How do banks create money? A very simple way to understand it is through a process called fractional reserve banking. The 'fraction' is the key part."
The Basic Idea
When you deposit money in a bank, the bank doesn't just lock it in a vault. It's required to keep only a small fraction of your money on hand (this is the "reserve"). It lends out the rest.
The "magic" happens when the bank makes a loan. It doesn't hand over a briefcase of cash. Instead, it simply adds digital numbers to the borrower's bank account. In that instant, new money is created.
Let's walk through it.
A Simple Example: The $1,000 Deposit
Imagine the "reserve requirement" is 10%. This means banks must keep 10% of all deposits and can lend out 90%.
You deposit $1,000 into Bank A.
Bank A's vault: It holds $100 (10% reserve) and can lend out $900.
- Money Supply: $1,000 (your deposit)
Bank A lends $900 to Sarah, who wants to buy a bike. The bank creates a $900 deposit in Mr Ahmad's account.
Sarah buys the bike from Tom and pays him $900.
Money Supply: Now it's $1,900 (your $1,000 + Tom's new $900).
Tom deposits that $900 into his account at Bank B.
Bank B's vault: It holds $90 (10% of $900) and can lend out $810.
Bank B lends $810 to Martin, who gets a new deposit for that amount.
Money Supply: Now it's $2,710 (your $1,000 + Martin's $900 + David's $810).
This process continues, with each new loan creating a new deposit, which is then re-deposited and re-loaned (in smaller and smaller amounts).
Your single $1,000 deposit has allowed the banking system to "multiply" it into thousands of dollars of new money.
Key Takeaways
Banks create money by lending. They don't lend your actual money; they create new digital money (a deposit) for the borrower.
This new money is technically a debt. The borrower gets a deposit (an asset) but also has a loan (a liability).
The reserve requirement (set by the central bank) controls how much money can be created. A lower requirement means banks can lend more, creating more money.
An important note: In some countries, like the United States, the reserve requirement has actually been set to 0%. Banks are no longer limited by this rule, but other regulations (like capital requirements) still govern how much they can lend. However, the basic principle of creating money through new loans remains the same.
These videos on fractional reserve banking provide a simple visual walk-through of this money-multiplying process.
Encik Zahid menerangkan berkaitan "Money Creation"
dalam Bahasa Melayu. Click CC to auto translate to English etc
Islamicbankingway
ONLY ALLAH KNOWS BEST
