Advocates of the view that “loans create deposits” have been getting too uppity of late. That is, they’ve been claiming that the view that banks lend on deposits is old hat. That’s going too far. What commercial banks do is actually a mix of the latter two activities.
As an example of the latter “uppitiness”, Positive Money quotes Mervyn King, former governor of the Bank of England who said “When banks extend loans to their customers, they create money by crediting their customers’ accounts.”
The reality is that the commercial bank system cannot increase loans unless there are people out there prepared to lend: i.e. leave money for relatively long periods in bank accounts. That is, assuming the economy is at capacity, one person cannot consume more (i.e. raise demand) unless someone else cuts their consumption (i.e. cuts demand).
Moreover, those who “leave money for relatively long periods” in bank accounts will tend to put their money into so called “term” accounts: that’s accounts where there is no instant access to the money. And that so called money is often not counted as money – though the EXACT practice there varies from country to country.
Of course banks engage in a certain amount of maturity transformation: i.e. lending on money placed in instant access accounts. But certainly if loans rise, that will to a large extent be funded by so called money in term accounts, which is not really money. And to the extent that loans are funded out of instant access money, there has to be an increase in instant access deposits to enable banks to lend.
So do loans create deposits or do depositors make loans possible? It’s a chicken and egg question.