hussen omari
Jul 9
Explain the process of money creation by the commercial banks with the help of numerical example ?
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Jul 9
The process of money creation by commercial banks is known as the fractional reserve banking system. This system allows banks to create money through the process of lending out a portion of the deposits they receive from customers.
Here is a simplified numerical example to explain the process of money creation by commercial banks:
1. Let's assume Bank A receives a deposit of $1,000 from a customer. According to the fractional reserve requirement set by the central bank, Bank A is required to hold a certain percentage of this deposit as reserves. Let's assume the reserve requirement is 10%.
2. With a reserve requirement of 10%, Bank A is required to hold $100 (10% of $1,000) as reserves and can lend out the remaining $900.
3. Bank A lends out the $900 to another customer, who then deposits the money into Bank B.
4. Bank B is also required to hold 10% of this deposit as reserves, which is $90. Bank B can then lend out the remaining $810.
5. This process continues as the money is deposited and lent out by different banks, creating a multiplier effect on the initial deposit.
In this example, the initial deposit of $1,000 has led to the creation of $10,000 in new money ($1,000 / 10% reserve requirement = $10,000). This process of money creation by commercial banks is a key driver of economic activity and growth in the economy.
Here is a simplified numerical example to explain the process of money creation by commercial banks:
1. Let's assume Bank A receives a deposit of $1,000 from a customer. According to the fractional reserve requirement set by the central bank, Bank A is required to hold a certain percentage of this deposit as reserves. Let's assume the reserve requirement is 10%.
2. With a reserve requirement of 10%, Bank A is required to hold $100 (10% of $1,000) as reserves and can lend out the remaining $900.
3. Bank A lends out the $900 to another customer, who then deposits the money into Bank B.
4. Bank B is also required to hold 10% of this deposit as reserves, which is $90. Bank B can then lend out the remaining $810.
5. This process continues as the money is deposited and lent out by different banks, creating a multiplier effect on the initial deposit.
In this example, the initial deposit of $1,000 has led to the creation of $10,000 in new money ($1,000 / 10% reserve requirement = $10,000). This process of money creation by commercial banks is a key driver of economic activity and growth in the economy.
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Google Gemini AI
Jul 9
Process of Money Creation by Commercial Banks
Commercial banks play a crucial role in money creation through the process of fractional reserve banking. Here's how it works, illustrated with a numerical example:
Step 1: Deposits
- A customer deposits $100,000 in a commercial bank.
Step 2: Reserve Requirement
- The bank is required by law to hold a portion of this deposit (e.g., 10%) as a reserve. In this case, the reserve requirement is $10,000.
Step 3: Excess Reserves
- The remaining $90,000 is the bank's excess reserves, which it can lend out to borrowers.
Step 4: Lending
- The bank lends out the excess reserves to a borrower. Let's assume it lends out $80,000.
Step 5: Deposit Creation
- The borrower uses the loan to make a purchase, creating a deposit equal to the loan amount ($80,000) in another commercial bank.
Step 6: Repeat of Steps
- The new bank also has to follow the reserve requirement, so it holds back 10% of the deposit ($8,000) as a reserve.
- The remaining $72,000 becomes excess reserves and can be lent out.
Money Creation Effect
- Through this process, the original $100,000 deposit has led to the creation of $180,000 in new deposits (the original deposit + the $80,000 loan from the first bank).
- The multiple expansion of deposits is known as the money multiplier effect.
Money Multiplier
- The money multiplier is calculated as: 1 / Reserve Requirement Rate
- In this example: 1 / 0.1 (10%) = 10
- This means that for every $1 of reserve liability, the banking system can create $10 of demand deposits.
Limitations
- The money creation process is limited by the reserve requirement, which ensures that banks have sufficient reserves to meet withdrawals.
- Other factors, such as economic conditions and regulation, can also impact the money multiplier effect.
Commercial banks play a crucial role in money creation through the process of fractional reserve banking. Here's how it works, illustrated with a numerical example:
Step 1: Deposits
- A customer deposits $100,000 in a commercial bank.
Step 2: Reserve Requirement
- The bank is required by law to hold a portion of this deposit (e.g., 10%) as a reserve. In this case, the reserve requirement is $10,000.
Step 3: Excess Reserves
- The remaining $90,000 is the bank's excess reserves, which it can lend out to borrowers.
Step 4: Lending
- The bank lends out the excess reserves to a borrower. Let's assume it lends out $80,000.
Step 5: Deposit Creation
- The borrower uses the loan to make a purchase, creating a deposit equal to the loan amount ($80,000) in another commercial bank.
Step 6: Repeat of Steps
- The new bank also has to follow the reserve requirement, so it holds back 10% of the deposit ($8,000) as a reserve.
- The remaining $72,000 becomes excess reserves and can be lent out.
Money Creation Effect
- Through this process, the original $100,000 deposit has led to the creation of $180,000 in new deposits (the original deposit + the $80,000 loan from the first bank).
- The multiple expansion of deposits is known as the money multiplier effect.
Money Multiplier
- The money multiplier is calculated as: 1 / Reserve Requirement Rate
- In this example: 1 / 0.1 (10%) = 10
- This means that for every $1 of reserve liability, the banking system can create $10 of demand deposits.
Limitations
- The money creation process is limited by the reserve requirement, which ensures that banks have sufficient reserves to meet withdrawals.
- Other factors, such as economic conditions and regulation, can also impact the money multiplier effect.
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