Alomar_111_MCP1 Money Creation Process

Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of the bank by (100) If the bank keeps the (100) in cash, this rises the assets side of the balance sheet

Alomar_111_MCP3 A L

Alomar_111_MCP4 Since cash is part of bank’s reserves, the (100) becomes reserves now A L

Alomar_111_MCP5 If the required reserve ratio = 10%, then reserves can be divided into: Required reserves = (10%)(100)=KD10 Excess reserves = = KD90

Alomar_111_MCP6 A L

Alomar_111_MCP7 Since excess reserves earn no interest. Bank (A) may choose to make a loan worth of (90). (why not lend the 100)? The bank make profits now: (interest paid on loan) – (interest paid on deposits)

Alomar_111_MCP8 A L RR 10 Checkable D 100 ER 0 Loans 90

Alomar_111_MCP9 Assume now that your friend who borrowed the (KD90), went to bank (A) and opened a checking account

Alomar_111_MCP10 A L RR 19 Checkable D ER 81 Checkable D 2 90 Loans

Alomar_111_MCP11 Total deposits = KD190 Since excess reserves earn no interest, bank (A) will make a loan of the (81) to another person. Excess reserves = 0 Total loans = KD171

Alomar_111_MCP12 A L RR 19 Checkable D ER 0 Checkable D 2 90 Loans

Alomar_111_MCP13 This process will continue… We started with (KD100) but total deposits increased by more than the initial (KD100) This is called “money creation”

Alomar_111_MCP14 Deposit multiplier = 1/rrr = 1/0.10=10 Thus, the total amount of deposits bank (A) can create = (10)(100) = KD1000 Total loans = 1000 – 100 = 900 (total deposits – total required reserve)