Scene 1: Suppose, under fractional banking with a 20% reserve requirement, bank A gets $100 as deposit. Does this mean bank A can directly (at one go, independently) make $500 worth of loans?
Scene 2: Wikipedia's article on fractional banking (http://en.wikipedia.org/wiki/Fractional-reserve_banking#Example_of_deposit_multiplication) sees the the money creation process in fractional banking to be more of a complex process involving a series of banks withholding 20% of the real hard money they get as deposits in each cycle, and the process eventually leading to the creation of $500 of new money.
Which of the above two scenes is correct? Or are both correct?
DD5: This is simply the common practice under central banking. It is both efficient for interbank clearings and it just happens to make the effective outcome of money creation less conspicuous in the accounting balance sheets. But there is nothing in principle that prevents banks from issuing $900 worth of new loans on account of a $100 deposit.
This is simply the common practice under central banking. It is both efficient for interbank clearings and it just happens to make the effective outcome of money creation less conspicuous in the accounting balance sheets. But there is nothing in principle that prevents banks from issuing $900 worth of new loans on account of a $100 deposit.
true, they could, but there are inherent risks in doing this. From Mystery of Banking:
To see the answer, we have to examine the detailed bank-to- bank process of credit expansion under central banking. To make it simple, suppose we assume that the Fed buys a bond for $1,000 from Jones & Co., and Jones & Co. deposits the bond in Bank A, Citibank. The first step that occurs we have already seen (Figure 10.9) but will be shown again in Figure 11.1. Demand deposits, and therefore the money supply, increase by $1,000, held by Jones & Co., and Citibank’s reserves also go up by $1,000. At this point, Citibank cannot simply increase demand deposits by another $4,000 and lend them out. For while it could do so and remain with a required minimum reserve/deposit ratio of 20 percent, it could not keep that vital status for long. Let us make the reasonable assumption that the $4,000 is loaned to R.H. Macy & Co., and that Macy’s will spend its new deposits on someone who is a client of another, competing bank. And if Citibank should be lucky enough to have Macy’s spend the $4,000 on another of its clients, then that client, or another one soon thereafter, will spend the money on a nonclient. Suppose that Macy’s spends $4,000 on furniture from the Smith Furniture Co. But the Smith Furniture Co. is the client of another bank, ChemBank, and it deposits Macy’s Citibank check into its Chem- Bank account. ChemBank then calls on Citibank to redeem its $4,000. But Citibank hasn’t got the $4,000, and this call for redemption will make Citibank technically bankrupt. Its reserves are only $1,000, and it therefore will not be able to pay the $4,000 demanded by the competing bank. In short, when Citibank’s demand deposits were owed to Macy’s, its own client, everything was fine. But now, not from loss of confidence or from a sudden demand for cash, but in the course of regular, everyday trade, Macy’s demand deposits have been transferred to ChemBank, and ChemBank is asking for reserves at the Fed for redemption. But Citibank doesn’t have any reserves to spare and is therefore insolvent. One bank, therefore, cannot blithely heap 5:1 on top of new reserves. But if it cannot expand 500 percent on top of its reserves, what can it do? It can and does expand much more mod- erately and cautiously. In fact, to keep within its reserve require- ments now and in the foreseeable future, it expands not by 500 percent but by 1 minus the minimum reserve requirement. In this case, it expands by 80 percent rather than by 500 percent. We will see in the figures below how each bank’s expanding by 80 percent in a central banking system causes all banks, in the aggregate, in a short period of time, to expand by the money multiplier of 5:1. Each bank’s expansion of 80 percent leads to a system or aggre- gate expansion of 500 percent.
To see the answer, we have to examine the detailed bank-to- bank process of credit expansion under central banking. To make it simple, suppose we assume that the Fed buys a bond for $1,000 from Jones & Co., and Jones & Co. deposits the bond in Bank A, Citibank. The first step that occurs we have already seen (Figure 10.9) but will be shown again in Figure 11.1. Demand deposits, and therefore the money supply, increase by $1,000, held by Jones & Co., and Citibank’s reserves also go up by $1,000.
At this point, Citibank cannot simply increase demand deposits by another $4,000 and lend them out. For while it could do so and remain with a required minimum reserve/deposit ratio of 20 percent, it could not keep that vital status for long. Let us make the reasonable assumption that the $4,000 is loaned to R.H. Macy & Co., and that Macy’s will spend its new deposits on someone who is a client of another, competing bank. And if Citibank should be lucky enough to have Macy’s spend the $4,000 on another of its clients, then that client, or another one soon thereafter, will spend the money on a nonclient. Suppose that Macy’s spends $4,000 on furniture from the Smith Furniture Co. But the Smith Furniture Co. is the client of another bank, ChemBank, and it deposits Macy’s Citibank check into its Chem- Bank account. ChemBank then calls on Citibank to redeem its $4,000. But Citibank hasn’t got the $4,000, and this call for redemption will make Citibank technically bankrupt. Its reserves are only $1,000, and it therefore will not be able to pay the $4,000 demanded by the competing bank.
In short, when Citibank’s demand deposits were owed to Macy’s, its own client, everything was fine. But now, not from loss of confidence or from a sudden demand for cash, but in the course of regular, everyday trade, Macy’s demand deposits have been transferred to ChemBank, and ChemBank is asking for reserves at the Fed for redemption. But Citibank doesn’t have any reserves to spare and is therefore insolvent.
One bank, therefore, cannot blithely heap 5:1 on top of new reserves. But if it cannot expand 500 percent on top of its reserves, what can it do? It can and does expand much more mod- erately and cautiously. In fact, to keep within its reserve require- ments now and in the foreseeable future, it expands not by 500 percent but by 1 minus the minimum reserve requirement. In this case, it expands by 80 percent rather than by 500 percent. We will see in the figures below how each bank’s expanding by 80 percent in a central banking system causes all banks, in the aggregate, in a short period of time, to expand by the money multiplier of 5:1. Each bank’s expansion of 80 percent leads to a system or aggre- gate expansion of 500 percent.
in scene 1, the bank creates new money of $420 just by opening checking accounts for new loans (worth $420) that are provided to the borrowers.
Banks do not create money by opening checking accounts. The money is created when a new loan is made. However a single bank can, theoretically, expand the money supply in the same way mulitple banks would. In order for this to happen the money that was lent out would only need to be redeposited bank into the original bank. The bank could then create a new loan (thus new money) based on that deposit.
The bank cannot open a checking account for $900 for Cust2 and lend him the same amount the same time.
Banks have no limit on reserve requirements, so they can withhold 20% or 1% or 0%, but their ability to make loans is limited by the scarcity of their loan officers, who need to make sure that the loans are good and will be paid back (or at least serviced).
This is why finance employment goes up in a credit expansion.
The fallacies of intellectual communism, a compilation - On the nature of power
I think you may be confused. I can see how i might have been unclear. The loan created first and the money is Then put into his account. That is exactly what happens everyday at banks. I lend you money and deposit it into your account.
Banks have no limit on reserve requirements, so they can withhold 20% or 1% or 0%,
Sure there is (at least in the US). Both the FED and FDIC regulatehow much banks can lend out. these limits are based on capital requirements, deposits, loans, etc.
but their ability to make loans is limited by the scarcity of their loan officers, who need to make sure that the loans are good and will be paid back (or at least serviced).