The commonly perceived operation of a bank is fairly simply; a bank received deposits and holds them in trust
The bank lends out the funds to generate income - the loanable funds model..
While this perceived intermediary role of a bank is fairly typical, it in fact does not illustrate the process and method by which banks hold deposited funds. The actual method is called Fractional reserve banking [FRB], in which banks are required to keep a fraction of the total reserves (deposits) held, hence the name fractional reserve banking. Any amount held beyond the reserve requirement (excess reserve) can be loaned out and put into the economy.
However as a result of such practice, a particular amount of actual money can be multiplied resulting …show more content…
Let 's assume that Cathy, an individual with some cash to be deposited in the bank, will take $1,000 and deposit into her local bank branch; Bank A. Currently, in the United States, the reserve ratio [RR] is 10% of the liabilities [for net transaction accounts exceeding $110.2 million, the Federal Reserve].
Therefore, of the $1000 deposited into the bank, $100 must be kept on hand as Required Reserve. The remaining $900 is Excess Reserve and can be used by the bank to generate income. Often the claim is that the bank must earn money with the excess reserve because interest is paid to the depositor as well as bank overhead [and profit!]. Hence the bank will loan out the $900 to earn interest.
Continuing with the example, let 's further assume that Joe, an individual in need of capital for his business, frequents Bank A and borrows the $900 that is available with interest of course. A quick snapshot at this point reveals that there is now the initial $1000 deposited by Cathy in the system with the additional $900 in the hands of Joe, for a total of $1,900. The added $900 was created as a result of the fractional reserve process. However we aren’t done
The bank lends out the funds to generate income - the loanable funds model..
While this perceived intermediary role of a bank is fairly typical, it in fact does not illustrate the process and method by which banks hold deposited funds. The actual method is called Fractional reserve banking [FRB], in which banks are required to keep a fraction of the total reserves (deposits) held, hence the name fractional reserve banking. Any amount held beyond the reserve requirement (excess reserve) can be loaned out and put into the economy.
However as a result of such practice, a particular amount of actual money can be multiplied resulting …show more content…
Let 's assume that Cathy, an individual with some cash to be deposited in the bank, will take $1,000 and deposit into her local bank branch; Bank A. Currently, in the United States, the reserve ratio [RR] is 10% of the liabilities [for net transaction accounts exceeding $110.2 million, the Federal Reserve].
Therefore, of the $1000 deposited into the bank, $100 must be kept on hand as Required Reserve. The remaining $900 is Excess Reserve and can be used by the bank to generate income. Often the claim is that the bank must earn money with the excess reserve because interest is paid to the depositor as well as bank overhead [and profit!]. Hence the bank will loan out the $900 to earn interest.
Continuing with the example, let 's further assume that Joe, an individual in need of capital for his business, frequents Bank A and borrows the $900 that is available with interest of course. A quick snapshot at this point reveals that there is now the initial $1000 deposited by Cathy in the system with the additional $900 in the hands of Joe, for a total of $1,900. The added $900 was created as a result of the fractional reserve process. However we aren’t done