Explain how banks can create money.

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Business

Owen Hunter

23 November, 18:10

Explain how banks can create money.

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Luciana Weaver · Answer 1

Banks usually operate in a fractional reserve banking system which means that they only have to keep a fraction of all their deposits and can loan out the rest, so they can create money by lending out money. For example if $10 is deposited into a bank and the required reserve ratio is 10% they can loan out $9 and have to keep only $1 in reserve. When they loan out $9 they are creating new money as someone who didn't have any money now has $9. And this keeps on going on as the $9 might also end up in the bank and 90% of that will be loaned out.

Explanation:

Banks usually operate in a fractional reserve banking system which means that they only have to keep a fraction of all their deposits and can loan out the rest, so they can create money by lending out money. For example if $10 is deposited into a bank and the required reserve ratio is 10% they can loan out $9 and have to keep only $1 in reserve. When they loan out $9 they are creating new money as someone who didn't have any money now has $9. And this keeps on going on as the $9 might also end up in the bank and 90% of that will be loaned out.