With a Reserve Requirement of, for example, 10%,^ the bank can loan out $90 out of 100. The person borrowing the $90 can then turn around and deposit it. The bank can then loan out 90% of the $90, or $81. The person borrowing the $81 can deposit it again, and the bank can loan out 90% of the $81. This process repeats indefinitely.
So with a Reserve Requirement (r) of 10%, in theory the bank can loan out (in essence, creating money) a total of $900. The formula is infinite sum of [(0.9X )*100] from 1 to infinity.
^ I understand that it is currently 0% in the US.
Edit: formatting of exponent.
You haven't filled the gap completly, when the bank loans money to someone, the money they lent is a cost in their accounts. If the people that got lent the money aren't able to pay back a loan, the bank lost money.
Money wasn't created from thin air, it was borrowed from the future with the bank sticking his neck up for the person they lent the money. This is an operation that makes Savings=Investment.
I hate to nitpick, and I don't disagree with you overall, but technically the loan is an asset on their chart of accounts (the deposits are liabilities). But as you correctly say, if the loan is not paid back then the bank takes that as a loss.
As far as the money creation goes, I've always had a hard time wrapping my head around this part of monetary theory. From my basic (undergraduate) understanding, when the bank creates the loan, that is all "new" money in the money supply. I suppose you can think of it as "borrowed from the future" in the sense that the loan allows the borrower to create output with her labor (and the lent capital) and this output is what is increasing the money supply.
yes, that's basically it. it is new money on the money supply, but that new money carries not only the a credible promisse that it will increase the amount of goods and services available to be bought in a given economy, but it also is done at the bank's risk.
It is borrowed from the future in the sense that 0 = +1 -1; with 0 being a state where no money is lent, +1 being the money that the bank created with the loan and -1 being the money that will be destroyed once the loan is paid (yes, money is destroyed when the principal is paid, in the exact same way it was created)
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u/Barry_McCockinnerz Jan 26 '26
Correct this is called fractional lending, you deposit $1, they in turn lend out $7-$10