Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve...

Deposit creation by Jody Wong, YLMASS

1

Process of Multiple Deposit Creation in a Fractional Reserve Banking System


2

Assumptions

1.Fractional reserve system

Minimum reserve ratio / legal reserve ratio e.g. 20% of the total deposits.

Banks do not hold excess reserves


3

Assumptions

2. No cash leakages ( loans made by a bank will return to the banking system. )

3. Adequate qualified borrowers ( enough investment opportunities )

4. One type of deposits


4

Why do banks need to keep minimum reserves?

Banks keep minimum reserves because

1. They are required by the law to do so.

2. Banks keep minimum reserves to meet the normal withdrawal of the depositors.


5

What are minimum reserves?

Minimum reserves refer to the minimum amount of reserves/reserves required by the law that a bank must keep to meet the withdrawal of the depositors.

The amount depends on the legal reserve ratio and the amount of deposits.


6

How to calculate the amount of minimum reserves?

Suppose a bank receives a new deposit of $5000 and the minimum reserve ratio is 25%.

The minimum amount of deposits kept by the bank = $5000 ( 25% )

= $1250


7

What are excess reserves?Excess reserves =

Actual reserves – minimum reserves

New deposit = $5000 and minimum reserve ratio = 25%

Minimum reserves = $5000( 25% ) = $1250

Excess reserves = $5000 - $1250 = $3750


8

A Bank’s Balance Sheet

Assets include

• Reserves ( in the form of cash or very liquid assets ) kept in banks

• Loans

• Investment

Liabilities

• Deposits


9

Process of Deposit creation

Assumptions : Revisited

1. Minimum reserve ratio, e.g. 20% of deposits

2. No cash leakage

3. Adequate investment opportunities/enough qualified borrowers

4. One type of deposits


10

Process of Deposit Creation

New deposits = $1000

Mr.

deposits $1000 cash in Bank A.

Minimum reserve ratio = 20%


11

Bank A’s Balance Sheet: Immediate effect ( New

deposits )Balance Sheet

Assets: Liabilities:

Reserves Deposits1000 1000


12

Bank A

• Minimum reserves = $1000 ( 20% ) = $200

• Excess reserves = $1000 - $200 = $800

• Excess reserves are loaned out. $800 loan made to a borrower will be deposited to his bank, say Bank B.


13

Bank A’s Balance Sheet after loaning out excess reserves

Bank A’s Balance Sheet

Assets: Liabilities:Minimum

reserves 200

Loans 800

Deposits 1000


14

Bank B gains a new deposit of $800


15

Bank B’s Balance Sheet: Immediate effect ( New

deposits )Balance Sheet




16

Bank B


• Excess reserves = $800 - $160 = $640

• Excess reserves are loaned out. $640 loan made to a borrower will be deposited to his bank, say Bank C.


17

Bank B’s Balance Sheet after loaning out excess reserves

Bank B’s Balance Sheet


Minimum reserves

Loans

Deposits160

640

800


18

Bank C gains a new deposit of $640


19

Bank C’s Balance Sheet: Immediate effect ( New

Deposits )Balance Sheet




20

Bank C


• Excess reserves = $640 - $128 = $512

• Excess reserves are loaned out. $512 loan made to a borrower will be deposited to his bank, say Bank D.


21

Bank C’s Balance Sheet after loaning out excess reserves

Bank C’s Balance Sheet


Minimum reserves

Loans

Deposits128

512640


22

The process goes on and on ……..


23

Summary of the above balance sheets

Bank A

Bank B

Bank C

DepositsMinimum reserves Loans

1000 200 800

800 160 640

640 128 512

……… on and on …………………


24

Maximum Amount of Deposits Created

Maximum amount of deposits created

= $1000 + $800 + $ 640 + $512 ……

= $1000 ( 1 + 0.8 + 0.82 + 0.83 + 0.84 …. )

= $1000 ( 1/1-0.8 )

= $1000 ( 1/0.2 )


25

Maximum Amount of Deposits Created

Maximum amount of deposits created

= Initial deposits ( 1/minimum reserve ratio )

Maximum Banking Multiplier

= 1/minimum reserve ratio


26

Does the supply of money change?

Yes! But Why?

Bank deposits are components of money supply. When more deposits are created, the money supply also increases.

But by how much ?


27

Is the increase in money supply the same as the amount of deposits created?

It depends on the source of the initial deposits!


28

If the initial deposit comes from money in circulation, then

the maximum increase in money supply is smaller than the maximum increase in total deposits.


29

Initial deposit = $1000 ( cash in circulation, before being deposited in Bank A)

The maximum increase in deposits is $5000.

The maximum increase in money supply is $5000 - $1000 = $4000


30

If the initial deposit does not come from money in circulation, then

the maximum increase in money supply is the same as the maximum increase in total deposits.


31

Initial deposit = $1000 ( e.g. $1000 brought into the economy by a 金山阿伯阿威 from the US )

The maximum increase in deposits is $5000.

The maximum increase in money supply is also $5000


32What if ………………?


33

Limitations to the process of multiple deposit creation

1. What if banks keep excess reserves ?


34


2. What if there are cash leakages?


35


3. What if there are not enough qualified borrowers?


36

Process of Multiple Deposit Contraction in a Fractional Reserve Banking System

What happens to the total deposits of the banking system if a depositor withdraws money from the bank, assuming the banking system is fully loaned up?

How will the change in bank deposits affect the money supply?


37

END

Date post:	29-Dec-2015
Category:	Documents
Upload:	shanon-oconnor
View:	216 times
Download:	0 times

Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve...

Documents