ELI5: Why do banks lend money they don’t have?

Banks lend money they don't currently have because they create new money based on what people deposit and their trust that everyone won't ask for all their money back at once.

Think of it like this: Imagine you and your four friends decide to start a lemonade stand. Everyone puts in $10, so you have $50. That's your deposit.

Now, your neighbor wants to buy a bike but only has $10. You, as the "bank" (lemonade stand co-op), decide to lend him $40, even though you only really have $50 in the cash box. Where did the extra money come from? You are trusting that your friends don't all need their $10 back right now, and you hope the neighbor will pay you back with a little extra (interest) so everyone benefits.

Here's how banks work similarly in real life:

• People deposit money in the bank.
• The bank keeps a small amount of that money in the vault (called a reserve).
• The bank lends the rest to other people or businesses who need it for things like buying houses or starting companies.
• When the bank lends money, it's essentially creating new money in the form of a loan. The person who borrowed the money can now spend it.
• The bank charges interest on the loan, which is how it makes money.