Money Creation - Money Creation Through The Fractional Reserve System

Money Creation Through The Fractional Reserve System

Through fractional-reserve banking, the modern banking system expands the money supply of a country beyond the amount initially created by the central bank. There are two types of money in a fractional-reserve banking system, currency originally issued by the central bank, and bank deposits at commercial banks:

  1. central bank money (all money created by the central bank regardless of its form, e.g. banknotes, coins, electronic money)
  2. commercial bank money (money created in the banking system through borrowing and lending) - sometimes referred to as checkbook money

When a commercial bank loan is extended, new commercial bank money is created. As a loan is paid back, more commercial bank money disappears from existence. Since loans are continually being issued in a normally functioning economy, the amount of broad money in the economy remains relatively stable. Because of this money creation process by the commercial banks, the money supply of a country is usually a multiple larger than the money issued by the central bank; that multiple is determined by the reserve ratio or other financial ratios (primarily the capital adequacy ratio that limits the overall credit creation of a bank) set by the relevant banking regulators in the jurisdiction.

Read more about this topic:  Money Creation

Famous quotes containing the words money, creation, fractional, reserve and/or system:

    Ford. If money go before, all ways do lie open.
    Falstaff. Money is a good soldier, sir, and will on.
    William Shakespeare (1564–1616)

    There have been heroes for whom this world seemed expressly prepared, as if creation had at last succeeded; whose daily life was the stuff of which our dreams are made, and whose presence enhanced the beauty and ampleness of Nature herself.
    Henry David Thoreau (1817–1862)

    Hummingbird
    stay for a fractional sharp
    sweetness, and’s gone, can’t take
    more than that.
    Denise Levertov (b. 1923)

    Her face had the seamed reserve of the old in this country [Japan]. It was a neighborhood poignantly rich in old ladies.
    Angela Carter (1940–1992)

    The United States is unusual among the industrial democracies in the rigidity of the system of ideological control—”indoctrination” we might say—exercised through the mass media.
    Noam Chomsky (b. 1928)