Multiple Deposit Creation

11 Key excerpts on "Multiple Deposit Creation"

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  Credit and Creed

  A Critical Legal Theory of Money

  • Andreas Rahmatian(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  There can be no doubt that, in the most convenient use of language, all deposits are ‘created’ by the bank holding them…. But it is equally clear that the rate at which an individual bank creates deposits on its own initiative is subject to certain rules and limitations; – it must keep step with the other banks and cannot raise its own deposits relatively to the total deposits out of proportion to its quota of the banking business of the country…. the ‘pace’ common to all the member banks is governed by the aggregate of their reserve resources.

  Thus according to Keynes, banks also withdraw from their deposits at the central bank (‘reserve resources’) in order to lend money, though with caution in order not to upset the equilibrium between aggregate deposits and aggregate reserves. Only a ‘multiple deposit expansion’ (Paul Samuelson)13 allows the banks in aggregate to create money; an individual bank is unable to do that: the size of its loans is still confined to its deposits received. The fractional reserve system with its ‘money multiplier’ approach is typically discussed at length in economics textbooks, so that a brief outline suffices for present purposes, particularly since the legal theory of money put forward in this book does not accept the fractional reserve theory of money anyway, and even the Bank of England has rejected it fairly recently.14

  11 Quoted in Werner (2016: 364).

  12 Keynes (2013a: 25–26).

  13 Werner (2014b: 8).

  14 Bank of England (2014a: 15).

  Money creation through bank credit will be explained in detail below.15 The fractional reserve theory claims that money creation is restricted by the operation of the money multiplier. If customer A deposits cash, say 100, in a bank account, this does not have an effect on the money supply because the cash has been converted into a claim of customer A against the bank to pay out on demand.16 Then, according to the fractional reserve theory, the bank retains a certain amount of A’s deposit, say, 10% as reserves and lends out the rest, that is, 90, to B, by way of a cash payment. At this stage, the money supply is increased because in addition to the 100 as debt of the bank against A, 90 in form of cash are put into circulation. B can then use the cash to buy goods from C, and C may then deposit the received 90 in cash in his bank account (with the same or another bank). The bank holding C’s account can then take 90% of the 90 (10% are retained as a reserve) to lend these 81 to D, paying out in cash, and D can buy goods for 81, so that the recipient of 81 in cash can deposit that amount with his bank, which, in turn has 90%, or 72.9 available for a new loan. And so forth: 100 − 10% = 90 − 10% = 81 − 10% = 72.9 – 10% = 65.61 − 10% = 59.049. Thus the money supply has been increased from 100, the initial deposit, to 100 + 90 + 81 + 72.9 + 65.61 + 59.049.17

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  A Systems Perspective on Financial Systems

  • Jeffrey Yi-Lin Forrest(Author)
  • 2014(Publication Date)
  • CRC Press

    (Publisher)

  For example again, if after bank B 2 lends a loan to an individual, instead of leaving the borrowed money in a bank account that person keeps the money all in cash, then the imagined process of deposit expansion is terminated right there and right then. Evidently, the created deposit total in this case will not be as large as what the models depict. The deposit creation models assume that banks do not hold any excess reserve. However, in reality, each bank maintains a certain amount of excess reserve. The existence of excess reserves is an important omission of the deposit expansion model. It makes the deposit multiplier less than the reciprocal of the rate of the statutory reserve. After learning these shortcomings of the Multiple Deposit Creation models, the significance of the models become clear. They mean that the amount of bank deposits that is supported by the reserves required by the law is the maximum possible amount of deposits instead of the realistic amount of deposits. Additionally, other than the behavior of the central bank that affects the level of deposits, the decisions of individual borrowers to hold cash and the decisions for commercial banks to maintain amounts of cash on hands also influence the level of deposits. They can all cause the money supply to change. It can be said that the behaviors of all four capital providers of the financial market, financial institutions, Supply and demand of money 99 industrial enterprises and commercial firms, government agencies, and families and individuals, can all impose effects on the level of deposits. Hence, in the study of money supply, these relevant aspects should not be ignored. 4.2.2 Monetary multiplier The so-called monetary multiplier stands for the ratio of the money supply M and the monetary base MB , denoted by m . That is, symbolically, we have m = monetary multiplier = money supply monetary base = M MB (4.13) This expression indicates that the money supply is a multiple of the monetary base.

