Question

How is money created in a banking system that has fractional reserve requirements?

Answer 1

this can be better understood by an example -

Suppose the Cash Reserve Ratio is 20% and a person deposits Rs. 10,000/- with Bank of India. This is primary deposit. The bank keeps Rs. 2000 as CRR and balance of Rs. 8000 is used for granting credit.

Now suppose Bank of India lends Rs. 8000 to Mr. A and Mr. A pays a cheque of Rs. 8000 to Mr. B, who has an account in Bank Of baroda. Then Bank Of Baroda receives Rs. 8000 as primary deposit. It keeps Rs. 1,600 (20%) as CRR and excess amount of Rs. 6,400 is used for giving credit. Now if, Mr. C is granted this loan and Mr.C gives a cheque of Rs. 6,400 to another person who may deposit it in Bank of Maharashtra. Bank of Maharashtra will keep Rs. 1,280 as CRR and issue a loan of Rs. 5,120. This process continues until the original excess reserves of Rs. 8000 with the first Bank of India, have been parceled out among various banks and have been required resources. As a result, the aggregate of derivative deposits in the entire banking system, approximates 5 times the initial derivative deposit over a period of time.

and this is how money is created by banks in an econmy