Fractional Reserve Banking When banks hold only a small portion of deposits to cover potential withdrawals and then loans the rest of the money out. If we all went to the bank to withdrawal money at the same time what would happen? BANK RUN! 1 Copyright ACDC Leadership 2015

Bank Balance Sheets Checkable Deposits- Money deposited in a commercial bank in a checking account Required Reserves- The percent that banks must hold by law Excess Reserves- The amount that the bank can loan out Balance Sheet- A record of a bank’s assets, liabilities, and net worth. Are checkable deposits in a bank an asset or a liability? Liability for the bank, asset to the depositor 2 Copyright ACDC Leadership 2015

AssetsLiabilities and Net Worth CREATING A BANK Transaction #1 Vault cash: cash held by the bank Creating a Bank Balance Sheet 1: Wahoo Bank Cash$250,000Stock Shares$250,

AssetsLiabilities and Net Worth CREATING A BANK Transaction #2 Acquiring property and equipment Acquiring Property and Equipment Balance Sheet 2: Wahoo Bank Cash$10,000Stock Shares$250,000 Property240,

Assets Liabilities and Net Worth CREATING A BANK Transaction #3 Commercial bank functions Accepting deposits ($100,000) Making loans Accepting Deposits Balance Sheet 3: Wahoo Bank Cash $110,000 Checkable Deposits $100,000 Property 240,000 Stock Shares 250,

CREATING A BANK Transaction #4 Depositing reserves in a Federal Reserve bank Required reserves Reserve ratio Reserve ratio = Commercial bank’s Required reserves Commercial bank’s Checkable-deposit liabilities 32-6

AssetsLiabilities and Net Worth CREATING A BANK Depositing Reserves at the Fed Balance Sheet 4: Wahoo Bank Cash$0Checkable Deposits $100,000 Property240,000Stock Shares250,000 Reserves110,000 Transaction #4 Assume the bank deposits all cash on reserve at the Fed 32-7

RESERVE REQUIREMENTS Excess reserves Actual reserves - required reserves Required reserves Checkable deposits x reserve ratio Example: Checkable deposits $100,000 Reserve ratio 20% 32-8

AssetsLiabilities and Net Worth CREATING A BANK Transaction #5 Clearing a check $50,000 check reduces reserves and checkable deposits Clearing a Check Balance Sheet 5: Wahoo Bank Checkable Deposits $50,000 Property 240,000 Stock Shares250,000 Reserves $60,

AssetsLiabilities and Net Worth MONEY CREATING TRANSACTIONS Transaction #6a Granting a loan $50,000 loan deposited to checking When a Loan is Negotiated Balance Sheet 6a: Wahoo Bank Checkable Deposits $100,000 Property240,000 Stock Shares250,000 Reserves$60,000 Loans50,

AssetsLiabilities and Net Worth MONEY CREATING TRANSACTIONS Transaction #6b Using the loan $50,000 loan cashed After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank Checkable Deposits $50,000 Property240,000 Stock Shares250,000 Reserves$10,000 Loans50,000 A single bank can only lend an amount equal to their preloan excess reserves After transaction #5, what were their excess reserves?

AssetsLiabilities and Net Worth MONEY CREATING TRANSACTIONS Transaction #7 – (from #5) Bank buys government securities from dealer Dealer deposits payment into checking Buying Government Securities Balance Sheet 7: Wahoo Bank Checkable Deposits $100,000 Property240,000 Stock Shares250,000 Reserves$60,000 Securities50,000 New money is created 32-12

THE BANKING SYSTEM Multiple-deposit expansion Assumptions: 20% required reserves All banks “loaned up” Banks lend all of excess reserves A $100 bill is found and deposited Multiple deposits can be created 32-13

Bank (1) Acquired Reserves and Deposits (2) Required Reserves (3) Excess Reserves (1)-(2) (4) Amount Bank Can Lend; New Money Created = (3) Bank A $100 $20 $80 $80 Bank B $80 $16 $64 $64 Bank C $64 $12.80 $51.20 $51.20 Bank D $51.20 $10.24 $40.96 $40.96 The process will continue… The Banking S ystem 32-14

Bank A Bank B Bank C Bank D Bank E Bank F Bank G Bank H Bank I Bank J Bank K Bank L Bank M Bank N Other Banks Bank (1) Acquired Reserves and Deposits (2) Required Reserves (Reserve Ratio =.2) (3) Excess Reserves (1)-(2) (4) Amount Bank Can Lend; New Money Created = (3) $ $ $ $ $ The Banking S ystem 32-15

THE MONETARY MULTIPLIER Monetary multiplier = 1 required reserve ratio New Reserves $100 $20 Required Reserves $80 Excess Reserves $100 Initial Deposit $400 Bank System Lending Money Created Graphic Example = 1 R This also can work in reverse to destroy money when loans are repaid…

BE A CENTRAL BANKER!! What would be a good number for the reserve requirement? Why?

RESERVE REQUIREMENTS Type of Deposit Current Requirement Statutory Limits Checkable deposits: $0-$9.8 Million $9.3-$43.9 Million Over $43.9 Million Noncheckable nonpersonal savings and time deposits 0% % Fed can establish and vary reserve ratio within limits set by Congress Required reserves help Fed control lending abilities of commercial banks 32-18

RESERVE REQUIREMENTS Type of Deposit Current Requirement Statutory Limits Checkable deposits: $0-$13.3 Million $13.3-$103.6 Million Over $103.6 Million Noncheckable nonpersonal savings and time deposits 0% % Since Quantitative Easing, the banking system has had a glut of excess reserves, but individual banks may still face shortfalls 32-19

HOMEWORK Read pgs and complete quick quiz