Profits change the distribution of existing money. Profits don’t make new money tokens. Many economists and almost all lay people make this mistake, resulting in misconceptions that harm society. How we literally make money tokens is critical to society's functioning. Making a profit is complicated, which has resulted in unnecessarily complex financial systems because people think governments “make money” by banks making a profit on loans. Modern Monetary Theory describes how simple it is and how using methods other than profit-making loans can reduce the complexity of distributing money.
Money is made by a community agreeing to make it for a purpose on which most agree. Making a profit for the community is a good reason, but making a profit for a few individuals is not something most would agree to. Almost all will object to making unnecessary profits for a few when making new money tokens.
Unfortunately, that is the situation with banking today. It occurs when banks use compound interest loans, not simple interest loans. Compound interest unnecessarily more than doubles bank profits from making new money, and the extra profits and the new money go to a few.
Banks charge double the fee they need to charge to provide a banking service for loans. Their purpose with loans is to provide a service to the government to create new government money and a service to depositors to lend the depositors money and make a profit for the depositor.
Banks do not lend their own money. Instead, they lend new money from the government and savings from depositors. They provide a service and share the interest they charge with depositors as interest on deposits and with the government as a tax on profit. Banks are service providers - not owners of money.
When a person takes out a loan, the bank puts new money into a deposit account and creates another account called the loan account, which keeps track of the money owed. If the loan account is increased by extending the loan, the bank puts money into the deposit account. However, each month, the bank extends the loan by the interest amount, BUT they do not put money into the deposit account because it is deemed a payment of interest. If it was a payment of interest, the interest owed should drop from the loan account - but it doesn’t. The bank takes the money as income to the bank and leaves the borrower to pay the interest again. This should never happen; it is obvious when we call bank interest a service fee.
The image above shows what should happen on the left and what does happen on the right. On the left, the bank extends the loan by adding interest, and the extension puts money into the borrower's deposit account. The bank increases the amount loaned and should transfer it immediately to the loan account, reducing the balance and paying the interest. If the borrower now pays the interest and a return on capital, the balance will come down.
If the bank uses compound interest, the extra step of extending the loan is missed, resulting in the second payment of interest.
The concept that profits create (make) money is deeply embedded in economic thinking, which is probably why economists—until MMT—have not called it out.
The remedy suggested requires all banks to use simple interest on loans. Simple interest is a fee the bank charges for storing and lending the money. Other changes are for communities to agree to other uses of money than loans for profit while still using banks to introduce new money. Examples are money to replace taxes for community services and new community assets.
An example of where new money is not needed is the transfer of ownership of existing assets.