Banks can have enormous amounts of money loaned out through mortgages, business loans, credit cards, and other lending, even though they obviously don't keep an equivalent amount of cash sitting around.

What actually happens inside the banking system when a bank gives someone a loan? Where does that spendable money come from, and what prevents banks from creating unlimited amounts of it?

Banks are required to keep a certain % of deposits in their vaults daily, it's why you see money trucks going in and out.

I do not know what you mean by they don't have equal cash sitting around for a mortgage...they have the house as colleterial. If you don't pay your mortgage the bank takes the house THEY paid for, they own it, until you fully pay it off. Banks do not create 'unlimited money' because they don't view unlimited scenarios as profitable to themselves...

Banks do not loan out more than they have in deposits, they do loan most of it, there is a % of deposits that have to be held for customers to withdraw

When a bank gives you a loan it doesn't take cash from a vault, it lit types new numbers into your account creating digital money out of thin air. Central Bank rules, interest rates and default risks are the only things keeping them from doing it limitlessly

if banks lended all of their money, in case of an economic implosion most people would try to draw their money, if the bank couldnt pay back it would be a big problem

Just like any person’s assets can be liquid or not, so can a banks. They may not have a trillion in cash in the vault, but if they lend money to someone to buy a house, the bank owns that house until they receive the money for it from them and that is an asset that can be liquidated. That is why once you own an asses outright, you can borrow money agains that asset. You are essentially pawning the asset but keeping it in your possession until the money is repaid.

The banks, essentially, create the money from the loan with simple bookkeeping. The federal government gives them this power. As the loan is paid back, the money is “destroyed”, again as part of the bookkeeping. After the loan is paid off the inflation of the created money is deflated away.

If a bank gives you a loan, they add x $ to your account. That money didn't exist before. When you pay the loan back, the $ x will stop existing again. In the end, the bank will only have the interest you paid them.

The bank needs to possess a fraction of the loan value as a Security to prevent the banks giving out unlimited loans. How large this fraction is is decided by the government.

It is by doing something called fractional reserve banking. It works because not everyone who has a deposit at the bank wants all of their money at the same time.

A quick search of the term will help you get the idea.

Banks loan out WAY more money than they have in deposits

A lot of it is based on the expectation of having loans paid back with interest. That's why banks have loan officers and all that actually consider the risk to the bank of lending the money, and why you have to apply for a loan instead of just getting one.

If I have a thousand dollars, and I have three people asking to borrow $500 each, I have to consider each of them. I know they're all good for it, so I can give them all $500 by "borrowing" money that James also gave to me to hold for him. A month later, they all pay me back $600 each, so I return the money I "borrowed" from James and have now also made $300 for myself by using it.

Now, one friend has asked for $2000. I know he's been one to not pay back very reliably, so I can't in good faith "borrow" $700 from James along with my $1300 and lend it to him, so I deny.

Nope, not in the US. Since March 2020 the fractional reserve rate requirement has been 0%. Before that it was something super low anyway like 10%

Banks don’t make billions on your measly 2.5% interest rate on a loan.

The reason banks don’t have piles of cash in vaults is because money sitting around doing nothing loses value as inflation goes up. Banks (and insurance companies, who aren’t making the millions to pay out in claims and to pay their execs from your $200/month premiums) keep their piles of cash in investments, and by lending it out to other borrowers at higher interest rates. Banks use your money to make their money.