Banks and the Creation of Money

1. Banks and the Creation of Money

2. Basic Accounting and Bank Lending • For any business: Assets = Liabilities + Capital

3. Basic Accounting and Bank Lending 2. Bank assets include - Building - Holding of government securities - Stocks and bonds - Cash - Loans **

4. Basic Accounting and Bank Lending 3. Bank liabilities include - the usual stuff - customer deposits **

5. Banks and the Creation of Money • Banks wish to make profit, and the only way they can do this is by making loans. • Banks make loans out of their customer’s deposits.

6. Banks and the Creation of Money 3. Banks set aside legal reserves ( also called required reserves), and then lend out the rest. • In the process of lending customer deposits, banks create money and expand the money supply.

7. Process • Banks total up all of the different types of customers deposits. • This total of customer deposits becomes the total reserves of the bank. • Out of the total reserves, bank must subtract out the required reserves.

8. Process • What is left over are the excess reserves. • The excess reserves are lent out and become loans.

9. Process The greater the amount of excess reserves that are lent out, the more loans a bank has. The more loans it has, the more revenues it will generate. The more revenue, the greater the profits.

10. Process Therefore banks have a great incentive to turn all excess reserves to loans.