How RRR works!?

[CristianOff]

There are two ways to increase the money supply:

• the central bank prints money
• normal banks issue loans

From my understandings there is a concept called RRR or Required Reserve Ratio which is set by the government, say 10%.
If a customer deposits $100 to their bank, the bank is required to keep in reserves 10% or $100 x 0.10 = $10

This means that the other $90 can be loaned out (excess reserves = deposits - RRR)
(issuing loan = making new money but not as in printing new money, more like increasing the total supply)


Assuming that I've got this concept right and that the customer did not withdraw their money, the bank can earn interest on that $90.
In a perfect scenario the borrower returns the $90 + the interest for the bank and now the guy who deposited money can now withdraw them.

Correct me if I'm wrong, the money supply in the world increased by the amount the bank loaned ( $90 ). Why? How?


I find this concept very confusing. What happens if the customer who deposited money takes their money back when part of their money
is loaned!? Does that make the banks non-compliant?

[odolvlobo]

Simple fractional reserve banking works like this:

The bank has $100 in deposits -- $10 in reserves and $0 in loans, so $90 more can be lent.
The bank loans $90 to A who purchases something from B, and B deposits the $90.
The bank now has $190 in deposits -- $19 in reserves, $90 in loans, so $81 more can be lent.
The bank loans $81 to C who purchases something from D, and D deposits $81.
The bank now has $271 in deposits --  $27 in reserves, $171 in loans, so $73 more can be lent.
The bank loans $73 to E who purchases something from F, and F deposits $73.
The bank now has $344 in deposits --  $34 in reserves, $244 in loans, so $66 more can be lent.

...

The bank now has $1000 in deposits --  $100 in reserves, $900 in loans, so no more can be lent.


Now, loans are constantly being paid off so withdrawals can be accommodated. However, if withdrawals are made too quickly, the bank can run out of money (because it is all tied up in loans) and collapse. One way that banks avoid running out of money is by borrowing excess reserves from other banks.

[abhiseshakana]

Fractional Reserve Banking is a banking practice whereby banks are required to keep only a fraction of public savings funds so that the rest can be utilized by banks as loans to other parties, while still maintaining the ability of banks to return public savings funds whenever requested.

FRB is a way to create multiple loans from customer savings or reserves/capital. For example, a bank has funds (can be from customer savings or from a central bank) Rp. 100 billion. This bank may lend these funds to others and leave only a part of it, for example, 10%. This means that Rp. 90 billion can be lent and the remaining Rp. 10 billion will be used as reserves. We will see the scale of the country that has several commercial banks. Of course, the borrower (the debtor) will not withdraw his money (his debt, credit) and bring it home and keep it under a pillow (except in Japan). But kept in his account at the bank. By banks, this Rp 90 billion money may also be lent again by as much as 90%, namely Rp 81 billion. And the rest, 10%, namely Rp. 9 billion is used as a reserve. The same thing happens with this Rp. 81 billion, 90% of it can be lent again and the rest (Rp. 8.1 billion) is used as a reserve. This can happen so that the money that was only Rp. 100 billion can create a credit of Rp. 900 billion.

Now think about it: if there is a debtor to lose Rp. 100 billion and cannot pay, go bankrupt, go bankrupt. Automatic initial deposit (capital) of Rp. 100 billion was destroyed, could not be paid. And banks have negative equity.

The funds deposited at the Bank may be used for anything, can be lent, can be bought shares, bonds or for speculation on the money market and other practices on the condition that when customers suddenly withdraw deposits in banks either partially or in full, the bank must be able to fulfill them. But sudden events of customers withdrawing all of their money are very rare. But it is certain that if all bank customers withdraw their money simultaneously and together, the bank will collapse.

[webtricks]

~snip~
...

Perfect answer.


Would like to add two things:

Now, loans are constantly being paid off so withdrawals can be accommodated. However, if withdrawals are made too quickly, the bank can run out of money (because it is all tied up in loans) and collapse. One way that banks avoid running out of money is by borrowing excess reserves from other banks.

