Money Creation Process

1
Money Creation Process
2

• A person opens a checking account at bank (A)
  with (KD100) in cash.
• This rises the liability of the bank by (100)
• If the bank keeps the (100) in cash, this rises
  the assets side of the balance sheet

3

• A L

4

• Since cash is part of banks reserves, the (100)
  becomes reserves now
• A L

5

• If the required reserve ratio 10, then
  reserves can be divided into
• Required reserves (10)(100)KD10
• Excess reserves 100-10 KD90

6

• A L

7

• Since excess reserves earn no interest. Bank (A)
  may choose to make a loan worth of (90). (why not
  lend the 100)?
• The bank make profits now
• (interest paid on loan) (interest paid on
  deposits)

8

• A L
• RR 10 Checkable D 100
• ER 0
• Loans 90

9

• Assume now that your friend who borrowed the
  (KD90), went to bank (A) and opened a checking
  account

10

• A L
• RR 19 Checkable D1 100
• ER 81 Checkable D2 90
• Loans 90
• 190
  190

11

• Total deposits KD190
• Since excess reserves earn no interest, bank (A)
  will make a loan of the (81) to another person.
• Excess reserves 0
• Total loans KD171

12

• A L
• RR 19 Checkable D1 100
• ER 0 Checkable D2 90
• Loans 171
• 190
  190

13

• This process will continue
• We started with (KD100) but total deposits
  increased by more than the initial (KD100)
• This is called money creation

14

• Deposit multiplier 1/rrr
• 1/0.1010
• Thus, the total amount of deposits bank (A) can
  create (10)(100) KD1000
• Total loans 1000 100 900
• (total deposits total required reserve)