Most people are taught a simple story about banking. Households deposit their savings, banks collect those deposits, and the money is then lent to businesses and consumers who need credit.
It is an intuitive explanation, but economist Jesus Felipe argues that it does not accurately describe how modern banking works.
Felipe, Distinguished Professor at the Carlos L. Tiu School of Economics of De La Salle University, raises the issue in his study, Could Pope Leo XIV and Karl Marx See Eye to Eye? Comments and Questions on MAGNIFICA HUMANITAS. The paper critically examines Pope Leo XIV’s encyclical Magnifica Humanitas, including its discussion of artificial intelligence, labor, finance, inequality and the broader economic system.
Felipe agrees with several of the Pope’s concerns about finance, but he argues that the encyclical makes a mistake when it describes savings as being transformed into credit.
“The mistake is to argue that savings are transformed into credit,” Felipe writes.
His argument goes to the heart of how money is created in a modern banking system.
Banks do not simply wait for deposits before lending
The traditional explanation presents banks primarily as intermediaries. Savers provide funds, banks pool those funds, and borrowers receive loans from the pool.
Felipe argues that the process actually works in the opposite direction.
“In reality, money is endogenous: banks lend (not deposits!) and in doing so, they create the customers’ deposits,” he writes.
Consider what happens when a bank approves a loan.
If a customer receives a ₱1 million business loan, the bank does not necessarily identify another customer’s ₱1 million deposit and transfer that money to the borrower. Instead, the bank records a ₱1 million loan as an asset on its balance sheet and credits the borrower’s account with a ₱1 million deposit.
A new bank deposit has effectively been created as part of the lending process. The borrower now has money available to spend, while the bank holds a corresponding financial claim on the borrower. This means that lending itself can create bank money.
Felipe contrasts this with what he describes as the textbook version of fractional reserve banking, where loans are presented as a multiple of deposits already held by banks. He argues that the quantity of bank money is not simply fixed in advance by the central bank.
What limits bank lending?
If banks can create deposits when they make loans, an obvious question follows: why can they not simply lend unlimited amounts of money?
Felipe’s answer focuses on whether banks believe borrowers can repay.
“All commercial banks care about is whether a customer is worthy of a loan (the business proposal) and whether the loan is going to be reimbursed (no default) or not,” he writes.
This does not mean banks face no constraints. Felipe’s specific point in the study is that lending is not mechanically limited by a fixed stock of deposits waiting to be redistributed. Credit decisions therefore matter enormously.
When banks become optimistic about households and businesses, they can extend more loans, which creates more deposits and supports additional spending and investment. When banks become cautious, credit creation can slow sharply even if plenty of people are willing to save.
This makes banks much more than passive middlemen between savers and borrowers. Their decisions influence the amount of credit circulating through the economy.
Why credit matters so much
Although Felipe criticizes the Pope’s explanation of how savings and lending interact, he strongly agrees with the encyclical on a broader point: finance and credit are fundamental to the economic system.
He says Pope Leo XIV is “absolutely correct” about the relationship between finance and economic crises and about the importance of credit to economic activity.
Credit allows households to purchase homes and other large assets without waiting decades to accumulate the full amount in cash. Businesses can borrow to build factories, acquire equipment or finance expansion before the resulting revenues arrive.
This ability to spend today against expected future income is one reason credit can accelerate economic growth, but the same mechanism can also magnify problems.
If banks extend too much credit to borrowers who cannot repay, asset prices can become inflated and debt can accumulate faster than income. When borrowers eventually struggle to meet their obligations, banks can respond by tightening lending, which can weaken spending and investment across the economy.
Felipe links this part of the discussion to economist Hyman Minsky, whose work emphasized the relationship between finance, rising leverage and economic instability.
The implication is that credit can support economic expansion while also creating vulnerabilities if lending standards deteriorate.
Saving still matters, but not in the way many people think. None of this means household savings are irrelevant.
People still need savings for emergencies, retirement and future spending. Banks also need stable funding and must manage liquidity, capital and other financial risks.
Felipe’s argument is more specific. The economy does not need to wait for someone to save a peso before a bank can lend that same peso to someone else.
This distinction changes the way people think about financial conditions.
When credit expands rapidly, the important question is not only whether households are saving enough. It is also whether banks are creating loans for productive purposes and whether borrowers will generate enough income to repay them.
Likewise, when lending slows, simply having more deposits in the banking system does not guarantee that banks will increase credit. If lenders become worried about defaults or economic conditions, they can remain cautious regardless of the amount of savings available. This gives banking institutions an unusually important role in the economy.
Banks do not merely move existing money from one person to another. Through lending, they help create much of the money that households and businesses use.
Felipe’s disagreement with Pope Leo XIV may appear technical, but the implication is significant. Understanding how credit is created also helps explain why banks can fuel economic booms, why credit contractions can deepen downturns and why the health of the financial system matters far beyond the savings accounts sitting inside it.
The familiar description of banks as institutions that take deposits from savers and lend them to borrowers is therefore incomplete.
In modern economies, the loan often comes first. The deposit follows.
