How Do banks Create Money ?

I Explain the process of money creation by banks

 How Do banks Create Money ?

I have summarized the steps banks adopt in creating money. We provide two examples to understand this process:

The process of money creation by banks, often referred to as fractional reserve banking, is a fundamental aspect of modern economies. Here's how it usually works:

Initial Deposit: It all starts when you deposit money into a bank. Let's say you deposit $2,000 into your bank account.

Reserve requirements: Banks are required to hold only a portion of their deposits as reserves by regulatory authorities. For example, suppose the reserve requirement is 10%.

Establish Reserves: With a 10% reserve requirement, the bank must hold $200 (10% of $2,000) in reserves and can lend the rest. This means they can lend $1,800.

Loan Origination: The bank loans $1,800 to an individual or other entity. Let's say this person wants to buy a bike and takes out a loan for $1,800.

New Deposit: The person who borrowed money to buy the bike pays the seller by writing a check or making a wire transfer. The seller deposits $1,800 into his bank account.

Repeat the process: Now, that $1,800 becomes a deposit into the seller's account. The bank must keep 10% of this deposit ($180) as a reserve and can lend the rest ($1,620).

Continuing cycle: This process continues as newly deposited money becomes the basis for more loans, which in turn creates more deposits. Each time, the bank keeps only part of the new deposit in reserve and lends the rest.

Let's modify the scenario with an initial deposit of $200:

Initial Deposit: You deposit $200 into your bank account.

Reserve Requirement: Assuming the reserve requirement is still 10%, the bank must hold $20 (10% of $200) in reserves and can lend the rest. This means they can lend $180.

Loan Origination: The bank loans $180 to an individual or other entity.

New Deposit: The borrower uses $180 and the recipient deposits it into their bank account.

Repeat the process: Now, that $180 becomes a deposit into the recipient's account. The bank must keep 10% of this deposit ($18) as a reserve and can lend out the rest.

The cycle continues, creating additional deposits and expanding the money supply based on the initial deposit of $200.

This cycle repeats itself, effectively creating money through the banking system. It's important to note that even though the original deposit of $2,000 is still in your account, there is now an additional $1,800 in the economy that wasn't there before.

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