How Banks Create Money

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How Banks Create Money

By: Tanner Larsson

Did you know that banks can "create" money?

The vast majority of people have only the 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 the scenes, they would demand much more than the pitiful, if any, interest rates they are getting now.

Now I'm going to give you a behind the 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 the bank, they can lend out $10.) This is called the money multiplier and it is based on the required reserve ratio.

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

To figure out the current money multiplier, use the following formula:

1 / Required Reserve Ratio = Money Multiplier

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

Begin Example

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

Bank A

Deposit: $10,000

Reserve (10%): $1,000

Lendable Amount: $9,000

Mary borrows $9,000 from Bank A and buys a car. The car dealer then deposits $9,000 into their account at Bank B.

Bank B

Deposit: $9,000

Reserve (10%): $900

Lendable Amount: $8,100

Mark borrows $8,100 from Bank B and has surgery. The doctor then deposits $8,100 into his account at Bank C.

Bank C

Deposit: $8,100

Reserve (10%): $810

Lendable Amount: $7,290

Sue borrows $7,290 and shops at Versace. Versace then deposits $7,290 into their account at Bank D.

Bank D

Deposit: $7,290

Reserve (10%): $729

Lendable Amount: $6,561

Kim borrows $6,561 from Bank D and pays off her credit card, the Credit Card Company then deposits $6,561 into their account at Bank E.

Bank E

Deposit: $6,561

Reserve (10%): $656.) 10

Lendable Amount: $5,904.) 90

And so on through the system. When M1* is measured, and the FRB totals the checking account balances in the entire system, the original $10,000 deposit will have created a total of $100,000 in deposits system wide.

*M1 = First level of money supply = All currency held by the public.

End Example

That in its simplest form is how the banks create money. Now considering how much money the banks are making off of every dollar you deposit, does the 0.01% or 0.25% interest rate you're getting paid seem fair?

Not to me, but because the general public is uninformed of this fact of life, the banks and other financial institutions will continue to reap extraordinary profits from practically imaginary money.

Copyright Tanner Larsson


About The Author

Tanner Larsson is a veteran entrepreneur and the publisher of the award winning Work At Home Success Newsletter. Subscribe to his newsletter and recieve 4 EXCLUSIVE Bonuses valued at $276.)


Msz Tastee 06.06.2010. 19:39

How does a bank create money? How does a bank create money? What is the relationship between the deposits received by a bank and the amount of loans the bank can provide to borrowers?

Msz Tastee

Admin 06.06.2010. 19:39

Basically, banks take money from one person (or many people) and lend it to other people.

2 of the ways banks get money to lend is by taking other peoples' savings deposits and also by borrowing money from the US government.

When people deposit money into a bank account, the bank pays them an amount based on how much they deposit. Let's say banks pay 1% for deposits. And they have 10 people who have deposited $1000 each. The bank will pay each one of these people 1%.

The bank will take those deposits and lend that money to someone else at 10%.
This difference betweeen what banks pay depositors and what they charge borrowers is called a spread.

In the above example the spread is the difference between the 10% lending rate and the 1% deposit rate.

This is the basics of how a banl creataes money.

Watch this series on you tube to see this system in greater detail.

It's a 17 part series and the first 3 or 4 parts in the theoretical banking system but the later series' get into the details how the system really works.


sonyboy812 01.04.2008. 22:47

Can China create money out of thin air and lend it to another country to make money? Can China do this just like how banks create money out of thin air via debt? Assuming the US pays back the debt, China will be richer. But, if US defaulted, it doesn't matter to China because they just conjured up the money in the first place.


Admin 01.04.2008. 22:47

Banks don't create money of out thin air. They have deposits from people with savings and checking accounts. They loan out this money...

China could loan dollars out too. They have a bunch of them from US people buying more chinese goods than chinese buy american goods.

good luck!

No one can just 'conjure up money'. That isn't the way the systems work.


CV 01.03.2011. 00:21

How and why Banks create new money during deposit multiplier process? Help!

Carefully explain how and why banks create new money during the deposit multiplier process.
Thank you!


Admin 01.03.2011. 00:21

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Growth vs. Oil 15.09.2010. 04:50

Can someone sue a bank for creating money unlawfully to loan them? If someone finds out that the bank created the money out of thin air and the only thing that backs up the money is the demand for the loan, can they sue for not disclosing how the money was created in the contract to repay and making the customer partake in a unlawful act due to the way the money was created?

Growth vs. Oil

Admin 15.09.2010. 04:50

What was the unlawful act did the bank force to to participate in? Money is not "created". It comes from deposits which are the bank's assets, so I dont understand what you are asking. A personal loan must be secured by collateral. What did the bank fail to disclose about a loan they gave you?

You have to be clear.


Ravi L 16.06.2008. 01:49

what happens to money multiplier when currency drain increases? Banks create money by making loans using excess reserves.
If people decide to hold more money in their wallets or under their mattresses (as a proportion of all money in the economy) because of an increase in bank service fees, what would happen to the money multiplier?

A. It would increase due to a higher currency drain ratio.

B. It would decrease due to a higher currency drain ratio.

C. It would increase due to a lower currency drain ratio.

D. It would decrease due to a lower currency drain ratio.

E. It would not change.

Ravi L

Admin 16.06.2008. 01:49

'B' is right answer. Money Multiplier=1/(reserve requirement+currency drain)


righteousness 19.04.2009. 00:44

how do banks create money through loans? some people say when you get a mortgage loan, the bank

is creating money through loaning you the amount you need

do the banks always create money through loans?

don't they use their deposits to make loans?
how can you possibly loan money

that you don't have?


Admin 19.04.2009. 00:44

Banks are allowed to loan out a lot more than just the money they have from their depositors through a system called Fractional Reserve Banking.

Officially, banks are allowed to loan out 10 times the amount of money they have from their depositors. But there are many loopholes in regulations that allow banks to loan out 30 or 40 times the amount of money they have from their depositors.


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