Did you know that banks can “create” money?

The vast majority of people have only vaguest idea of how banks and financial institutions in general, operate. They just go about their lives never understanding what happens every time they deposit money into their bank.

I guarantee you if they did know what went on behind scenes, they would demand much more than pitiful, if any, interest rates they are getting now.

Now I’m going to give you a behind scenes look at how banks create money.

Currently when banks receive a sum of money, they are able to lend out ten times that amount. That’s right for every $1 that comes into bank, they can lend out $10.This is called money multiplier and it is based on required reserve ratio.

The required reserve ratio is percentage of total deposits bank recieves that must be held in reserve and cannot be lent out. The required reserve ratio is determined by Federal Reserve Bank (FRB). Whatever is left over after reserve has been met can be lent out.

To figure out current money multiplier, use following formula:

1 / Required Reserve Ratio = Money Multiplier

Below you will find a basic example of how banks create money, in this example Federal Reserve Requirement is 10%. That means that money multiplier is 10, so banks can lend out $10 for every dollar they receive.

---- Begin Example ----

John deposits $10,000 into his checking account at Bank A.