Question

14. Commercial banks create money by

A. printing money as the needs of the economy change.
B. borrowing money from other banks.
C. accepting loan payments that are made on time.
D. making loans while only keeping a fraction of deposits in cash on hand at any given
time.

Answer 1

Commercial banks create money by making loans while only keeping a fraction of deposits in cash on hand at any given time. This process is known as fractional reserve banking.

When a bank receives a deposit from a customer, it is required to keep a certain percentage of that deposit in reserve, usually set by the central bank. The remaining portion of the deposit can be used by the bank to make loans to other customers.

For example, let's say you deposit $1,000 in a commercial bank. The bank is required to keep a fraction, let's say 10%, in reserve. This means that $100 of your deposit will be held as cash in the bank's vault. The bank can then use the remaining $900 to make loans to borrowers.

When the bank makes a loan, it credits the borrower's account with the loan amount. This creates new money in the form of a loan, which the borrower can then use for their needs. For instance, if the bank lends $900 to a borrower, the borrower now has an additional $900 to spend.

At the same time, the bank's liabilities (deposits) have increased by $900, but its assets (cash reserves) have not changed. This creates new money in the economy because the borrower can spend the loaned amount, while the original depositor can still access their $1,000 deposit.

In summary, commercial banks create money by making loans while keeping only a fraction of deposits in cash reserve. This process allows banks to increase the money supply and support economic activity.

I hope this helps you. :)

Answer 2

D. making loans while only keeping a fraction of deposits in cash on hand at any given time.

Step-by-step explanation:

This process is known as fractional reserve banking. When a bank receives a deposit from a customer, it is required by law to hold a certain percentage of that deposit in reserve, usually with the central bank. The remaining amount can be used to make loans to other customers.

When a bank makes a loan, it credits the borrower's account with the amount of the loan. This increases the total amount of deposits in the banking system, without any corresponding increase in physical currency. Thus, commercial banks create new money by extending credit and creating deposits in the process.

It's worth noting that while commercial banks have the ability to create new money through lending, they are subject to various regulations and oversight to ensure the safety and stability of the financial system.