities (BoE Money)
      Purchaser (0,0) Comm Bank (10,0) Cent Bank (0,10)

      Note that assets = liabilities in each currency both before and after the repayment.

      So the commercial bank has given up its asset in its currency (or own issued liabilities) in exchange for the acquisition of the asset of central bank currency (or their liabilities). It still has its liability towards the vendor, for whom nothing has changed at all.

      So I’m sorry that Steve seems to have deserted me but I think I’m still with Keynes on this one!

      • You’ll find that what has happened in this case is that the balance sheet in the commercial bank circuit has shrunk. It was (20,20) and now it is (10,10). That’s what creation/destruction looks like – expanding and shrinking balance sheet totals.

      • I don’t understand why the commercial bank was (20,20). I’d put (10,10)

        Before the repayment, the bank has a liability of the 10 it created which ended up with vendor, and an asset of 10 due to the acceptance of the loan by the purchaser. It is this asset which changes on repayment. It becomes the ownership of BoE money rather than the debt.

      • I see what you’re saying: the money the bank created went out but eventually came back in and replaced the loan agreement as an asset. If this were/is the case then the bank has created £10k new money for itself! This does happen indirectly when banks create money for one another – say to buy gilts. But when banks pay loans off, just the same as individuals, the money disappears again. Hence we have a mechanism for boom and bust!

  6. Prof Keen responded on twitter on this
    @ProfSteveKeen: Actually @netbacker I have changed my mind on this thanks to Minsky double-entry modeling! Currency issue still relevant though.

  7. Yep. It seems that I misinterpreted Steve, and the lack of discount window usage didn’t come from his private circuit dynamic stuff. And I’ve been attributing that to Steve’s work for a while.

  8. Afraid it’s common-sense guys! With 97% of the money in circulation there’s a 97% chance that the money the car-buyer used to pay-off his debt to the bank had been created by a bank somewhere so there’s a 97% chance that the repayment destroyed the EQUIVALENT amount of money that had been created by the loan.

  9. Sorry! In my previous post please insert “having been created by commercial banks” after “With 97% of the money in circulation”.

  10. On a slightly different tack: A debt-based money creation system [inevitably?] creates income inequality. Income inequality is not compatible with a successful thriving mature consumer led economy. Unless the problem is addressed pro-actively and constructively it will [inevitably?] result in re-active unsavoury solutions – financial collapse/mayhem or warfare.

    • Peter,

      You’re one of the Positive Money group? Yes, they make a big thing about the 97% figure.

      But it could be whatever the commercial banks wish it to be. The better they are at managing with low levels of reserves the closer it will be to 100%. The commercial banks are constantly swapping received BoE money for their own money. In normal times they don’t get any interest on their central bank money so they exchange as much as they possibly can for gilts which do pay out some interest.

      • No I’m not with PM though I support their analysis and some of their conclusions. But the full reserve banking which they propose will not work!
        I go with Adair Turner’s proposals made in April 2013 at the Philadephia conference – progressively hiking up commercial bank reserve requirements to 30% thereby restricting their money creation/lending whilst at the same introducing debt free money through state capital expenditure and a progressive scaling down of the treasury bond system. this will push investors such as pension and insurance funds towards corporate bonds and free the banks up to do what they should be doing : financing SME and private expenditure – with no need for unrealistic salaries and bonuses::
        Philadelphia Global Centre 31st Annual and Monetary Trade Conference: Fixing the banking system for good on April 17th.
        The proceedings can be viewed at:
        Also Adair Turner at the INET conference in Hong Kong:
        Please note agaoin I am not convinced of “positive money”‘s totalitarian ideas but Turner’s halfway house is a good bet!

      • P.S. Michael Kumhof [IMF reesearcher] at the same Philadelphia Conference is good sound stuff – even if his presentation is abysmal!

  11. When you repay a loan you first put the govt money in the bank – bank now has a liability (deposit to you) and an asset. When you then use your deposit to repay the loan the bank’s liability (deposit) is cancelled together with the bank’s asset (loan). So yes, equal number of bank money that had been created by the loan now evaporates. Number of govt money stays constant in this operation, it only changed hands.

    • Please see my reply to Neil Wilson above. I agree with your last sentence but the bank’s liability is still the same before and afterwards. It is its assets in its own ‘currency’ which is reduced.

      • Right. When private loans are made, no new net financial assets are created for the private sector. New deposits are matched by new liabilities. But net financial assets are not the same thing as money. Money, as generally defined, is created and destroyed by bank loans and repayments…

  12. Pingback: Loan repayments destroy credit money. Right? Wrong. They don’t. (Part2) | Modern Monetary Theory: Real Economics

  13. Couple of things, first of all cash represents Central Bank reserves and Bank-issued deposits. When a loan is repaid, we can say that some monetary measure has been reduced, but we can’t know which one.

    Imagine the depositor has a £10k savings account (which is liability for the bank) and then takes out a £10k loan (which is a bank asset). Let’s say the depositor pays off the loan from the savings accounts (so there is no cash to worry about in this example, and lets ignore interest). When the loan is paid off, the depositor has £0 in the savings account and £0 loan balance. What does the bank have? The bank has a £0 balance asset (the loan is closed) and has a £0 deposit liability.

    Destroyed may not be the exact right word, but it pretty close to what happens.

    The issue when you get into cash is that cash can represent both CB-issued reserves as well as Bank-issued deposits. Reserve transaction occur between banks and the CB. Cash transactions occur between individuals, between individuals and banks and between banks and the CB. Bank-issued deposit transactions occur between individuals and banks and between banks.

