Principles of Banking PDF

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@ 1998 by the American Bankers Association
Cartoons on the following pages are reprinted with permission:

Pages 37, 53, 77, 93, 117, and 153 are Frank and Ernest 0 1988, 1994, 1995, 1996, and 1997
by Thaves.
Page 209 62 1996 Theodore Goff.
Pages 169 and 189 62 1998 and 1997 Randy Glasbergen.
Pages 1, 15, 137, and 229 0 1998 American Bankers Association by Sharon C. Lamberton.
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Role of Banks in Creating Money bank has $10,000 in loans, $10,000 in cash (the
dealer's deposit) and $10,000 in demand depos-
The Fed establishes ranges for the growth rate its; the stockholders' investment does not
of the money supply on the basis of a number of change. Exhibit 3.5 uses a T-account to show
economic factors. The Fed then uses its tools for how this transaction would be shown in the
monetary control to keep the money supply within bank's books (bank accounting is discussed in
those ranges. Banks play an important role in the chapter 10).
growth of the money supply because of their abil- If the bank has a reserve requirement of 10 per-
ity to create demand deposits. cent, the bank must keep 10 percent of its demand
Banks create money for demand deposits deposits in cash or balances at the Federal Re-
through a combination of the deposit and the credit serve. In this example the bank must keep $1,000
functions. When banks make loans, they also in- as reserves (10 percent of $10,000), so it has only
crease the volume of demand deoosits. Here is an $9,000 available to lend to other customers
example of how demand deposits are increased: ($10,000 minus $1,000). If the bank lends out its
ABC Bank has $10,000 in cash assets-part of available $9,000, that $9,000 will be deposited in
the stockholders' original investment-and $0 in the same or another bank in a demand deposit ac-
demand deposits. A consumer borrows the count. The result of this transaction is that demand
$10,000 in cash from ABC to buy a car and pays deposits are increased by $9,000, as is the money
the $10,000 cash to the car dealership. The deal- supply. The fact that the deposits may not be made
ership deposits the $10,000 to its checking ac- to the same bank is irrelevant. The point is that
count, also at ABC. Now ABC Bank's demand money lent out by banks ends up in demand de-
deposits are increased by $10,000, and its money posits that can be loaned out again after reserves
supply is also increased. After the transaction, the are kept, causing a recycling of funds.
Exhibit 3.5 How Banks Create Money

BANK BALANCE SHEET BEFORE LOAN
Cash
--
$10,000 Deposits
Stockholder equity
$ 0
$10,000
Total Total liabilities &

Assets $10,000 stockholder equity $10,000
BANK 6,'" '\NCE SHEET AFTER LOAN
Cash $1 0,000 1 Deposits $1 0,000
Loans $10,000
I Stockhotcter equity $10,000
Total Total liabilities &

Asse . '20,000 1 stnckholmr e m t L . $20,000
Chapter 3 - Federal Reserve System

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This publication is designed to provide accurate and authoritative information in regard to the subject

The AMERICAN BANKERS ASSOCIATION is committed to providing innovative,high-quality

@ 1998 by the American Bankers Association

Cartoons on the following pages are reprinted with permission:

Printed in the United States of America

Exhibit 3.5 How Banks Create Money

Total Total liabilities &

I Stockhotcter equity $10,000

Total Total liabilities &

Chapter 3 - Federal Reserve System

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