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  Economics

  Theory and Practice

  • Patrick J. Welch, Gerry F. Welch(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  Although these loan‐making institu- tions include savings associations and credit unions, it is the commercial banks that are primarily engaged in money creation and destruction. Because of the huge impact that 2 Some economists write the equation of exchange as an identity: MV PQ . This equation is so classic that it was for years the license plate of a money and banking professor in St. Louis. 3 In reality, the velocity of money (M1) does change over time. However, in looking at the effect on the economy of increasing or decreasing the money supply at a particular moment in time, the assumption that V is fixed is appropriate. 206 Chapter 8 Money Creation, Monetary Theory, and Monetary Policy money supply changes have on the economy, it is important that the capacity of finan- cial institutions to make loans be highly controlled. This is one of the functions of the Federal Reserve. However, in order to understand how the Fed exerts its control over money supply changes, we need to understand under what conditions a financial depository institution can make a loan and how those conditions change. The Process of Money Creation Every financial depository institution has two assets that it counts as its actual reserves: the institution’s reserve account and its vault cash. Every institution must have a reserve account, which, as we saw in Chapter 7, can be held at a Federal Reserve bank or at an approved designated institution. Vault cash is all the cash in the depository institution’s vault and cash drawers. Depository institutions have a reserve requirement, which is a specific percent- age of deposits that must be kept as actual reserves. For example, a bank with a reserve requirement of 10 percent on demand deposits must have an amount on reserve equal to 10 percent of the value of the demand deposits it is holding.

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  Money, Banking, Financial Markets and Institutions

  • Michael Brandl(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 151 CHAPTER 2 Sample Design About Money What the Simple Deposit Multiplier Tells Us and Its Problems There are a couple of key insights to draw from the simple deposit multiplier: First, banks can create as well as destroy money; second, banks are subject to bank runs; third, banks can harm the overall economy if they do not lend. Let’s consider each in turn. 7-6a Banks Create and Destroy Money Remember in Chapter 2 we examined the various money supplies. We said that one of the most important components of M1 were demand deposits. With the help of the simple deposit multiplier, we can now see how the level of demand deposits increases. When a bank receives a deposit, it lends out the majority of that new deposit by creating new money. This new money then is deposited into another bank, and the process repeats. Thus, a one-time deposit into the banking system is going to wind up increasing the money supply by much more than that initial deposit. This is what the simple deposit multiplier captures. The process can also work in reverse. Imagine Anchor Bank holds only its level of required reserves with a required reserve ratio of 10%. Now assume a customer comes into the bank and withdraws $5,000 cash. The bank needed that $5,000 to back up $50,000 worth of deposits. Anchor Bank no longer has the customer’s $5,000 account, so we no longer need the $500 in reserves that was “backing up” that account. Anchor Bank does, however, need $4,500 to have enough reserves for the other $45,000 it has on deposit.

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  Sovereign Money

  Beyond Reserve Banking

  • Joseph Huber(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  This may result in a balance sheet crisis rather than the rule reliably function- ing as a liquidity buffer. Seen from a bank’s point of view, all such restrictions in fact curb their potential for credit and deposit creation. However, the hindrance is short- rather than long-term. By cooperative credit and deposit creation, the bank- ing industry, supported by quasi-automated fractional refinancing of the central banks, creates for itself what it needs in order to extend the limits and fulfill the requirements, by building up equity, providing sufficient liquidity, acquiring enough collateral and so forth. The ‘masters of the universe’ will not create what it needs in six days and rest on the seventh. But they might be able to do it in seven months or a couple of years. As a result, the ability of the banking sector to extend credit and create bankmoney seems to be limitless in the long term. Not quite. As will be seen in chapter 5 on the dysfunctions of the bankmoney regime, real eco- nomic output will always be a gravitational limit that cannot arbitrarily be outsmarted. Banks and financial markets can overshoot that mark and in fact they recurrently do. It regularly proves to be unsustainable, resulting in vio- lent self-corrections of the markets, and in general crises causing damage to the entire economy and population. 4.9 Creation of Bankmoney: The Entire Picture So far, we have discussed how a bank creates bankmoney by making loans and granting overdrafts. It has not yet been discussed that banks also create bank- money when they purchase financial and real assets for their own account, such as securities, equity and real estate, also including office equipment, IT infrastructure, software, company cars, licences and so on, all items which are entered into the books as tangible or intangible assets. 24 Securities may gain or lose value, and the equipment and other durables are subject to scheduled write-down.

