How Can Commercial Banks Create Money, Essay Example

Commercial Banks create money by the management of invested funds. They operate under what is termed a ‘fractional reserve system’, meaning the law requires them to set aside a fraction of the deposits as ‘required reserves’. Bonds can then lend an equal amount to what is left called ‘excess reserves’. Profit is generated by lending and charging interest and administration or banking charges on loans.

Commercial Banks also create credits and as such this enables more deposits to be generated through the loan process. By the process of granting loans to their customers, the banks increase the purchasing power of the borrower. This in turn helps towards increasing the amount of money in circulation. No individual Bank can make this happen as an individual entity, it requires the participation of the entire banking community.

The US Treasury oversees the production  of currency and notes in the USA. The US mint is responsible for the production of coins and the Bureau of Engraving and Printing produces the paper money. It is the Treasurer of the USA that advises on all matters relative to the production of monies in the USA. ” During fiscal year 2007, the Bureau of Engraving and Printing (BEP) produced approximately 38 million notes a day with a face value of approximately $750 million.”  (US Dept of the Treasury).

One of the most common methods a commercial bank adopts to create money is termed ‘ the deposit creation multiplier’; essentially the measurement by which the commercial banking sector can increase the supply of money. Other methods include:

• Government production of Treasury Bonds;
• Federal reserve checks.

The illustration to the right shows an indication of the trend of US Money supply over time.