Explain what happens to a commercial bank’s reserves and checkable deposits after it has made a...

Explain what happens to a commercial bank’s reserves and checkable deposits after it has made a loan.

Expert Solution

Increasing time a dollar is credited to a bank account, the total assets of a bank are increased. The bank will keep some of it on hand as required reserves, but will loan out the excess reserves. When the loan is made, the money supply increases.
That is how banks "make" capital and increase the supply of capital. If a bank makes loans from surplus funds the supply of money increases. With money multiplier we can estimate the full change in the money supply.

A bank loans a loan to a customer who borrows. This at the same time gives both the bank and the borrower a credit and a liability. The borrower shall be credited with a deposit in his account, and shall be held responsible for the loan sum. The bank now has an asset equal to the value of the loan and a deposit-liability. All four of these accounting entries reflect an increase in their respective categories: the assets and liabilities of the bank have risen, and so have those of the borrower.

The bank fulfills its capital requirement by discounting a deposit it has made from its own loan. That is, it fulfills the requirement of capital with nothing but its own power of producing income. This makes sense because, as we can see in a moment, it has the advantage of reducing the bank's debt without decreasing its assets. All it does is just allow the bank to have an asset that is greater than the liability for the deposit it made.

Rahul Sunny answered 8 months ago

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