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How Money is Created: Understanding the Process Behind Modern Banking

Discover how money is actually created and circulated in Indonesia’s economy through central banks, commercial banks, and financial instruments.

Introduction

Have you ever wondered where the money in your bank account comes from? Many people assume it is printed by the central bank and then distributed to the public. In reality, the process is much more complex and fascinating. Understanding how money is created helps us grasp how modern economies function and why banking regulations matter for financial stability.

The Role of Central Banks

In Indonesia, Bank Indonesia acts as the monetary authority responsible for controlling the money supply. While we rarely see them “printing” cash, they set policies that regulate how money enters the economy.

Forms of Money

• Cash (Uang Kartal): Physical money in the form of coins and banknotes.
• Demand Deposits (Uang Giral): Digital money stored in bank accounts such as savings, current accounts, or deposits.
• Quasi Money: Financial instruments like bonds, shares, and time deposits considered near-money assets.

Interestingly, most money circulating today is digital. At the end of 2021, Bank Indonesia reported that out of IDR 7,413 trillion in circulation, only IDR 2,246 trillion was physical cash, while the rest consisted of digital money and quasi money.

How Cash Is Created

Cash is printed by Perum Peruri and distributed by Bank Indonesia to commercial banks. These banks then circulate cash to society through ATMs, bank branches, and cash-based transactions. However, money is not simply handed out; it often flows into society through business loans and productive financing.

How Digital Money Is Created

This is where things get interesting. Commercial banks create new digital money when they approve loans. For example, when a business applies for a loan, the bank doesn’t give out existing money but instead creates a new balance in the borrower’s account. This balance is then used to pay employees, suppliers, and other expenses, spreading money into the wider economy.

Fractional Reserve Banking

Banks don’t need to hold 100% of deposits as reserves. Under fractional reserve banking, they only keep a fraction (such as 3% for mandatory reserves) and lend out the rest. This system allows banks to “multiply” money through lending while being monitored by Bank Indonesia to avoid excessive inflation.

Regulatory Requirements

To ensure stability, Bank Indonesia enforces rules such as:

• Loan-to-Deposit Ratio (LDR): Maximum 92%, ensuring banks hold enough capital.
• Mandatory Reserve Ratio: 3% of deposits must be kept with Bank Indonesia.
• Credit Quality Standards: Borrowers must meet strict criteria to qualify for loans.

How Quasi Money Is Created

Quasi money arises from financial instruments and investments handled by banks. These include bonds, stocks, time deposits, and mutual funds. Profits from such investments can also generate new money within the banking system.

Special Situations: Quantitative Easing (QE)

During crises, central banks can directly inject money into the economy. For instance, in 2020 Bank Indonesia launched a QE program worth IDR 166 trillion, purchasing government bonds to increase liquidity and support the economy during the pandemic.

“Most of the money circulating today is not physical cash but digital balances created by commercial banks through lending.”

Conclusion

Money creation is not just about printing cash—it’s a dynamic system involving central banks, commercial banks, and financial markets. While banks have the power to create money through lending, strict regulations ensure that this power does not destabilize the economy. Understanding this process gives us valuable insight into how modern economies grow and why financial policies matter for everyone.

If you found this explanation useful, share your thoughts in the comments and let others know how money truly works in today’s world!

Labels

Finance

References

• Video: Bagaimana Uang Diciptakan?
• Channel: Ngomongin Uang
• Watch the original video here