Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve Banking System.

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Presentation transcript:

Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve Banking System

Deposit creation by Jody Wong, YLMASS 2 Assumptions 1.Fractional reserve system Minimum reserve ratio / legal reserve ratio e.g. 20% of the total deposits. Banks do not hold excess reserves

Deposit creation by Jody Wong, YLMASS 3 Assumptions 2.No cash leakages ( loans made by a bank will return to the banking system. ) 3.Adequate qualified borrowers ( enough investment opportunities ) 4.One type of deposits

Deposit creation by Jody Wong, YLMASS 4 Why do banks need to keep minimum reserves? Banks keep minimum reserves because 1.They are required by the law to do so. 2.Banks keep minimum reserves to meet the normal withdrawal of the depositors.

Deposit creation by Jody Wong, YLMASS 5 What are minimum reserves? Minimum reserves refer to the minimum amount of reserves/reserves required by the law that a bank must keep to meet the withdrawal of the depositors. The amount depends on the legal reserve ratio and the amount of deposits.

Deposit creation by Jody Wong, YLMASS 6 How to calculate the amount of minimum reserves? Suppose a bank receives a new deposit of $5000 and the minimum reserve ratio is 25%. The minimum amount of deposits kept by the bank = $5000 ( 25% ) = $1250

Deposit creation by Jody Wong, YLMASS 7 What are excess reserves? Excess reserves = Actual reserves – minimum reserves New deposit = $5000 and minimum reserve ratio = 25% Minimum reserves = $5000( 25% ) = $1250 Excess reserves = $ $1250 = $3750

Deposit creation by Jody Wong, YLMASS 8 A Bank’s Balance Sheet Assets include Reserves ( in the form of cash or very liquid assets ) kept in banks Loans Investment Liabilities Deposits

Deposit creation by Jody Wong, YLMASS 9 Process of Deposit creation Assumptions : Revisited 1.Minimum reserve ratio, e.g. 20% of deposits 2.No cash leakage 3.Adequate investment opportunities/enough qualified borrowers 4.One type of deposits

Deposit creation by Jody Wong, YLMASS 10 Process of Deposit Creation New deposits = $1000 Mr. deposits $1000 cash in Bank A. Minimum reserve ratio = 20%

Deposit creation by Jody Wong, YLMASS 11 Bank A’s Balance Sheet: Immediate effect ( New deposits ) Balance Sheet Assets: Liabilities: ReservesDeposits 1000

Deposit creation by Jody Wong, YLMASS 12 Bank A Minimum reserves = $1000 ( 20% ) = $200 Excess reserves = $ $200 = $800 Excess reserves are loaned out. $800 loan made to a borrower will be deposited to his bank, say Bank B.

Deposit creation by Jody Wong, YLMASS 13 Bank A’s Balance Sheet after loaning out excess reserves Bank A’s Balance Sheet Assets: Liabilities: Minimum reserves 200 Loans 800 Deposits 1000

Deposit creation by Jody Wong, YLMASS 14 Bank B gains a new deposit of $800

Deposit creation by Jody Wong, YLMASS 15 Bank B’s Balance Sheet: Immediate effect ( New deposits ) Balance Sheet Assets:Liabilities: Reserves Deposits800

Deposit creation by Jody Wong, YLMASS 16 Bank B Minimum reserves = $800 ( 20% ) = $160 Excess reserves = $800 - $160 = $640 Excess reserves are loaned out. $640 loan made to a borrower will be deposited to his bank, say Bank C.

Deposit creation by Jody Wong, YLMASS 17 Bank B’s Balance Sheet after loaning out excess reserves Bank B’s Balance Sheet Assets: Liabilities: Minimum reserves Loans Deposits

Deposit creation by Jody Wong, YLMASS 18 Bank C gains a new deposit of $640

Deposit creation by Jody Wong, YLMASS 19 Bank C’s Balance Sheet: Immediate effect ( New Deposits ) Balance Sheet Assets:Liabilities: Reserves Deposits 640

Deposit creation by Jody Wong, YLMASS 20 Bank C Minimum reserves = $640 ( 20% ) = $128 Excess reserves = $640 - $128 = $512 Excess reserves are loaned out. $512 loan made to a borrower will be deposited to his bank, say Bank D.

Deposit creation by Jody Wong, YLMASS 21 Bank C’s Balance Sheet after loaning out excess reserves Bank C’s Balance Sheet Assets:Liabilities: Minimum reserves Loans Deposits

Deposit creation by Jody Wong, YLMASS 22 The process goes on and on ……..

Deposit creation by Jody Wong, YLMASS 23 Summary of the above balance sheets Bank A Bank B Bank C Deposits Minimum reserves Loans ……… on and on … ………………

Deposit creation by Jody Wong, YLMASS 24 Maximum Amount of Deposits Created Maximum amount of deposits created = $ $800 + $ $512 …… = $1000 ( …. ) = $1000 ( 1/1-0.8 ) = $1000 ( 1/0.2 )

Deposit creation by Jody Wong, YLMASS 25 Maximum Amount of Deposits Created Maximum amount of deposits created = Initial deposits ( 1/minimum reserve ratio ) Maximum Banking Multiplier = 1/minimum reserve ratio

Deposit creation by Jody Wong, YLMASS 26 Does the supply of money change? Yes! But Why? Bank deposits are components of money supply. When more deposits are created, the money supply also increases. But by how much ?

Deposit creation by Jody Wong, YLMASS 27 Is the increase in money supply the same as the amount of deposits created? It depends on the source of the initial deposits!

Deposit creation by Jody Wong, YLMASS 28 If the initial deposit comes from money in circulation, then the maximum increase in money supply is smaller than the maximum increase in total deposits.

Deposit creation by Jody Wong, YLMASS 29 Initial deposit = $1000 ( cash in circulation, before being deposited in Bank A) The maximum increase in deposits is $5000. The maximum increase in money supply is $ $1000 = $4000

Deposit creation by Jody Wong, YLMASS 30 If the initial deposit does not come from money in circulation, then the maximum increase in money supply is the same as the maximum increase in total deposits.

Deposit creation by Jody Wong, YLMASS 31 Initial deposit = $1000 ( e.g. $1000 brought into the economy by a 金山阿伯阿威 from the US ) The maximum increase in deposits is $5000. The maximum increase in money supply is also $5000

Deposit creation by Jody Wong, YLMASS 32 What if ………………?

Deposit creation by Jody Wong, YLMASS 33 Limitations to the process of multiple deposit creation 1.What if banks keep excess reserves ?

Deposit creation by Jody Wong, YLMASS 34 Limitations to the process of multiple deposit creation 2.What if there are cash leakages?

Deposit creation by Jody Wong, YLMASS 35 Limitations to the process of multiple deposit creation 3.What if there are not enough qualified borrowers?

Deposit creation by Jody Wong, YLMASS 36 Process of Multiple Deposit Contraction in a Fractional Reserve Banking System What happens to the total deposits of the banking system if a depositor withdraws money from the bank, assuming the banking system is fully loaned up? How will the change in bank deposits affect the money supply?

Deposit creation by Jody Wong, YLMASS 37 END