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How do banks make money out of thin air?

by Admin

Many have an awareness of the ability of Central Banks to create money right out of thin air. With the help of printing presses and a couple of clicks on a central server, these banks can easily create endless amounts of physical banknotes and electronic money.

However, it’s worth noting that central banks are far from the only players involved in money creation. Ordinary banks such as JPM, Wells Fargo, Barclays, and Deutsche Bank are also involved.

The possibility of such creativity stems from the partial reserve norms that are associated with the emergence of the banking system itself. Banks expand the money supply, that is, they “create money” by lending borrowers a portion of the money received from their depositors.

a bank uses a deposit of 1 million dollars, leaving, for example, 8% as a mandatory reserve and issuing the remaining 92% as loans. After repayment of the loan, the money received is again repeatedly used in the form of new loans.

This process increases the volume of money in the economy, creating the effect of repeatedly increasing the money supply. However, it is important to note that this entire process relies on trust in the banking system and its ability to manage risk effectively.

The mandatory reserve is part of the measures to ensure the stability of the banking system and prevent systemic crises. This reserve represents the proportion of deposits that a bank is obliged to hold in a correspondent account with the Central Bank, which ensures a minimum level of liquidity.

What is unique is that each transaction with this virtual money, which is debt receipts, earns the bank its “modest interest.” Imagine now that the mandatory reserve rate is 100%. In such a case, the bank is unable to issue loans using depositors’ funds, and it makes no sense for depositors to place their money on deposit. Economic progress comes to an impasse.

On the one hand, without the bank multiplier, as this mechanism is called, mankind would probably still be traveling on horses on dirt roads. On the other hand, are you willing to trust a bank with 92% of your money with the ability to invest in pretty much “anything and everything”?

No matter how one feels about it, the bank multiplier is an undeniably brilliant invention. It is the reason why large bank stocks are included in the portfolios of many famous investors, including the legendary Warren Buffett. Think about it, knowing how banks operate, it is better to invest in their business than to be limited to a modest percentage of the deposit. Thus, people become investors …

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