How Banks Create Money

Did you know that banks can create money? The vast majority of people have only the vaguest idea of how banks and financial institutions in general, operate. They just go about their lives never understanding what happens every time they deposit money into their bank. I guarantee you if they did know what went on behind the scenes, they would demand much more than the pitiful, if any, interest rates they are getting now. Now Im going to give you a behind the scenes look at how banks create money. Currently when banks receive a sum of money, they are able to lend out ten times that amount. Thats right for every $ that comes into the bank, they can lend out $.This is called the money multiplier and it is based on the required reserve ratio. The required reserve ratio is the percentage of the total deposits the bank recieves that must be held in reserve and cannot be lent out. The required reserve ratio is determined by the Federal Reserve Bank (FRB). Whatever is left over after the reserve has been met can be lent out. To figure out the current money multiplier, use the following formula: / Required Reserve Ratio = Money Multiplier Below you will find a basic example of how banks create money, in this example the Federal Reserve Requirement is %. That means that the money multiplier is , so the banks can lend out $ for every dollar they receive. ---- Begin Example ----

John deposits $, into his checking account at Bank A.

Bank A Deposit: $, Reserve (%): $, Lendable Amount: $,

Mary borrows $, from Bank A and buys a car. The car dealer then deposits $, into their account at Bank B.

Bank B Deposit: $, Reserve (%): $ Lendable Amount: $,

Mark borrows $, from Bank B and has surgery. The doctor then deposits $, into his account at Bank C.

Bank C Deposit: $, Reserve (%): $ Lendable Amount: $,

Sue borrows $, and shops at Versace. Versace then deposits $, into their account at Bank D.

Bank D Deposit: $, Reserve (%): $ Lendable Amount: $,

Kim borrows $, from Bank D and pays off her credit card, the Credit Card Company then deposits $, into their account at Bank E.

Bank E Deposit: $, Reserve (%): $. Lendable Amount: $,.

And so on through the system. When M is measured, and the FRB totals the checking account balances in the entire system, the original $, deposit will have created a total of $, in deposits system wide.

M = First level of money supply = All currency held by the public. ---- End Example ---- That in its simplest form is how the banks create money. Now considering how much money the banks are making off of every dollar you deposit, does the .% or .% interest rate youre getting paid seem fair? Not to me, but because the general public is uninformed of this fact of life, the banks and other financial institutions will continue to reap extraordinary profits from practically imaginary money.

Copyright © Tanner Larsson