Banks and the Creation of Money

• How do banks "create" money ?
• by lending out deposits that are used multiple times
• Where do the loans come from ?
• from depositors who take cash and place it in their banks
• How are the amounts of potential loans calculated ?
• using a bank balance sheet or a T - account that consists of assets and liabilities for the bank
• Bank Liabilities ( right side of T-Account Sheet )
• what you owe
1. Demand Deposits ( DD ) or checkable deposits
• cash deposits from the public
• liability because it belongs to the depositors
2. Owner's Equity ( stock shares )
• values of stocks held by the public ownership of bank shares
• Key Concepts of Liabilities
• demand deposit comes from someone's cash holdings, then DD is already part of the money supply
• DD comes in from purchase of bonds ( by the FED ) , this creates new cash and therefore creates new money supply ( MS )
• Bank Assets ( left side of T-Account Sheet )
• what you own
1. Required Reserves ( RR )
• percentages of demand deposits that must be held in the vault so that same depositors have access to their money
2. Excess Reserves ( ER )
• source of new loans
• the amount applied to the Monetary Multiplier or the Reserve Multiplier ( DD = RR + ER )
3. Banking Property Holdings ( buildings and fixtures )
4. Securities ( Federal Bonds )
• bonds purchased by the bank or new bonds sold to the bank by the Federal Reserves Bank
• bonds can be purchased from the bank, turned into cash that immediately becomes available as "excess reserve"
5. Customer Loans
• can be amounts held by banks from previous transactions, owed to banks by prior customers
• Money Creation ( Using Excess Reserves )
• banks want to create profit by lending ER and collecting interest
• loans will go out into customer's or business's accounts
• more loans created in decreasing amounts (because of RR)
• rough estimate of number of loan amounts created by any first loan is the "money multiplier"
• Monetary Multiplier ( aka )
• Checkable Deposits Multiplier
• Reserve Multiplier
• Loan Multiplier
• Formula :
• 1 / RR = Monetary Multiplier
• ex : RR = 10 %
• 1 / .1 = 10
• Excess Reserves are multiplied by the Multiplier
• to create create new loans for the entire banking system
• this creates new Money Suppyl