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How does a single bank create money under the fractional reserve system?

A single bank creates money under the fractional reserve system by lending out more money than it takes in in deposits.  This is one reason why banks are so important in our system.


When a person deposits money in the bank, that money does not simply sit there.  Instead, the bank loans it out.  The bank is not allowed to loan all of the money out.  It has to keep some fraction of the money...

A single bank creates money under the fractional reserve system by lending out more money than it takes in in deposits.  This is one reason why banks are so important in our system.


When a person deposits money in the bank, that money does not simply sit there.  Instead, the bank loans it out.  The bank is not allowed to loan all of the money out.  It has to keep some fraction of the money in what is called reserves, thus the term “fractional reserve” banking.  When it loans that money out, it creates money that had not existed before.


Imagine that you deposit $1000 in the bank.  Let us say that the bank is required to keep 10% of that money in reserves.  It then lends me $900.  It has created $900 that had not previously existed.  You still have the right to $1000, but I also have $900 in money that the bank just created.  Now imagine that I deposit the $900 that I borrowed in my account.  The bank would have to keep $90 of it (10%) in reserve, but it could still loan out the other $810.  Now, the bank has created $1710 that did not exist before.  This could go on and on, with the amount that the bank creates getting larger and larger.  This is how a single bank can create money under the fractional reserve system.


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