Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
14
C HAPTE R
How Banks and
Thrifts Create Money
Key Terms
Previous
Slide
End
Show
14 - 1
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 2
Next
Slide
BALANCE SHEET OF A
COMMERCIAL BANK
ASSETS = LIABILITIES + NET WORTH
The Goldsmiths
Fractional Reserve Banking
System
Money Creation & Reserves
Bank Panics & Regulation
Copyright McGraw-Hill/Irwin, 2005
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 3
Next
Slide
TRANSACTION
1
Creating a bank
$250,000 Cash
for
Capital Stock
Copyright McGraw-Hill/Irwin, 2005
LIABILITIES AND
NET WORTH
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
LIABILITIES AND
NET WORTH
$250,000
Capital Stock
$250,000
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 4
Next
Slide
Deposit Added to Vault Cash
Copyright McGraw-Hill/Irwin, 2005
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
LIABILITIES AND
NET WORTH
$250,000
TRANSACTION
2
Acquiring
Property and
Equipment
$240,000 Cash
Previous
Slide
End
Show
14 - 5
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$ 10,000
240,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 6
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
The Monetary
Multiplier
LIABILITIES AND
NET WORTH
$ 10,000
240,000
TRANSACTION
3
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Accepting
Deposits
$100,000 Cash
Previous
Slide
End
Show
14 - 7
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Capital Stock
$250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$110,000
240,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 8
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 9
LIABILITIES AND
NET WORTH
$110,000 Checkable
NOTES:
240,000
Deposits
deposits
are
Capital
Stock
Bank
subject to a reserve
requirement.
Reserve
ratio
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
=
Commercial bank’s
required reserves
Commercial bank’s
checkable-deposit
liabilities
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 10
Next
Slide
LIABILITIES AND
NET WORTH
$110,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
Three Important Issues...
1 - Excess Reserves = Actual
Reserves - Required Reserves
(assume 20% reserve requirement)
$110,000 - 20,000 = $90,000
2 – Control of Lending Ability
3 - Asset or Liability to Which Bank?
Copyright McGraw-Hill/Irwin, 2005
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Property
Multiple Deposit
Expansion Process
The Monetary
Multiplier
LIABILITIES AND
NET WORTH
$110,000
240,000
TRANSACTION
4
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Deposits
at the FED
$110,000 Cash
Previous
Slide
End
Show
14 - 11
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Reserves
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$
0
110,000
240,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 12
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
$
0
Reserves
110,000
TRANSACTION
Property
240,000
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
5
A check is
drawn against
the bank
$50,000
Previous
Slide
End
Show
14 - 13
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
Reserves
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$
0
60,000
240,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 14
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Cash
$
0 Checkable
Reserves
60,000
Deposits
create money
Property Banks240,000
Capital Stock
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 15
NOTES:
by lending excess
reserves and destroy
it by loan repayment.
Purchasing bonds
from the public also
creates money.
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
Property
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
$ 60,000
240,000
TRANSACTION
6
Make a loan
from excess
reserves
$50,000
Previous
Slide
End
Show
14 - 16
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
Loans
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$ 60,000
50,000
240,000
Checkable
Deposits
Capital Stock
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 17
Next
Slide
Making the loan
created money!
Copyright McGraw-Hill/Irwin, 2005
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
Loans
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$ 10,000
50,000
240,000
Checkable
Deposits
Capital Stock
$ 50,000
250,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 18
Next
Slide
After a check for the $50,000
is drawn against the bank
Copyright McGraw-Hill/Irwin, 2005
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
$ 10,000
Loans
50,000
TRANSACTION
Property
240,000
Multiple Deposit
Expansion Process
The Monetary
Multiplier
7
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Repaying a
loan with cash
$50,000
Previous
Slide
End
Show
14 - 19
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$ 50,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
Loans
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$ 10,000
0
240,000
Checkable
Deposits
Capital Stock
$
0
250,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 20
Next
Slide
$50,000 in money supply
is destroyed!
Copyright McGraw-Hill/Irwin, 2005
FORMATION OF A
COMMERCIAL BANK
LIABILITIES AND
NET WORTH
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
$ 60,000
Securities
50,000
TRANSACTION
Property
240,000
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
End
Show
14 - 21
(Assume previous
balance sheet)
Buy Government
Securities
Key Terms
Previous
Slide
8
Next
Slide
$50,000
Copyright McGraw-Hill/Irwin, 2005
Checkable
Deposits
Capital Stock
$100,000
250,000
FORMATION OF A
COMMERCIAL BANK
Balance Sheet of a
Commercial Bank
ASSETS
Formation of a
Commercial Bank
Reserves
Securities
Property
Multiple Deposit
Expansion Process
LIABILITIES AND
NET WORTH
$ 60,000
50,000
240,000
Checkable
Deposits
Capital Stock
$100,000
250,000
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 22
Bankers pursue two conflicting goals:
Profits and Liquidity
Next
Slide
Use of Federal Funds Market
Federal Funds Rate
Copyright McGraw-Hill/Irwin, 2005
MULTIPLE DEPOSIT EXPANSION PROCESS
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 23
Next
Slide
Bank
Acquired reserves Required
and deposits
reserves
Excess
reserves
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
Total amount of money created by the banking system $400.00
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.21
H
20.97
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.99
Copyright McGraw-Hill/Irwin, 2005
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
MULTIPLE DEPOSIT EXPANSION PROCESS
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 24
Next
Slide
Bank
Acquired reserves Required
and deposits
reserves
Excess
reserves
Amount bank
can lend - New
money created
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
Total amount of money created by the banking system $400.00
A
$100.00
B
80.00
C
64.00
D
51.20
E
40.96
F
32.77
G
26.21
H
20.97
I
16.78
J
13.42
K
10.74
L
8.59
M
6.87
N
5.50
Other banks 21.99
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
Money
destruction works
in exactly the same
multiple way!
Copyright McGraw-Hill/Irwin, 2005
THE MONETARY MULTIPLIER
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
Monetary
Multiplier
1
= Required reserve ratio
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 25
Next
Slide
Maximum
checkabledeposit
creation
=
Copyright McGraw-Hill/Irwin, 2005
Excess
reserves
x
Monetary
Multiplier
OUTCOME OF MONEY EXPANSION
$100
New reserves
Balance Sheet of a
Commercial Bank
$80
Excess
reserves
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
$20
Required
reserves
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 26
$400
Bank system lending
Next
Slide
Money Created
Copyright McGraw-Hill/Irwin, 2005
$100
Initial
Deposit
OUTCOME OF MONEY EXPANSION
$100
New reserves
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 27
$80
Excess
reserves
Leakages exist...
$20
Required
reserves
Currency Drains
Excess Reserves $100
$400
Bank system lending
Next
Slide
Money Created
Copyright McGraw-Hill/Irwin, 2005
Initial
Deposit
Balance Sheet of a
Commercial Bank
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Need for
Monetary Control
Outcome of Money
Expansion
Need for Monetary
Control
Key Terms
Previous
Slide
End
Show
14 - 28
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
balance sheet
fractional reserve system
vault cash
required reserves
reserve ratio
excess reserves
actual reserves
Federal Funds rate
monetary multiplier
Copyright McGraw-Hill/Irwin, Inc. 2005
BACK
END
Balance Sheet of a
Commercial Bank
Next...
Formation of a
Commercial Bank
Multiple Deposit
Expansion Process
The Monetary
Multiplier
Outcome of Money
Expansion
Monetary Policy
Need for Monetary
Control
Key Terms
Chapter 15
Previous
Slide
End
Show
14 - 30
Next
Slide
Copyright McGraw-Hill/Irwin, 2005