Fractional Reserve Banking

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 accounts at banks
• Fractional Reserve Banking 

Bank Liabilities (the right side of the T Account Sheet):
1 ) Demand Deposits (also known as “Checkable Deposits”)(DD)

• cash deposits from the public.
• liability because they belong to the depositors and can be withdrawn by the depositors.

2 ) Owners Equity (also known as “Stock  Shares”)

• values of stocks held by the public ownership of bank shares.

Bank Assets (the left side of the T Account Sheet):
 
1) Required Reserves (RR)

• percentages of demand deposits that must be held in the vault so that some depositors have access to their money. 

2) Excess Reserves (ER)

• These are the source of new loans.

DD = RR plus ER

3) Bank Property Holdings (Buildings and Fixtures)
These are usually stated as a money value of the bank’s property…

4) Securities (Federal Bonds)
    
5) Customer Loans

• This 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 profit.  
• They can generate profit by lending the excess reserves and collecting interest payments.  
• each loan will go out into customer’s and business’ accounts, more loans are created in decreasing amounts. 
• Each successive bank must pull some of the money out for required reserves.  
• A rough estimate of the number of loan amounts created by any first loan is the “monetary multiplier”.

The Monetary Multiplier (also known as):

• Checkable Deposits Multiplier
• Reserve Multiplier
• Loan Multiplier

Formula:  1 divided by the reserve requirement (ratio)
An example = RR = 10% = 1/.1 = Monetary Multiplier of 10.

• Excess Reserves are multiplied by the Multiplier to create new loans for the entire banking system and this creates new Money Supply.