Most of the times banks don't face this situation because reserve is fixed by the central authority keeping in view the economic condition. This percentage is usually enough keeping in view that all depositors won't come to withdraw money at the same time and there is constant flow of new deposits. Developing countries usually have reserve requirement around 15-25% while developed/underdeveloped have lower requirement. However, banks may rarely face such issues some times hence they use financial instrument known as Call Money. Call Money is usually cleared by bank on overnight basis.


Second concept I would like to talk about is of 'Money Multiplier'. One can easily calculate how much money banks can create by simply using this formula:

m = 1/RRR

If RRR is 10% then banks can lend up to 10 times the amount they receive as deposits.

[o_e_l_e_o]

Two additions to the above points.

Running alongside fractional reserve, is that when banks give out loans, they can create new money out of nothing. Lets say you take out a loan for $1000. The bank issues a credit to you of $1000, and also a debit against you of $1000. The bank's bottom line doesn't change; their books are still perfectly balanced - a new $1000 liability, and a new $1000 asset. Except now you have $1000 you can spend, $1000 which didn't exist before you took out the loan.

Secondly, a month ago, the Federal Reserve reduced the minimum reserve requirement of US banks from 10% to 0% - https://www.federalreserve.gov/monetarypolicy/reservereq.htm. This essentially means banks can print unlimited money in the form of new loans, since there is no requirement for them to hold any percentage in their reserves.

[CristianOff]

Two additions to the above points.

Running alongside fractional reserve, is that when banks give out loans, they can create new money out of nothing. Lets say you take out a loan for $1000. The bank issues a credit to you of $1000, and also a debit against you of $1000. The bank's bottom line doesn't change; their books are still perfectly balanced - a new $1000 liability, and a new $1000 asset. Except now you have $1000 you can spend, $1000 which didn't exist before you took out the loan.

Secondly, a month ago, the Federal Reserve reduced the minimum reserve requirement of US banks from 10% to 0% - https://www.federalreserve.gov/monetarypolicy/reservereq.htm. This essentially means banks can print unlimited money in the form of new loans, since there is no requirement for them to hold any percentage in their reserves.

LOL
I think this was needed because banks may see higher loans taken as a result of covid19. In UK for example there is this "furlough worker" scheme which means the
employer pays 80% of wages. They will pay them from own pockets and in June they will claim those money back from the government. Some employers however need to
take a loan in order to do that.

I don't really know about the US but for sure some companies need money to survive. The 0% minimum reserve requirement sounds dangerous if misused. 

[abhiseshakana]

I don't really know about the US but for sure some companies need money to survive. The 0% minimum reserve requirement sounds dangerous if misused. 

It is not a dangerous 0% minimum reserve requirement, but a bank is a very dangerous institution. Banks seriously affect social problems by inhibiting the circulation of money and inhibiting the use of money maximally and proportionally. Interest plays an important role in causing a crisis. The current global economic system is controlled by capitalist-created banks. Where rich countries suck the blood of poor countries with interest loans. The bank destroys the fundamentals of human life which are fundamental, namely helping and helping each other.

Interest makes money as a commodity. so that the function of money is as a medium of exchange (medium of change) does not work. Capitalism economy is a system that makes money as a commodity, where the money is traded. This is very vulnerable to an increase in the value of the dollar which in turn has caused disasters in many countries. The process of decreasing the value of the local currency is very short which in turn destroys the economy of a country and of course, impoverishes the people.

So in conclusion, interest is proven to create a crisis and impoverish because it opens up opportunities for speculators to make speculations that can lead to economic volatility in many countries. A side effect that is felt is the accumulation of assets in large numbers and controlled by a handful of people. While the majority of people do not get a source of life.

Interest rates also affect investment, production, and the creation of unemployment. The higher the interest rate, the lower investment. If investment decreases, the production also decreases. If production decreases, it will increase unemployment.

[mu_enrico]

The 0% minimum reserve requirement sounds dangerous if misused. 

Yep, they need to squeeze as much liquidity as possible, then if there is not enough cash, the risk of bank run increases.

Anyway,
Interest is just a logical consequence of lending money (with or without collateral), stop teaching nonsense!