Money Creation in Banking

Questions and Answers

Money is created when?

A bank grants a loan to a customer. (correct)

Someone lends money to a friend or a family member.

People use money to pay for stuff they buy from one another.

A depositor deposits money at the bank.

Fractional reserve banking refers to a system where banks?

Deposit a fraction of their reserves at the central bank.

Accept a portion of their deposits in checkable accounts.

Grant loans to their borrowing customers.

Hold only a fraction of their deposits in their reserves. (correct)

In a fractional reserve banking system?

The Federal Reserve has no control over the amount of money in circulation.

The monetary system must be backed by gold.

Banks can create money through the lending process. (correct)

Bank panics cannot occur.

The amount that a commercial bank can lend is determined by its?

Excess reserves. Signup and view all the answers

The primary purpose of the legal reserve requirement is to?

Provide a means by which the monetary authorities can influence the lending ability of commercial banks. Signup and view all the answers

A bank temporarily short of required reserves may be able to remedy this situation by?

Borrowing funds in the federal funds market. Signup and view all the answers

The reserves of a commercial bank consist of?

Deposits at the Federal Reserve Bank and vault cash. Signup and view all the answers

The greater the leverage in the financial system, all else equal?

The greater the instability of the financial system. Signup and view all the answers

The term 'leverage' refers to?

Using borrowed money in an attempt to increase profits. Signup and view all the answers

In prosperous times, commercial banks are likely to hold very small amounts of excess reserves because?

Federal Reserve Banks pay lower rates of interest on bank reserves than could be earned by the commercial banks loaning out the reserves. Signup and view all the answers

Other things being equal, an expansion of commercial bank lending?

Increases the money supply. Signup and view all the answers

The reserve ratio refers to the ratio of a bank's?

Required reserves to its checkable-deposit liabilities. Signup and view all the answers

Study Notes

Money Creation

Money is created when banks grant loans to customers, expanding the money supply.

Fractional Reserve Banking

Banks operate on a fractional reserve system, retaining only a portion of deposits as reserves.

Lending Process

In this banking system, banks can create additional money via lending, enhancing liquidity.

Lending Cap

A commercial bank’s lending capacity is dictated by its excess reserves, which determine how much can be loaned.

Legal Reserve Requirement

The primary role of the legal reserve requirement is to allow monetary authorities to influence the lending abilities of banks.

Resolving Reserve Shortages

Banks facing reserve deficits can borrow funds from the federal funds market to remedy shortfalls.

Components of Reserves

Reserves comprise vault cash and deposits held at the Federal Reserve Bank, ensuring liquidity.

Financial System Leverage

High leverage increases the instability of the financial system, leading to greater risks.

Definition of Leverage

Leverage involves using borrowed funds to amplify profits, frequently seen in investment strategies.

Excess Reserves During Prosperity

In prosperous periods, banks maintain low excess reserves because the interest earned from loans outweighs Federal Reserve interest rates.

Impact of Bank Lending

An expansion in commercial bank lending results in an overall increase in the money supply.

Reserve Ratio

The reserve ratio measures required reserves against checkable-deposit liabilities, reflecting a bank's liquidity management.

Reserve Market

The market for instantly accessible reserve balances at the Federal Reserve facilitates liquidity among banks.

Description

This quiz explores the principles of money creation and fractional reserve banking. Understand how banks operate, the lending process, and the significance of reserves within the financial system. Test your knowledge of the dynamics that influence lending capabilities and bank liquidity.