Interconnected banking network creating money

Decoding Interbank Credit: How Banks Create Money and What It Means for You

Theo Raines in Business & Economy December 2025 • 4 min read.

"Unraveling the complexities of interbank lending, money creation, and financial stability in today's economy."

Before the global financial crisis of 2008, mainstream economic theory often sidelined the critical roles of money and credit. The crisis, however, spotlighted how interconnected banks and their lending practices could trigger widespread economic disruption. This understanding shifted the focus toward interbank credit—the lending and borrowing between financial institutions—as a key factor influencing the money supply and overall economic stability.

Traditionally, banking has been seen as a simple process of intermediation where banks merely channel funds from savers to borrowers. However, this view overlooks the significant role banks play in creating money through lending. When banks lend to each other, or to individuals and businesses, they're not just moving existing money; they're creating new money that ripples through the economy.

Recent research delves into the intricacies of these dynamics, exploring how interbank lending networks function and what makes them vulnerable to crises. By understanding these mechanisms, we can better assess financial stability and prepare for potential disruptions. This article will explore the groundbreaking research of Yuri Biondi and Feng Zhou, focusing on their systemic perspective on the relationship between bank credit, money creation, and interbank credit.

The Money Manufacturing Process: How Interbank Credit Impacts the Economy

Interconnected banking network creating money

Biondi and Zhou's research challenges the conventional view that the money supply is solely controlled by central banks. Their findings suggest that interbank credit plays a vital role in money creation, potentially even decoupling the money supply from central bank controls. This happens because banks use interbank lending to manage their reserves and meet payment obligations, effectively creating new money in the process.

To illustrate, consider how banks operate daily: they don't just lend out existing deposits. They create new deposits when they grant loans. This is money multiplication. Interbank lending amplifies this process, allowing banks to leverage their reserves and expand credit further. If one bank needs reserves, it borrows from another, which in turn can lend out more based on its increased reserve. This creates a chain reaction with significant implications for the overall money supply.

Money Creation: Banks create money not just by lending deposits, but by issuing credit and facilitating payments.
Interbank Amplification: Interbank credit enhances this money creation, potentially making the money supply unbound from central bank controls under certain circumstances.
Financial Stability Link: Understanding interbank dynamics is vital for gauging financial stability and resilience.

The model Biondi and Zhou developed simulates how banks interact, lend, and borrow from each other under minimal institutional constraints. This agent-based model (ABM) helps to reveal emergent patterns of financial instability and provides insights into how coordination, or lack thereof, among banks impacts systemic risk. This research underscores how crucial it is for banks to effectively manage their interactions and lending practices to avoid crises.

Why Understanding Interbank Credit Matters

The research of Biondi and Zhou sheds light on the sometimes hidden mechanisms driving the financial system. By understanding interbank lending and its impact on money creation, policymakers, financial professionals, and the public can better grasp the complexities of economic stability. Recognizing the interconnectedness of banks and the potential for systemic risk is crucial for fostering a more resilient and stable financial future. As financial systems evolve, ongoing research and understanding of these dynamics will be essential for navigating an increasingly complex economic landscape.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

Everything You Need To Know

How does interbank lending contribute to money creation?

Interbank lending plays a significant role in money creation by enabling banks to manage their reserves and meet payment obligations. When a bank needs reserves, it borrows from another bank. This allows the borrowing bank to maintain its lending activities and the lending bank to further extend credit based on its increased reserves. This process amplifies the money supply beyond what central banks directly control, potentially decoupling the money supply from central bank controls under certain circumstances.

What is the conventional view of banking and how does it differ from the perspective presented by Biondi and Zhou?

The conventional view of banking portrays banks as intermediaries that channel funds from savers to borrowers. This perspective overlooks the role banks play in creating new money through lending. Biondi and Zhou's research challenges this view by highlighting that banks create money when they grant loans, a process amplified by interbank lending. This amplification allows banks to leverage their reserves and expand credit further, creating a chain reaction that significantly impacts the overall money supply.

Why is understanding interbank credit important for financial stability?

Understanding interbank credit is vital for gauging financial stability because it sheds light on the interconnectedness of banks and their lending practices. Recognizing how interbank lending can amplify money creation and potentially lead to systemic risk is crucial for policymakers, financial professionals, and the public. By understanding these dynamics, stakeholders can better assess vulnerabilities in the financial system and prepare for potential disruptions, fostering a more resilient and stable financial future.

What are the key insights from Biondi and Zhou's research on interbank credit and money creation?

Biondi and Zhou's research provides insights into how interbank credit impacts money creation and financial stability. Their work challenges the conventional view that the money supply is solely controlled by central banks, suggesting that interbank credit plays a vital role in money creation. This happens because banks use interbank lending to manage their reserves and meet payment obligations, effectively creating new money in the process. Their agent-based model (ABM) simulates how banks interact, lend, and borrow from each other, revealing emergent patterns of financial instability and highlighting the importance of coordination among banks to avoid systemic risk.

How does the agent-based model (ABM) developed by Biondi and Zhou contribute to understanding financial instability?

The agent-based model (ABM) developed by Biondi and Zhou simulates how banks interact, lend, and borrow from each other under minimal institutional constraints. This model helps reveal emergent patterns of financial instability by showing how coordination, or the lack thereof, among banks impacts systemic risk. By simulating these interactions, the ABM provides insights into how vulnerabilities can arise within the interbank lending network and how these vulnerabilities can lead to broader financial disruptions. This underscores the importance of banks effectively managing their interactions and lending practices to avoid crises.