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How Banks Create Money Please listen to the audio as you work through the slides.

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Presentation on theme: "How Banks Create Money Please listen to the audio as you work through the slides."— Presentation transcript:

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2 How Banks Create Money Please listen to the audio as you work through the slides

3 How Banks Create Money Learning Objectives: Students will be able to thoroughly and completely explain: 1.How banks create and destroy money, the role of the reserve requirement. 2.How the Money Multiplier works.

4 How banks create money 1.Through lending 2.Buying bonds from the public How banks destroy money 1.Through the payoff of loans 2.Selling bonds to the public

5 Fractional Reserve System Balance sheet – Assets = Liabilities + Net Worth – Both sides balance Necessary transactions to understand – Create a bank – Accept deposits – Lend excess reserves

6 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 1 Creating a bank $250,000 Cash for Capital Stock

7 Cash $250,000Capital Stock $250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH Deposit Added to Vault Cash

8 Cash $250,000Capital Stock $250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 2 Acquiring Property and Equipment $240,000 Cash

9 Cash $ 10,000 Property 240,000 Capital Stock $250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH

10 Cash $ 10,000 Property 240,000 Capital Stock $250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 3 Accepting Deposits into checking accounts $100,000 Cash

11 Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH

12 Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH NOTES: Bank deposits are subject to a reserve requirement. Reserve ratio Commercial bank’s required reserves Commercial bank’s checkable-deposit liabilities =

13 Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH Three Important Issues... 1 - Excess Reserves = Actual Reserves - Required Reserves (assume 20% reserve requirement) $110,000 - 20,000 = $90,000 2 – Control of Lending Ability 3 - Asset or Liability to Which Bank?

14 Cash $110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 4 Deposit Into FED account $110,000 Cash

15 Cash $ 0 Reserves 110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH

16 Cash $ 0 Reserves 110,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 5 A check is drawn against the bank $50,000

17 Cash $ 0 Reserves 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH

18 Cash $ 0 Reserves 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH NOTES: Banks create money by lending excess reserves and destroy it by loan repayment. Purchasing bonds from the public also creates money.

19 Reserves $ 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 6 Make a loan from excess reserves $50,000

20 Reserves $ 60,000 Loans 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH Making the loan created money!

21 Reserves $ 10,000 Loans 50,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH After a check for the $50,000 is drawn against the bank *

22 Reserves $ 10,000 Loans 50,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 ASSETS LIABILITIES AND NET WORTH TRANSACTION 7 Repaying a loan with cash $50,000 Formation of a Commercial Bank

23 Reserves $ 10,000 Loans 0 Property 240,000 Checkable Deposits $ 0 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH $50,000 in money supply is destroyed!

24 Reserves $ 60,000 Property 240,000 Checkable Deposits $ 50,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH Let’s buy bonds from public $50,000

25 Reserves $ 10,000 Securities 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH TRANSACTION 8 (Assume previous balance sheet) Bought Government Securities $50,000

26 Reserves $ 10,000 Securities 50,000 Property 240,000 Checkable Deposits $100,000 Capital Stock 250,000 Formation of a Commercial Bank ASSETS LIABILITIES AND NET WORTH Banks conflicting goals: Earn profit Make loans to earn interest Buy securities to earn interest Maintain liquidity Alternative? Overnight bank loans Federal funds rate

27 The Banking S ystem Multiple-deposit expansion – Assumptions: 20% required reserves All banks “loaned up” no excess reserves Banks lend all of excess reserves when they get them. A $100 bill is found and deposited Multiple deposits can be created 32-26

28 MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system

29 MULTIPLE DEPOSIT EXPANSION PROCESS Bank Acquired reserves and deposits Required reserves Excess reserves Amount bank can lend - New money created A B C D E F G H I J K L M N Other banks $100.00 80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 21.99 $20.00 16.00 12.80 10.24 8.19 6.55 5.24 4.20 3.36 2.68 2.15 1.72 1.37 1.10 4.40 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $80.00 64.00 51.20 40.96 32.77 26.21 20.97 16.78 13.42 10.74 8.59 6.87 5.50 4.40 17.59 $400.00 Total amount of money created by the banking system Money destruction works in exactly the same multiple way!

30 The Monetary Multiplier Maximum amount of new money created by a single dollar of excess reserves Higher R, lower m – R = Reserve ratio, m = monetary multiplier Reversibility – Making loans creates money – Loan repayment destroys money

31 Maximum checkable- deposit creation = Excess reserves x Monetary Multiplier Monetary Multiplier Required reserve ratio 1 = The Monetary Multiplier

32 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


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