How Banks Create Money

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Eventually after a period of time the banks would have increased the amount of money they hold. This could be demonstrated by the following formula;

Money Multiplier= 1/ reserve ratio

For these banks the reserve ratio was 10%. So in this case the deposit of $100 increased the money supply in the banks to $900.

Money multiplier=1/0.1

=10

As $90 was the one which was lent, we multiply 10 to $90

=$90*10

= $900

This shows that the money supply now available in the banks is $900.

This entire idea is called Fractional Reserve Banking, where banks hold a fraction of money and loan the rest out to create a new money supply.

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Bank charges

One of the ways commercial banks creates money is through the fees they charge for the services offered examples include ATM fees, minimum balance fees, fees for processing cheques, overdraft fees and many more. Overdraft fee is charged to customers of a bank when he/she withdraws more money than the money available in the account, many experts say that a large sum of banks creates money is through the overdraft fees they charge as the number of individuals and businesses who use overdraft is very high. There will be times when you can’t find your bank’s ATM and you must settle for another ATM just to get some cash (Zhen, n.d.). There are several times when this occurs and to many people and thus ATM fees will be charged to the customers and thus banks create money through the charges. There are some banks that charge a fee if their customers do not keep the minimum balance as required by the banks, as they believe it is needed to cover the costs for providing the account to customer. Banks create large sums of money through fees even though the fees are not large because these fees occur frequently and also because these fees are unavoidable to a great extent

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Auction of assets

Most banks only issue loans to individual who have a good line of credit which often depends on the customer’s ability to earn a stable income or some form of collateral, i.e. most loans require securities. The bank requires these securities so that when said individual default on their loan the bank can confiscate said securities and liquidate them to repay the loan. Common items used as securities include, land, mortgages, jewels, cars, business, shares e.t.c. banks often prefer highly marketable securities i.e. property that can be easily sold within a short period of time but for large amount, also items that do not depreciate at high rates such as cars.

When the bank confiscates said property it incurs maintenance cost which include depreciation and mechanical maintenance. This is to maintain the value of the assert till it’s sale, in order to full repay the loan i.e. if the assert is poorly maintained, for example a car being left exposed to the elements continuously throughout three months without servicing or driving, will be worth less than a car which was protected from the elements and efficiently serviced. Disposal of the asset is not just profitable but also a low expense affair for the bank while try to boost its bottom-line in the best possible manner.

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Charges for Vaults

Many high income earns often have extremely valuable property, such as jewels, which is often expensive to insure as an individual hence they often use bank vaults as a way to reduce cost but attain the same amount security. The greatest threat especially in African countries, is home theft hence keeping important home documents become necessary. Vaults of various sizes and dimension are provided by the bank to suit the various needs of their customers. The fees incurred by customers for using the vault include annual fees for the maintenance, upkeep and also monthly rental in return for these services. Banks increase their profits while customers enjoy the benefit of having their properties secured. Vault maintenance requires precise and intense security systems which often require specialized maintenance in information technology but minimum man power since most of the security is done through the use of technology.

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Interests

Whenever banks give loans to individuals or business they are given sometime to pay back the amount given. So at a given rate the person brings back the amount given to them plus a margin of interest. However this mode of income does not work in some communities e.g. the Islamic culture.

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Offering consultation and financial advice

Who would not seek information from fairly established financial institutions like banks? Banks sometimes give advice to fledging business that may be having brilliant ideas but don’t have an idea on managing the cash, the total number of shares to be issued and the maintenance of the liquidity in a business. Therefore banks charge for this and create money.

REFERENCES

Zhen, S. (n.d.).Finance 101: How Do Banks Make Money?Retrieved September 29, 2015, from http://www.moneyunder30.com/how-banks-make-money