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Money Creation by the Banking System 173 A More Realistic Look at Money Multipliers A few of the assumptions in our previous example were unrealistic. Let ’ s high-light them and explain the effect that relaxing each assumption has on the checking-deposit multiplier. In the process, we will develop an understanding of the factors influencing the real-life M1 and M2 money multipliers, which af-fect the M1 and M2 money supplies. In our checking-deposit-multiplier example, we assumed that: – After each loan was spent, all the funds were redeposited in another bank. No funds were withdrawn and used as currency in circulation. – Banks lent all their excess reserves, keeping nothing as a safety net or as a liquidity buffer for any other reasons. In short, we assumed that banks had no incentive to hold excess reserves. – After each loan was spent, redeposits were always placed into checking accounts. None of the redeposited funds was put in near-money accounts, such as savings deposits or time deposits. Relaxing these assumptions breathes life into our money multiplier example and helps explain why the banking systems ’ power to create money is consider-ably less than one divided by the reserve ratio on checking accounts. To explore Figure 8.20: Lend-Spend-Deposit Cycle. (Imagery used: © Sarah Maher, liravega258/123rf) 174 Chapter 8 Money Creation these effects, a small bit of pivoting is needed in terms of how we define the M1 and M2 money supplies. M1 Money Multiplier There are two equally valid ways to define the M1 money supply. M1 equals cur-rency in circulation (CC) plus checking deposits (D). It also equals a nation ’ s monetary base (B) times the M1 money multiplier (mm 1 ) (see Figure 8.21 – top). 2 The monetary base is composed of currency in circulation (CC) and reserves of financial institutions (TR), such as banks and thrift institutions. It can be thought of as the raw material from which a nation ’ s money supply is created.

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  Modern Monetary Theory and European Macroeconomics

  • Dirk H. Ehnts(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  The firm, however, has to transfer deposits worth 105 in order to repay the loan. If only 100 in deposits have been created through lending, where will the deposits come from that will allow the firm to repay the loan? Box 3.5 Maximisation of profits and minimisation of debts It is usually assumed that firms maximise profits. However, in a context of finan- cial crisis, firms might switch their top priority to debt minimisation. The repay- ment of debt destroys deposits, which slows down the monetary circuit. Had the deposits remained in circulation, they might have been used to finance investment, which would have led to more demand, more income and more growth. The additional deposits have been created, among other things, by other banks, and the owners of these deposits have transferred them to the firm. Alternatively, a bank might have bought something from the private sector by creating new deposits in the account of the seller. It might have been a house or a share of a firm. Naturally, the repayment of loans is easier when the amount of loans is growing strongly, since then more deposits are circulating in the economy. The creation of additional deposits from the public sector’s deficit spending or lower taxes might also be easing the pressure. The unit of currency and the acceptance of money So far, we haven’t looked at the denominations of the deposits in balance sheets of banks, firms and households. In principle, banks would be able to create deposits in all kinds of possible units: euro, dollar, lira or claims on bushels of fresh apples. Why do so many banks in Europe choose the euro? Bank deposits are created in the euro denomination because this is the accepted currency in the Eurozone. It is often said that we accept a particular means of payment because other people accept it. While this might be true today, it doesn’t explain how it came to be that way.

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  Money

  What It Is, How It's Created, Who Gets It, and Why It Matters

  • Sergio M. Focardi(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  In its simplest form, the theory of the multiplier states that the banking system receives exogenous deposits in the form of base money, typically banknotes or coins, and then, by making loans, creates an amount of new deposits whose total value is a multiple of the initial deposit. In order to offer a precise understanding of the functioning of the money generation process with the multiplier, let’s initially suppose that there are many commercial banks but there is no central bank (which, remember, was the case in the U.S until 1913). Let’s assume that coins and banknotes are issued directly by the government. This assumption (which will be discussed later) is made here for didactical reasons: we need to assume a source of exogenous money.

  There are two types of money, that is, two means of payment in the system:

  • base money formed by banknotes and coins;
  • bank deposits convertible into coins or banknotes.

  For simplicity, assume there are only banknotes, no coins, whose total value is in any case small and which, from the point of view of the multiplier, behave as banknotes. Suppose a bank receives a deposit in the form of banknotes. The bank becomes the owner of the banknotes and the depositor becomes a creditor of the bank, with the right to ask for his/her money back in the form of banknotes. In general, there are various agreements between banks and their clients that specify the conditions under which a client can ask for his or her deposit back. In particular, banks might assume the obligation to return the money to clients on demand or after a specified period of time. In general, banks pay interests on deposits in function of the conditions of the deposit. Demand deposits (checking accounts) generally pay no interest.

  The idea of fractional reserves banking is that banks receive deposits of banknotes and then keep a fraction of the deposits as reserves but can lend the remaining fraction. The rationale of fractional reserves is that, in general, clients will not withdraw all their money at the same time. In the classical tradition, reserves are used to satisfy clients’ requests for withdrawing banknotes, the amount of reserves being fixed by the government or by the central bank.

