Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve...
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Transcript of Deposit creation by Jody Wong, YLMASS 1 Process of Multiple Deposit Creation in a Fractional Reserve...
Deposit creation by Jody Wong, YLMASS
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Process of Multiple Deposit Creation in a Fractional Reserve Banking System
Deposit creation by Jody Wong, YLMASS
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Assumptions
1.Fractional reserve system
Minimum reserve ratio / legal reserve ratio e.g. 20% of the total deposits.
Banks do not hold excess reserves
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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
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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.
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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.
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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
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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
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A Bank’s Balance Sheet
Assets include
• Reserves ( in the form of cash or very liquid assets ) kept in banks
• Loans
• Investment
Liabilities
• Deposits
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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
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Process of Deposit Creation
New deposits = $1000
Mr.
deposits $1000 cash in Bank A.
Minimum reserve ratio = 20%
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Bank A’s Balance Sheet: Immediate effect ( New
deposits )Balance Sheet
Assets: Liabilities:
Reserves Deposits1000 1000
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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.
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Bank A’s Balance Sheet after loaning out excess reserves
Bank A’s Balance Sheet
Assets: Liabilities:Minimum
reserves 200
Loans 800
Deposits 1000
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Bank B gains a new deposit of $800
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Bank B’s Balance Sheet: Immediate effect ( New
deposits )Balance Sheet
Assets: Liabilities:
Reserves Deposits800 800
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Bank B
• Minimum reserves = $800 ( 20% ) = $160
• 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.
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Bank B’s Balance Sheet after loaning out excess reserves
Bank B’s Balance Sheet
Assets: Liabilities:
Minimum reserves
Loans
Deposits160
640
800
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Bank C gains a new deposit of $640
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Bank C’s Balance Sheet: Immediate effect ( New
Deposits )Balance Sheet
Assets: Liabilities:
Reserves Deposits640 640
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Bank C
• Minimum reserves = $640 ( 20% ) = $128
• 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.
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Bank C’s Balance Sheet after loaning out excess reserves
Bank C’s Balance Sheet
Assets: Liabilities:
Minimum reserves
Loans
Deposits128
512640
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The process goes on and on ……..
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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 …………………
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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 )
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Maximum Amount of Deposits Created
Maximum amount of deposits created
= Initial deposits ( 1/minimum reserve ratio )
Maximum Banking Multiplier
= 1/minimum reserve ratio
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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 ?
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Is the increase in money supply the same as the amount of deposits created?
It depends on the source of the initial deposits!
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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.
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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
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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.
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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
Deposit creation by Jody Wong, YLMASS
32What if ………………?
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Limitations to the process of multiple deposit creation
1. What if banks keep excess reserves ?
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Limitations to the process of multiple deposit creation
2. What if there are cash leakages?
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Limitations to the process of multiple deposit creation
3. What if there are not enough qualified borrowers?
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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?
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END