Download Deposit / Credit Creation

Functions of Banks
Savings
Investment
(deposits)
(loans)
Banks channel
savings into investment
1
Affecting Money Supply
Investment
(loans)
Savings
(deposits)
Money supply = Cp
(currency in public circulation)
+ Deposits
•save cash into bank account: Cp drops but deposit rises
•make loans to investors: reserves drop but Cp rises
2
Deposit / Credit Creation
Adam
Cp = $1000
deposit
= $1000
Bank
reserve = $1000
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
$1000
Deposit
$1000
Required reserve = $250
Excess reserve = $750
3
Ms = Cp + Dep = $1750
Bank
loan
RR = $250
= $750
ER = $750
Bobby
Cp = $750
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
$250
Loan
$750
Deposit
$1000
4
Ms = 0 + $1750 = $1750
Bobby
Cp = $750
deposit
= $750
Bank
reserve + $750
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
Loan
$1000
Deposit
$1750
$750
Required reserve = $437.5
Excess reserve = $562.5
5
Ms = $562.5 + $1750 = $2312.5
Bank
loan
RR = $437.5
= $562.5
ER = $562.5
Cindy
Cp = $562.5
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
Loan
$437.5
Deposit
$1750
$1312.5
6
Process of deposit creation
1. Initial deposit is saved into a bank
under fractional reserve system.
2. The bank lends out all excess reserve.
3. The public does not have cash leakage,
i.e., all cash will be re-deposited.
4. Banks lend out all excess reserve again
and the above process goes on and on.
5. Multiple deposit creation will happen.
7
Ms = 0 + $4000 = $4000
Zeith
Cp = $0.00..
deposit
= $0.00..
Bank
reserve + $0.00..
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
$1000
Loan
$3000
Deposit
$4000
Required reserve = $1000
Excess reserve = $0
8
Ms = 0 + $4000 = $4000
Bank
loan
RR = $1000
= $0
ER = $0
The public
Cp = $0
Balance Sheet of the Banking System
(required reserve ratio = 25%)
Reserve
$1000
Loan
$3000
Deposit
$4000
Further deposit / credit creation is impossible when
excess reserve = 0, or required reserve = actual reserve.
9
Formula of deposit creation
Maximum amount of deposit
= Initial deposit 
1
Required Reserve Ratio
Banking multiplier
10
Process of deposit contraction
1. Initial withdrawal of deposit from a bank
under fractional reserve system.
2. The bank lacks of actual reserve and
then calls back loans.
3. Since the public does not hold any cash
on hand, they have to withdraw deposit.
4. Banks lacks of actual reserve again and
the above process goes on and on.
5. Multiple deposit contraction will happen.
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