Explain, in your own words, how banks create money through the fractional reserve banking system. (Note:...
Explain, in your own words, how banks create money through the fractional reserve banking system. (Note: by 'create money' I mean just that...that is, how do banks increase the money supply, NOT how banks earn profit).
Homework Answers
In a fractional reserve banking system, a bank needs to keep a fraction of its deposits as reserve with it as a reserve and the bank can lend the remaining to borrowers.
The bank can create money with the help of money multiplier. Money multiplier = 1/reserve ratio.
When a bank receives a deposit, it needs to keep a portion of the deposit as reserve ans loan out the rest. The loaned out money also comes back to the bank as a form of deposit. Now the bank needs to keep a portion of the new deposit as a reserve and again the loan put the remaining. This process keeps on continuing and the money supply keeps increasing.
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Explain, in your own words, how banks create money through the
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