Money creation in modern economies, including Nigeria, is primarily driven by commercial banks through the lending process, while the Central Bank of Nigeria (CBN) provides the reserve infrastructure that supports the banking system.
Key Highlights
• Commercial banks create most of the money in circulation through lending.
• New money is created when banks issue loans and credit borrowers’ accounts.
• The CBN manages reserves used by banks to settle transactions between themselves.
• Banks do not need to hold reserves before granting loans; they can obtain reserves afterward if required.
• Every new loan increases deposits within the banking system, thereby expanding the money supply.
How Commercial Banks Create Money
When a commercial bank approves a loan, it does not typically lend out existing deposits. Instead, the bank creates a new deposit in the borrower’s account.
For example:
• If a customer named Segun receives a ₦100,000 loan from GTBank, the bank records:
• A ₦100,000 loan asset on its balance sheet.
• A ₦100,000 deposit liability in Segun’s account.
At that moment, ₦100,000 of new money has effectively been created within the banking system.
The Role of the Central Bank
The CBN serves as the banker to commercial banks. Each bank maintains a reserve account with the apex bank, which is used to settle interbank transactions.
For instance:
• If Segun transfers ₦50,000 to Abdul-Lateef, who banks with Access Bank, GTBank must transfer ₦50,000 from its reserve account at the CBN to Access Bank’s reserve account.
• These reserves facilitate payment settlements between banks.
What Happens If a Bank Lacks Sufficient Reserves?
If a bank does not have enough reserves to complete a transaction, it can:
• Borrow reserves from another bank.
• Sell assets to raise liquidity.
• Borrow directly from the CBN using eligible collateral.
This demonstrates a key principle of modern banking: banks typically create loans first and secure reserves later.
Impact on Money Supply
Assume total deposits in the banking system amount to ₦2 million before Segun’s loan.
After GTBank grants the ₦100,000 loan:
• Total deposits increase from ₦2 million to ₦2.1 million.
• The banking system’s money supply expands by ₦100,000.
This process illustrates how bank lending contributes directly to money creation and economic activity.
Conclusion
Money creation in Nigeria largely occurs through commercial bank lending rather than direct printing of currency. By issuing loans, banks create new deposits that increase the money supply, while the CBN ensures smooth settlement of transactions through the reserve system. This framework forms the foundation of modern monetary systems and plays a critical role in supporting economic growth and financial intermediation.
