Economics of Financial Markets how do banks create money

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  • How do banks create money?
    • Banks create money by lending to those who need to borrow from savers
    • Banking systems
      • Fractional reserve banking system
        • banks keep a fraction of the deposits as reserves (use the rest to make loans)
          • CB establishes a reserve requirement, banks may hold more than this amount
        • Creates money but not wealth
      • no banking system
        • public holds 100% of reserves, no loans are made
      • 100% reserve banking system
        • bank holds 100% of funds in reserves, meaning it makes no loans
    • multiplier affect
      • amount of money the banking system generates with each pound of reserves
        • money multiplier= 1/R R=Reserves


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