Fractional Reserve Banking and Money Creation Fractional Banking
Fractional Reserve Banking and Money Creation
Fractional Banking: • Fractional Banking: a system in which only a fraction of total money supply (M 1, M 2, and M 3) is held in reserve as currency. In other words, a bank will store some of their total deposits in a vault (allowing direct access for withdraw), and the rest helps to earn some interest income through lending to businesses/households.
Fractional Banking: • Reserve Ratio: the required percentage of deposits a bank must hold in the Federal Reserve Bank in its district or vault cash. -vault cash: currency a bank has in its vault or cash drawers.
Money Creation
Money Creation: • Money Creation: happens due to the fact that the fractional reserve system can multiply one new bank deposit into new created money. NOTE: the reserve ratio is 10%, which allows for the follow equation to be created: Reserve ratio (rr)= cash reserves/total deposits=. 10
Money Creation: • Balance Sheet (TAccount): allows for a person to see how checking deposits become loans, and how loans become new money; shows the assets and liabilities of a bank. asset: anything owned by the bank or owed to the bank; cash on reserve and loans made to citizens. liability: anything owned by depositors or lenders to the bank; checking deposits or loans made to the bank.
• See handout on example of money creation in a real-life scenario:
Money Multiplier
Money Multiplier: • Money Multiplier: measures the maximum amount of new checking deposits that can be created by a single dollar of excess reserves. M=1/(reserve ratio) • Maximum amount only reached under these terms: 1) The banks must only keep the required dollars in reserve at every stage 2) Borrowers redeposit funds into the bank and keep none as cash at every stage 3) Borrowers are willing to take excess reserves as loans
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