  How does the multiplier work? Let’s make an example. Suppose that, to simplify calculations, banks must keep 10% of deposits as reserves. Suppose further that a bank – Bank A – receives a deposit of $1,000 in banknotes. The bank creates a deposit of $1,000, that is, it writes a note to the client stating that it has a debt of $1,000 with the depositor, and acquires ownership of the banknotes.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Excess reserves fuel the deposit expansion process, and a higher reserve requirement drains this fuel from the banking system, thereby reducing the amount of new money that can be created. On the other hand, with a reserve requirement of only 5 percent, banks would set aside less for required reserves, leaving more excess reserves available for loans. The simple money multiplier in that case would be 1/0.05, or 20. With $1,000 in fresh reserves and a 5 percent reserve requirement, the banking system could increase the money supply by a maximum of $1,000 3 20, which equals $20,000. Thus, the change in the required reserve ratio affects the banking system’s ability to create money. In summary, money creation usually begins with the Fed injecting new reserves into the banking system. An individual bank lends an amount no greater than its excess reserves. The borrower’s spending ends up in someone else’s checking account, fueling additional loans. The fractional reserve requirement is the key to the multiple expan- sion of checkable deposits. If each $1 deposit had to be backed by $1 in required reserves, the money multiplier would be reduced to 1, which is no multiplier at all. 28-3d Limitations on Money Expansion Various leakages from the multiple expansion process reduce the size of the money multiplier, which is why 1/r is called the simple money multiplier. You could think of “simple” as meaning maximum. To repeat, our example assumes (1) that banks do not let excess reserves sit idle, (2) that borrowers do something with the money, and (3) that people do not choose to increase their cash holdings. How realistic are these assump- tions? With regard to the first, banks have a profit incentive to make loans or buy some higher interest-bearing asset with excess reserves. Granted, banks earn some interest on reserves deposited with the Fed, but the rate is typically much less than could be earned on loans or on most other interest-bearing assets.

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  Money Income and Employment

  • Erich Schneider(Author)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  (33)

  33  The reader is urged to consult the work of E. Preiser “Der Kapitalbergriff und die neuere Theorie” in Die Unternehmung im Markt, essays in honour of Wilhelm Rieger, Stuttgart, 1954. Further: H. Gestrich, loc. cit. , pp. 79-101.

  As we have seen, deposit money is also continuously created and destroyed in the course of the banks’ passive business. But if payments habits in the non-banking sector remain unchanged this can never lead to a growth in the total volume of deposit money. Growth in the total volume of deposit money is possible only if the central bank makes available new cash to the commercial banks.(34)

  34  This state of affairs is described as follows in “The Federal Reserve System: Its Purpose and its Functions”, published by the Board of Governors of the Federal Reserve System (Washington, D.C., 3rd edition, 1954): “Taking the banking system as a whole deposits originate in bank loans and investments, but each individual bank’s ability to lend and invest arises largely from deposits brought to it by its customers” (p. 21). In this context “investments” refer to the acquisition of assets by the banks which do not arise from loans to customers (for example, purchases of securities on the Stock Exchange). Loans, in this context, refer to the claims which a bank acquires in the course of its active business. In the famous Macmillan Report (Report of the Committee on Finance and Industry, London 1931) the same state of affairs is explained as follows: “It is not unnatural to think of deposits of a bank as being created by the public through the deposits of cash.... But the bulk of the deposits arise out of the action of the banks themselves, for by granting loans, allowing money to be drawn on an overdraft, or purchasing securities a bank creates a credit in its books which is the equivalent of a deposit” (loc. cit.

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  The Money Revolution

  How to Finance the Next American Century

  • Richard Duncan(Author)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  From that point, money began leaking out of com-mercial bank deposit accounts and moving into other kinds of products, often in search of higher returns. Afterwards, what had been a relatively straightforward pro-cess in which the private depository institutions created money and credit through the system of fractional reserve banking became more complicated. 178 Credit Bank deposits gradually ceased to be the most impor-tant source of funding for the financial sector because deposi-tors took their money out of banks and invested it in the other investment products that non-bank financial institutions began to offer them. The Creation of Non-deposit Liabilities by Commercial Banks The way the financial sector created money and credit evolved during the second half of the twentieth century. To understand this evolution, let’s first look at the commercial banks and the other private depository institutions to see how their pattern of extending credit changed. We will find that over this period the financial sector began lending relatively less to non-financial sec-tor end users of the funds, such as the federal government and state and local governments, and relatively more to other entities within the financial sector, thereby providing them with funds they could use to extend credit themselves. At the end of World War II, investments in US government bonds accounted for a full 72% of all the credit extended by the private depository institutions. Loans made up only 22% of their total portfolio of loans and investments. The composition of these institutions’ portfolios changed very rapidly after the war, however. By the early 1960s, the relative proportion of govern-ment bonds and loans in the private depository institutions’ port-folios had been reversed, with the former falling to below 20% of the total and the latter rising above 70%. Between the mid-1960s and 2007, loans continued to account for 70% to 80% of these institutions’ total assets.

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