Money · Credit · New Zealand · Part 2
What actually happens when a bank creates a loan?
The easiest way to understand modern money is to stop imagining a bank vault and start looking at a balance sheet.
In the first article in this series, I looked at a fact the Reserve Bank of New Zealand states plainly: commercial bank lending creates bank deposits, and bank deposits make up the vast majority of broad money used in New Zealand.
That raises an obvious next question.
If the bank did not first take the exact same money from somebody else's savings account, what actually happens when it approves the loan?
Start with the bank's balance sheet
A bank has assets and liabilities.
An asset is something of value owed to or owned by the bank. A loan is an asset because the borrower has a legal obligation to repay it.
A liability is something the bank owes to someone else. A customer's deposit is a liability because the bank promises to honour withdrawals or transfers from that account.
That is the key to understanding the transaction.
Suppose a bank approves an $800,000 mortgage.
At the moment the lending transaction is completed, two entries can appear:
Bank asset: +$800,000 loan
Bank liability: +$800,000 deposit
The bank has expanded both sides of its balance sheet.
The Reserve Bank describes this process directly. Its 2023 Bulletin gives an example in which an $800,000 loan becomes an asset of the bank while a corresponding $800,000 deposit becomes a bank liability.
Reserve Bank: Money creation in New Zealand ↗
The bank has created a deposit — not physical cash
This distinction matters.
The bank has not printed $800,000 of Reserve Bank notes.
It has created a bank deposit: a promise by the bank to make payments on behalf of its customer.
That deposit is still money in the practical sense. It can be transferred to another person, used to buy property, paid to a supplier or moved through the banking system.
This is why bank deposits are included in broad money.
But bank deposits and Reserve Bank settlement cash are not the same thing.
So what are reserves — or settlement cash?
New Zealand banks and certain other financial institutions hold accounts with the Reserve Bank through the Exchange Settlement Account System, or ESAS.
The balances in those accounts are called settlement cash.
Settlement cash is central-bank money. It is used by banks to settle obligations between themselves.
The Reserve Bank is explicit that settlement cash cannot simply be lent out to the general public. It is held within the settlement system by eligible institutions.
Reserve Bank explanation of settlement cash and broad money ↗
Reserve Bank: Monetary policy implementation framework ↗
What happens when the borrower pays someone at another bank?
This is where settlement cash becomes important.
Imagine the borrower uses the $800,000 loan to buy a house from a seller whose account is at another bank.
The borrower's bank must honour the payment.
The seller's bank credits the seller's deposit account, and the two banks settle the payment between themselves through the settlement system.
In simplified form:
Borrower's bank: keeps the loan asset, loses a deposit liability as the payment leaves, and transfers settlement cash to the receiving bank.
Seller's bank: receives settlement cash and creates or increases the seller's deposit liability.
The deposit money has moved through the banking system.
The loan has not disappeared. The borrower still owes it.
Lending creates the credit relationship. Settlement moves the payment between institutions.
This is why "banks lend out their reserves" is misleading
It is tempting to imagine that a bank first receives $800,000 of reserves and then passes those reserves to the borrower.
That is not how the Reserve Bank describes modern broad-money creation.
The lending decision creates the loan and associated deposit. Banks then have to manage the liquidity, funding and settlement consequences of that lending.
Settlement cash still matters enormously. A bank must be able to make payments to other banks and meet withdrawals.
But reserves and customer deposits perform different functions.
Why can't a bank just create endless loans?
Because every loan creates obligations and risks for the bank.
The Reserve Bank identifies several important constraints.
Liquidity. A bank has to be able to meet withdrawals and payments to other banks.
Stable funding. Banks need funding sources that are not likely to disappear all at once.
Capital. If borrowers default, shareholders absorb losses. Banks therefore need sufficient equity to remain solvent through losses.
Credit risk. Banks still have to decide whether a borrower is likely to repay.
Demand. A bank cannot force viable borrowers to borrow. Customers must want the loan and be able to service it.
Interest rates and monetary policy. The cost of borrowing influences how much credit households and businesses demand.
So a bank's ability to create deposits through lending is real — but it operates inside a tightly connected system of balance-sheet constraints, regulation, risk and economic demand.
The scale is significant
Reserve Bank statistics reported total gross bank loans of approximately $615.1 billion in June 2026.
That figure includes lending across housing, business, agriculture, personal lending and other purposes.
Reserve Bank: Bank loans by purpose ↗
That is why the question of credit allocation matters so much.
Credit creation is not just an accounting curiosity. It influences what gets built, what gets purchased, which assets rise in price, which businesses can expand and which parts of the economy receive new purchasing power.
The question underneath the mechanics
Once we understand that banks do not simply recycle a fixed stock of pre-existing money, a more interesting policy question appears:
What kinds of activity do we want our credit system to make easier — and what kinds of activity should it make harder?
Housing?
Productive businesses?
Infrastructure?
Agriculture?
Energy?
Speculation?
Community assets?
New technology?
The mechanics do not answer that question for us.
They simply show that credit allocation is an active part of how an economy develops.
One final distinction
Understanding that bank lending creates deposits does not mean a private person can compel a bank to accept any privately created instrument at any value.
It also does not mean government spending, commercial bank lending, central-bank money creation and private financial instruments are interchangeable.
They are different legal and accounting relationships.
That distinction is important because serious monetary reform starts with understanding the existing system accurately.
Once we know what each part of the machinery actually does, we can ask better questions about how it could be used differently.
Next
The next question is the one I think matters most for the wider conversation:
If commercial banks can create deposits through lending, what actually limits the amount of credit they can create?
That takes us into capital, liquidity, regulation, the OCR, inflation, borrower demand and the real productive capacity of the economy.
That will be Part 3.
Primary sources
Reserve Bank of New Zealand — Money creation in New Zealand ↗
Reserve Bank of New Zealand — Monetary policy implementation framework ↗