Explain the process of money creation by commercial bank

Credit creation by commercial banks is the process of the creation of credit or money by banks when they lend money to borrowers. This process involves a series of steps that lead to the creation of credit, which is then used by borrowers to purchase goods and services. Process of credit creation by commercial banks: 1. Deposit mobilization - The first step in the process of credit creation by commercial banks is deposit mobilization. Banks mobilize deposits from their customers, which are then used to create credit. For example, if a customer deposits Rs. 10,000 in a bank, the bank can use this money to create credit. 2. Reserve Ratio - Banks are required to maintain a certain reserve ratio, which is the ratio of reserves to deposits. The reserve ratio is set by the central bank and is usually around 10%. This means that for every Rs. 100 deposited, the bank must keep Rs. 10 as reserves. 3. Lending - Once the bank has mobilized deposits and maintained reserves, it can then lend money to borrowers. For example, if a borrower wants to borrow Rs. 5,000, the bank can lend this money to the borrower. 4. Deposit creation - When the bank lends money, it creates a deposit for the borrower. For example, if the bank lends Rs. 5,000 to a borrower, it creates a deposit of Rs. 5,000 in the borrower's account. This deposit can then be used by the borrower to make purchases. 5. Repeat the process - The process of credit creation can be repeated again and again. When the borrower spends ...

Key term Definition Bank (sometimes called a commercial bank) A financial institution that accepts deposits and makes loans; banks are sometimes referred to as “depository institutions.” Central bank (sometimes called a reserve bank or banking authority) an institution that manages a country’s money supply and monetary policy Financial intermediary a middle-person in a financial transaction; a bank is an intermediary that coordinates borrowing and lending by combining the deposits of many agents into loans. Assets something of value to the agent that holds it; a bank’s assets include real assets owned by the bank (such as a building), the money they hold, and financial assets such as bonds and loans. Liabilities obligations to pay back; to a bank, your savings account is a liability because you might show up one day and want the money you deposited back. Fractional reserves the practice of keeping a percentage of deposits on hand but loaning out the rest Reserve requirement a legal obligation to keep a minimum amount of reserves; if the reserve requirement is 20 % 20\% 2 0 % 20, percent and you deposit $ 100 \$100 $ 1 0 0 dollar sign, 100 in a bank, the bank must keep $ 20 \$20 $ 2 0 dollar sign, 20 of that in its vaults, but it can loan out the rest. Excess reserves the remainder of the deposited money that banks are not required to keep on hand; banks can make loans out of excess reserves or choose to keep excess reserves in their vaults. Fully loaned out a situation in ...

Deficient demand refers to the situation when aggregate demand (AD) is less than the aggregate supply (AS) corresponding to full employment level of output in the economy. The situation of deficient demand arises when planned aggregate expenditure falls short of aggregate supply at the full employment level. It gives rise to deflationary gap. Deflationary gap is the gap by which actual aggregate demand falls short of aggregate demand required to establish full employment equilibrium. Reasons for deficient demand: 1. Decrease in Propensity to consume: A decrease in consumption expenditure, due to fall in the propensity to consume, leads to deficient demand in the economy. 2. Increase in taxes: AD may also fall due to imposition of higher taxes. It leads to decrease in disposable income and, as a result, the economy suffers from deficient demand. 3. Decrease in Government Expenditure: When government reduces its demand for goods and services due to fall in public expenditure, it leads to deficient demand. 4. Fall in Investment expenditure: Increase in the rate of interest or fall in the expected returns lead to decrease in the investment expenditure. It reduces the AD and gives rise to deficient demand. 5. Rise in Imports: When international prices are comparatively less than the domestic prices, then it may lead to a rise in imports, implying a cut in the aggregate demand. 6. Fall in Exports: Exports may fall due to comparatively higher prices of domestic goods or due to in...

