Question

True or False: the system of fractional reserve banking, banks can create money by expanding their balance sheet.

Answer 1

The given statement is true.

The system of fractional reserve banking, banks can create money by expanding their balance sheet. Fractional reserve banking system implies that banks are require to hold only a portion or fraction of the total money that customers deposit with the banks as reserves. This helps banks to create money by providing the rest of the amount as loans. This system helps in the expansion of the economy because the banks are able to lend the money to parties in need of loan. Instead of holding the entire deposits in the form of cash, banks only holds a portion of it in the form of cash & the rest in the form of loans to parties. So, on the liabilities side of the balance sheet bank has deposits & on the assets side it has cash & loans. On these loans banks are able to earn interest. Therefore, with the help of fractional reserve banking system, banks are able to segregate the deposits in cash & loans & are able to create money by expanding their balance sheet.