Where Does New Money Really Come From?

Who creates it: the government, the RBI, or the banks? And how can the same ₹1,000 printed by the RBI multiply into thousands more in circulation?

Understanding how money is created tells you not just how the economy works, but also why inflation, interest rates, and even your bank balance behave the way they do. At Finology, we believe that when you know how money moves, you make smarter decisions about saving and investing.

So today, let’s break down where money really comes from, how banks “print” it without a printing press, and what that means for you.

The Journey of Money: From Barter to Banks

Long before paper notes or UPI apps, people used the barter system. They exchanged goods directly, rice for sugar, cloth for grain, until they hit a major problem.

It was called the “double coincidence of wants.” You had to find someone who not only had what you wanted but also wanted what you had. Obviously, that didn’t work for long.

To fix this, people moved to gold and silver coins. They were valuable, durable, and solved the problem of direct exchange. But carrying heavy bags of coins while trading across towns or countries was risky. Theft, loss, and inconvenience made this system hard to maintain.

That’s when a middleman entered the “Seth ji,” or trusted banker. Traders deposited gold with him, and in return, he gave them a signed note promising that their gold was safe. These notes became the earliest version of paper money.

Instead of exchanging gold, traders simply exchanged notes that represented gold. It was convenient, and slowly, these notes themselves became money.

The Birth of Paper Money

Here’s where things got interesting. Seth ji noticed that traders were happily exchanging the notes, but no one came back to claim the actual gold. So, he took a bold step; he issued more notes than the gold he held.

For example, if he had 10,000 gold coins in his vault, he might issue notes worth 50,000 coins, assuming everyone wouldn’t show up at once to withdraw. Those extra notes represented money that didn’t exist physically; it was created through trust.

And that’s exactly how modern banks work today. The paper (or digital number) you see in your account is backed by only a fraction of real money. The rest is just…created.

How Banks Create Money Today

Let’s look at how this system functions now.

Suppose you deposit ₹1,000 in your bank account. The bank is required to keep a certain percentage with the RBI as a reserve; this is called the Cash Reserve Ratio (CRR), currently around 4%. That means ₹40 stays with the RBI, and the bank can lend out the remaining ₹960.

You still see ₹1,000 in your account, and the person who took the ₹960 loan also sees that amount in their account. Suddenly, ₹1,960 is now circulating in the economy, even though the RBI printed only ₹1,000.

Now, imagine the borrower spends ₹960 at a shop. The shopkeeper deposits that money into their bank account. Again, 4% of it is kept aside, and the rest is loaned out. This process repeats over and over, multiplying the money supply.

This is called the money multiplier effect. Banks literally create new money by lending the same deposits again and again.

So, while the RBI controls how much base money is printed, the banking system controls how much total money actually exists in the economy.

When Governments Print Money

Banks aren’t the only ones creating money. Governments do it too, especially when they run out of it.

Whenever a government spends more than it earns (a fiscal deficit), it borrows money, usually through bonds. But when it struggles to repay those loans, one tempting solution is to print more currency.

Printing money feels easy at first; you have more cash, you can pay debts, build infrastructure, and fund welfare programs. But as history shows, it rarely ends well.

Countries like Argentina, Zimbabwe, and Venezuela printed massive amounts of money to cover their deficits. The result? Hyperinflation. Prices soared, currencies collapsed, and ordinary citizens saw their life savings lose value overnight.

That’s why central banks like the RBI are cautious. Printing money may seem like a quick fix, but it quietly makes every rupee you own a little less valuable.

For Example,

Imagine a small village with ten families and ₹5,000 total in circulation. A piece of land in the village is worth ₹5,000.

Now, suppose one morning, ₹1,00,000 worth of new notes suddenly fall from the sky. Everyone feels richer. But when they all go to buy that same piece of land, they start bidding higher, ₹10,000, ₹20,000, ₹50,000.

Nothing about the land changed; only the amount of money did. Prices rise not because things are more valuable, but because money is worth less. That’s inflation in action: too much money chasing too few goods.

What It Means for You

You can’t control how much money your government prints or how many loans your bank gives. But you can control how your own money grows.

If the inflation rate is around 6-7%, and your savings account earns 3%, you’re actually losing value every year. The only way to protect yourself is to ensure your money compounds faster than inflation.

That’s where investing comes in, in stocks, mutual funds, gold, or real estate. Each of these helps your wealth grow at a rate that keeps ahead of inflation. The principle is simple: you can’t stop money from being created, but you can make sure yours doesn’t lose its worth.

What We Think 

When you see how banks and governments create money, it’s clear that currency itself is just a tool; what matters is how you use it.

We believe financial awareness is your best defence against inflation and uncertainty. Understanding money creation isn’t just economics; it’s a reminder that discipline, not just income, builds wealth.

So next time you see your bank balance or hear about the RBI printing more notes, remember this: money isn’t just printed; it’s multiplied, moved, and, at times, quietly devalued. Your job is to make sure you stay ahead of that cycle.

Wrapping Up

Money, in all its forms, coins, notes, or digital entries, is built on trust. The system works as long as people believe in it.

Banks multiply it, governments manage it, and inflation tests it. But for individuals like us, the real question is how wisely we grow it.

So, don’t chase printed money; focus on creating value with it. Because at the end of the day, understanding how money works is the first step to making it work for you.