Why Bank Money Creation?

We provide a rationale for bank money creation by comparing it to a system in which banks operate solely as intermediaries of loanable funds - a setup that could arise with the widespread adoption of stablecoins or the introduction of CBDCs. In a loanable-funds system, households impose leverage constraints on banks to ensure they retain sufficient “skin in the game†for diligent loan monitoring. However, if banks differ in their monitoring efficiency and this heterogeneity is unobservable, such discipline leads to inefficiently low aggregate lending. Bank money creation mitigates this inefficiency by allowing banks to extend credit without relying on prior deposit funding. With appropriately designed regulatory capital requirements, the gains from higher overall lending outweigh the losses from weaker monitoring incentives. These findings provide a clear justification for preserving the money creation privilege of banks.