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Why dont banks hold 100 percent reserves ? How is the amount of reserves bank hold...

Why dont banks hold 100 percent reserves ? How is the amount of reserves bank hold related to the amount of money the banking system creates?

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Answer #1

The money multiplier is the amount of money banks can create with an initial deposit. The reserve is the amount of deposit that the bank holds as actual cash the rest is lent out as loans. This is the fractional reserve banking system. Banks cannot keep the entire deposits as reserves because this would not allow them to create money.If the reserve requirement is 10%, then banks only keep 10% of their deposits as cash and available for withdrawal. The banks lend out the rest of the deposits as loans.

If Person X deposits $100 in Bank A. Bank A will keep $10 and lend out $90 to Person Y. Person Y then deposits the money into Bank B. Bank B keeps $9 in the reserve and is free to loan out $81. Money is created because with that $100 original deposit Person X , the checking deposit in the banks A and B have increased by $100+$90+$81=$271.

Money Multiplier= 1/ Reserve Ratio

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