bank deposit creation

Bank deposit creationclick for a larger image
Fig. 15 Bank deposit creation. Deposit creation operated with a 50% reserve-asset ratio in a multibank system.

bank deposit creation

or

credit creation

or

money multiplier

the ability of the COMMERCIAL BANK system to create new bank deposits and hence increase the MONEY SUPPLY. Commercial banks accept deposits of CURRENCY from the general public. Some of this money is retained by the banks to meet day-to-day withdrawals (see RESERVE-ASSET RATIO). The remainder of the money is used to make loans or is invested. When a bank on-lends, it creates additional deposits in favour of borrowers. The amount of new deposits the banking system as a whole can create depends on the magnitude of the reserve-asset ratio. In the example set out in Fig. 15, the banks are assumed to operate with a 50% reserve-asset ratio: Bank 1 receives initial deposits of £100 million from the general public. It keeps £50 million for liquidity purposes and on-lends £50 million.

This £50 million, when spent, is redeposited with Bank 2; Bank 2 keeps £25 million as part of its reserve assets and on-lends £25 million; and so on. Thus, as a result of an initial deposit of £100 million, the banking system has been able to ‘create’ an additional £100 million of new deposits.

Since bank deposits constitute a large part of the MONEY SUPPLY, the ability of the banking system to ‘create’ credit makes it a prime target for the application of MONETARY POLICY as a means of regulating the level of spending in the economy