How do banks create money?

Question

by holding money in their vaults

by issuing loans and opening checking accounts

by charging interest

by printing it

Answer 1

Banks create money primarily by issuing loans and opening checking accounts. Here's how it works:

1. Deposits and Reserves: When customers deposit money into their accounts, banks are required to hold a fraction of that amount as reserves (this is known as the reserve requirement). The rest can be used for loans.

2. Fractional Reserve Banking: Through the process of fractional reserve banking, banks lend out a portion of the deposits. When banks issue loans, they effectively create new money because the borrowers receive funds that they can spend, which then circulates in the economy.

3. Checking Accounts: When a loan is made, the money is typically credited to the borrower's checking account, creating a deposit that didn't exist prior to the loan. This means that the act of lending increases the overall money supply.

4. Interest and Repayment: While banks charge interest on the loans they issue, the process of creating money does not primarily involve charging interest or printing physical cash.

Overall, the primary method by which banks create money is through the issuance of loans and the establishment of checking accounts, contributing to the money supply in the economy.