To know the entire process of cash creation today, let’s produce a hypothetical system of banks. We shall concentrate on three banking institutions in this system: Acme Bank, Bellville Bank, and Clarkston Bank. Assume that most banks have to hold reserves corresponding to 10% of these checkable deposits. The total amount of reserves banking institutions have to hold is named needed reserves. The book requirement is expressed as being a needed book ratio; it specifies the ratio of reserves to checkable deposits a bank must maintain. Banking institutions may hold reserves more than the level that is required such reserves are known as extra reserves. Excess reserves plus needed reserves total that is equal.
Because banking institutions make fairly small interest on their reserves held on deposit using the Federal Reserve, we will assume which they look for to put up no extra reserves.
When a bank’s extra reserves equal zero, it’s loaned up. Finally, we shall ignore assets apart from reserves and loans and deposits aside from checkable deposits. To simplify the analysis further, we will guess that banking institutions do not have web worth; their assets are add up to their liabilities.
Why don’t we guess that every bank within our imaginary system starts with $1,000 in reserves, $9,000 in loans outstanding, and $10,000 in checkable deposit balances held by clients. (more…)