Commercial banks literally conjure new money out of thin air through a magical process called fractional reserve banking every time they approve a loan.

How a bank loan creates a deposit

When a commercial bank makes a loan, it usually records two entries at once: an asset, the borrower’s promise to repay, and a liability, a deposit the borrower can spend. The deposit is new bank money—not a pile of someone else’s savings moved into the borrower’s account.

That accounting explains how a home purchase can begin before the borrower has repaid anything. The borrower pays the seller, and the deposit moves to the seller’s account. If the seller banks elsewhere, the two banks settle the payment between themselves, typically using central-bank money. The customer’s deposit has changed hands; the banks still have to meet the payment.

What keeps lending from being unlimited

Creating a deposit does not create wealth for the bank without risk. The loan is an asset only if the borrower repays it. The bank must also handle withdrawals and payments, comply with capital and liquidity requirements, and judge whether the expected interest and fees justify the chance of default. A bank can create deposits through lending, but it cannot create unlimited lending capacity.

Those constraints help explain why banks do not simply approve every application. A borrower’s ability to repay matters, as do the bank’s funding needs, balance sheet and appetite for risk. If many borrowers fail to pay, the bank’s loan assets lose value even though the deposits created earlier may already have been spent.

How repayment reverses part of the process

When a borrower repays loan principal from a bank deposit, the bank reduces both the loan balance and its deposit liability. In that sense, repayment extinguishes the bank money created by the loan. Interest is different: it is income to the bank, not repayment of principal, and its later movement through the economy depends on how the bank spends or distributes that income.

The striking consequence is that money in a modern economy is not only transferred from saver to borrower. A large share enters circulation as a bank records a debt and a matching deposit—then contracts again as principal is repaid.