BANKS AND THE CREATION OF MONEY

How do banks create money?

*By lending out deposits(money).

Where do loans come from?

*Loans come from depositors who take cash and place it in accounts at the banks.

How are the amounts of potential loans calculated?

*They are calculated by using a T-Account that consists of assets and liabilities.

Banks liabilities(the right side of the T-Account sheet):

*Demand deposits: these are cash deposits from the public, they are a liability because they belong to             depositors and can be withdrawn by depositors.
*Owner's Equity: values of stocks held by the public ownership of bank shares.

Key Concept for AP concerning liabilities:

1) If the DD comes in from someone's cash holdings then that DD is already part of the money supply.
2) If the DD comes in from the purchase of bonds(by the FED) then it creates new cash and therefore               creates new money supply.

Bank assets(the left side of the T-Account sheet):

1) Required reserves(RR): These are the percentages of DD that must be held in the vault so that some            depositors have access to their money. it is usually 5%, 10%, 20% but in reality is 10% or below.
2) Excess reserves(ER): They are source for new loans.
3) Property.
4) Securities(bonds): Securities are bonds purchased by the bank. These could be bonds purchased by the       FED.
5) Loans: These can be amounts held by banks from previous transactions owed to the bank by prior               customers.

Money creation (using excess reserves)

*Banks want to create profits.

The money multiplier (also known as):

*The loan multiplier.
*Reserve multiplier.
*Check-able deposit multiplier.

The formula is:

*1 divided by the reserve requirement ratio (1/RR).
Excess reserves are multiplied by the multiplier to create new loans for the entire banking system and this creates new money supply.