    So in the example of “I walk into the bank with £10k of real government BoE printed notes . I hand that over to the bank. My loan is repaid. The bank puts the government money into its reserves.” Some money measure was reduced – as soon as the bank put the money into its reserves, it removed the money from circulation – because by doing so also affects the CB balances. If the bank just holds onto cash (cash on hand), then the CB is unaffected. The bank would put it in reserves because it has literally no use for it as cash.

    What the example shows is the system wide preference to hold cash vs. Bank-issued deposits, that all.

    • But the 10k you originally borrowed is surely still out there? and fragmented into several breakdowns given you spent the inititial loan and you’ve now paid back the laon so the bank has 10k, while the original 10k is floating around the country?

      • The bank doesn’t end up with £10k! – it’s easier to look at the transactions separately. The loan money was created by the bank on its books with the deposit account representing a debt to the borrower balanced by a loan agreement as a bank asset. The bit I have difficulty with is how to regard the difference between the loaned money being in the account or spent into circulation; but I’ll return to that in a minute! Regardless, when the loan is repaid the money does disappear.
        Meanwhile, with respect to the savings account let’s assume this savings money wasn’t transferred directly to pay off the loan but was first spent into circulation – lent to a friend for a week. Then the loan money was used to buy a car before paying off the loan with the savings money retrieved from the friend.
        At the end the bank has nothing – otherwise it would be a nice way for banks to create money for themselves! – which they are not allowed to do;[ they just do it for one another!] The savings money went into circulation through the purchase of the car and the guy now has a car and no savings so that balances. But back to the point I made earlier re. the loan money. The savings money will remain in circulation until at some point someone uses it to pay off a loan at which point it disappears.
        One crucial point is that it is not possible to tell the difference between savings money deposited at the bank and loan money created by the bank in question. As I understand it this is probably the reason the 1844 Bank Act didn’t prohibit the creation of deposit accounts – and it’s not easy to get your head around it – hence the reason politicians, bankers, economists and accountants struggle with it!

  14. Unless your Paul Daniels and believe in the disappearance at the flick of a wond, then there must be another logical reason why banks are issuers? the banks issue a loan, you spend the loan, that monies goes into cirrulation and you then pay the bank loan off, generating an annual GDP growth by burning off or disappearing cash just doesn’t ring true.The BoE came around in 1649, merely as a means to funds wars as did GDP, todays banks vaults and GDP are simply much helthier than they were way back at the begining, simply because money given to people was spent and currulated around the country before returning to government through taxes as banks built up a healthier gold bullion store.

    • The banks became the creators of money almost by default partly because the central bank came into being to prevent Monarchs printing money to pay debts/finance wars and obviously later to attempt to prevent governments bribing the electorate – though on this, clearly, if there was no bribery at all then there would be no point in elections since one votes for how one wants your money or taxes spent.
      It didn’t really get out of hand until after 1970 at which time BOE “real” money and bank created money were equal at £50 billion of each – now there’s £100bn BOE money to £1,850bn money that has been created by banks; £1.8 trillion of it since 1970!
      The trouble is that when things look good banks ladle it out and when it all goes pear-shaped they haul it all back in and it disappears; that is the problem in our current on-going depression [2008 —–?]

  15. FYI …

    Steve Keen has said a lot of things and then he has changed but he doesn’t admit that. So be careful with him. Sometime he said he has improved his accounting after criticisms of his models, so …

    Your first example looks okay except that it’s not the case that loans are always paid in cash.

    Around the time, people were trying to make him realize that he was confusing capital and reserves.

  16. Excuse my naivety please.

    1. If debt is destroyed on repayment is the interest also destroyed or does it continue existing?

    2. If debt is really destroyed in the greater scheme of things why does our debt keep increasing?

    3. Is the use of the word ‘destroyed’ the most appropriate word to describe the process? Is there a better word?


    • 1) You can figure out if you consider that all money is an IOU. BoE money is an IOU of the government, It is effectively a tax voucher so that when we pay our taxes the government takes possession of it own IOU and tears it up.

      2) Our debt doesn’t always increase. I, personally, used to be in much more debt when I was younger for example. Governments debt, as a percentage of GDP rises and falls. It was much higher in previous times. See the graphs on this link.


      3) You could say extinguished if you like. If I get back an IOU which I’ve issued, I just tear it up. Gamblers issue ‘markers’, which are just IOUs, when they run out of money which may or may not be accepted as a stake. If they win the hand they tear them up for security reasons. If they lose they have to pay up before they are handed back to be torn up.

  17. your example can be simplified by making the car purchaser an employee of the vendor whose yearly salary is 10k. the purchaser gets a one year loan from the bank to pay for a car from his employer, the vendor.

    a 10k asset representing the loan is created on the bank’s accounts. a 10k deposit is created for the purchaser in a loan account, a liability for the bank. the car purchaser wires the 10k to the vendor. the car is bought. the liability from the bank to the purchaser is now zero, and 10k to the vendor.

    when his employer, the vendor, pays him his annual salary by wiring 10k, his employer’s account is debited 10k, the banks deposit liability is reduced by 10k to zero for the vendor. the banks deposit liability to the purchaser is now 10k.

    the purchaser walks into a branch, tells them to pay the loan off from his loan account and to close it

    all deposits and liabilities on the bank’s accounts are zero.

    in an alternate scenario:

    if the employee is fired before receiving any salary and declares total bankruptcy, the bank’s loan asset of 10k is destroyed with a bad debt expense of 10k taken from its assets. the bank retains a deposit liability of 10k to the car vendor, but zero cash to pay for it (unless it has insurance or tries to go after the fired employee in court!)


    when you take interest into account you see that the assets created by the bank greatly exceed the liabilities they create by depositing a loan into a purchasers loan account. in this way I feel debt ‘money’ is created/inflated and you can see from the bankruptcy scenario above how it can only be destroyed.

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