How is the money supply increased when banks lend out their excess reserves? November 2, 2009
Posted by Banking in : Personal Finance , trackback
qtpie34 asked:
Banks are required to keep a certain percentage of their deposits on reserve, either in their own vaults or in their accounts at the Fed. This percentage of deposits that they are required to keep is called the reserve requirement. For example, if the reserve requirement is 5%, when a customer deposits $100 at the bank, the bank only has to keep $5 of that $100 deposit. The remaining $95 (called excess reserves) can be lent out to other customers.
Banks are required to keep a certain percentage of their deposits on reserve, either in their own vaults or in their accounts at the Fed. This percentage of deposits that they are required to keep is called the reserve requirement. For example, if the reserve requirement is 5%, when a customer deposits $100 at the bank, the bank only has to keep $5 of that $100 deposit. The remaining $95 (called excess reserves) can be lent out to other customers.
Comments»
I think that you answered your own question but the lower the rates whether the discount rate or the reserve requirement the banks don’t have to hold the money and lend it out to make more money on interest payments.
I think This is called money creation by the private banking industry, in a fractional reserve system.
A second bank can borrow the $95 of excess reserves from the first bank in your example, set aside 5% of that ($4.75) to meet their reserve requirements, and loan out their excess reserves ($90.25) to a third bank, and so on and so on.
The important thing to understand is that in our system, the government doesn’t create money, the private banking system does.