How do banks get money?

 How do you banks get money?

• From the public as deposits
•  The public wants safety and sometimes a return in the form of interest rates 
•  Since the deposits are the property of the public, banks  must record themselves as “liabilities” for the bank and are labeled as demand deposits. They’re also known as “checkqble deposits”  but the term is being useless with the demise of “checkbooks.”
• Banks, once in operation, can invest in the funds in the form of federal bond purchased from the fed.  The bonds earn the bank interest.  The bond amounts are the assets for the banks. 

 What do banks do with the money?

•  Lend it to the public in order to profit from the interest charges on the loans.  This money creates a “money multiplier” or “monetary multiplier.”

 Do banks lend all of the money?

•  All of the demand deposits. Since some of the public comes to the bank each day and wants to withdraw some of the demand deposits, banks must keep some cash in the vault.  This “reserve” is used to satisfy withdrawl request.
•  Banks that belong to the Federal Reserve system must keep a “required reserve”  percentage  set by the Fed.  The required reserve is approximately 10% of the demand deposits.  Since almost all the banks in the US are part of the Fed system this has become the national standard.
•  The remaining amount becomes the “excess reserve.”  The excess reserves are then used by the banks as loans to the public. 
•  Banks can lend all of the bond assets  they hold and not have to put any percentage in the required reserve.

What happens to the loans? 

•  When a person barrels from the bake it will be assumed that that money is spent somewhere else.  The next assumption is that the funds end up in the bank account as someone else’s demand deposits in the second bank.  The second bank then pulls out the required reserve.  The remaining excess reserves become a loan which another person can use and the money ends up in the third bank.
• Note however, through each new loan some is removed and held as required reserves.  The loan amount will shrink with each new loan.

 How many times can the process occur?  

• No one knows at which point any given amount will shrink to a point where borrowing will end, but estimates are made using the"money multiplier." The formula is based on the amount being drained out by the reserve requirement. The greater the reserve requirement, the quicker the loan amount will shrink and end the line of loans.
• The general formula is given as: 1/rr, with "rr" standing for required reserve percentage, known here also as the reserve ratio. If the rr is 10%, then every original loan of 1 dollar will create 10 dollars of loans in the banking system(1/.1). A 5% rr gives a multiplier of 20(1/.05) and a reserve of 20% lowers the multiplier to only 5(1/.2).

AP and Bank T-Accounts 

• Banks keep all of the accounting for this lending system in a t-account of assets and liabilities.
• The assets and liabilities are always equal to the show bank solvency.
• The t-account is a chart, with assets on the left and liabilities on the right.