Funding liquidity creation by banks

Abstract

Relying on theories in which bank create private money by making loans that create deposits—a process we call “funding liquidity creation”—we measure how much funding liquidity the U.S. banking system creates. Private money creation by banks enables lending to not be constrained by the supply of cash deposits. During the 2001–2020 period, 92 percent of bank deposits were due to funding liquidity creation, and during 2011–2020 funding liquidity creation averaged $10.7 trillion per year, or 57 percent of GDP. Using natural disasters data, we provide causal evidence that better-capitalized banks create more funding liquidity and lend more even during times when cash deposit balances are falling or unchanged. Large banks as well as the top banks in Federal Reserve districts create more liquidity.