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Learning Objectives • Explain and show how banks create money • Use the money multiplier formula to calculate how banks create money Money Creation by a Single Bank Banks and money are intertwined. It is not just that most money is in the form of bank accounts. The banking system can literally create money through the process of making loans. Let’s see how. Start with a hypothetical bank called Singleton Bank. The bank has $10 million in deposits. The T-account balance sheet for Singleton Bank, when it holds all of the deposits in its vaults, is shown in Figure 1. At this stage, Singleton Bank is simply storing money for depositors; it is not using these deposits to make loans, so it cannot pay its depositors interest either. Figure 1. Singleton Bank’s Balance Sheet: Receives $10 million in Deposits. Singleton Bank is required by the Federal Reserve to keep 10% of total deposits, or $1 million, on reserve to cover withdrawals. It will loan out the remaining $9 million. By loaning out the $9 million and charging interest, it will be able to make interest payments to depositors and earn interest income for Singleton Bank and make interest payments to depositors (for now, we will keep it simple and not put interest income on the balance sheet). Instead of becoming just a storage place for deposits, Singleton Bank can become a financial intermediary between savers and borrowers. This change in business plan alters Singleton Bank’s balance sheet, as shown in Figure 2. Singleton...

Main article: The term "money supply" commonly denotes the total, safe, • M0: The total of all physical currency including coinage. Using the United States dollar as an example, M0 = • M1: The total amount of M0 (cash/coin) outside of the private banking system [ clarification needed] plus the amount of • M2: M1 + most The money supply is understood to increase through activities by government authorities, Money creation by the central bank [ ] Central banks [ ] Main article: The authority through which monetary policy is conducted is the The central bank is the banker of the government Central banks operate in practically every nation in the world, with few exceptions. The central bank's activities directly affect interest rates, through controlling the Open-market operations [ ] Open-market operations (OMOs) concern the purchase and sale of securities in the open market by a central bank. OMOs essentially swap one type of Monetary policy [ ] Main article: Monetary policy is the process by which the monetary authority of a country, typically the central bank (or the Physical currency [ ] The central bank, or other competent, state authorities (such as the treasury), are typically empowered to create new, physical currency, i.e. paper notes and coins, in order to meet the needs of commercial banks for cash withdrawals, and to replace worn and/or destroyed currency. In modern economies, relatively little of the supply of Role of commercial banks [ ] Main article: When comme...

• • • • Question:The money supply increases every time a commercial bank makes a loan. Explain the process of money creation by commercial banks. When your friend borrows money from you, will the money supply increase the same way if she borrowed that same amount of money from a bank? Your response must be thorough (100 word minimum). The money supply increases every time a commercial bank makes a loan. Explain the process of money creation by commercial banks. When your friend borrows money from you, will the money supply increase the same way if she borrowed that same amount of money from a bank? Your response must be thorough (100 word minimum).

Learning Objectives • Explain what banks are, what their balance sheets look like, and what is meant by a fractional reserve banking system. • Describe the process of money creation (destruction), using the concept of the deposit multiplier. • Describe how and why banks are regulated and insured. Where does money come from? How is its quantity increased or decreased? The answer to these questions suggests that money has an almost magical quality: money is created by banks when they issue loans. In effect, money is created by the stroke of a pen or the click of a computer key. We will begin by examining the operation of banks and the banking system. We will find that, like money itself, the nature of banking is experiencing rapid change. Banks and Other Financial Intermediaries An institution that amasses funds from one group and makes them available to another is called a Banks play a particularly important role as financial intermediaries. Banks accept depositors’ money and lend it to borrowers. With the interest they earn on their loans, banks are able to pay interest to their depositors, cover their own operating costs, and earn a profit, all the while maintaining the ability of the original depositors to spend the funds when they desire to do so. One key characteristic of banks is that they offer their customers the opportunity to open checking accounts, thus creating checkable deposits. These functions define a Over time, some nonbank financial intermediaries have bec...