How to Money Creation by Banking System

Banks can lend only because they do not expect that all depositors will withdraw their deposits at the same time. When a bank lends to a person, a new deposit account is opened in that person’s name. Thus the money supply is increased by adding to the old deposits and by adding new deposits (as well as currency).

Let us take an example. Suppose there is only one bank in the country. Let us draw a hypothetical balance sheet for this bank. The balance sheet is a record of the assets and liabilities of any firm. Traditionally, the assets of the firm are recorded on the left side and the liabilities on the right side. Accounting rules say that the two sides of the balance sheet should be equal or the total assets should be equal to the total liabilities. Assets are things that a firm owns or which a firm can claim from others. In the case of a bank, apart from buildings, furniture, etc., its assets are the loans made to the public.

When the bank lends US$100 to a person, the bank has a claim of US$100 on that person. Another asset that a bank has is reserves. Reserves are the deposits that commercial banks keep with the central bank, the Reserve Bank, and its cash. These reserves are kept partly in the form of cash and partly in the form of financial instruments (bonds and treasury bills) issued by the RBI. Reserves are similar to the deposits kept in banks. We keep deposits and these deposits are our assets, which we can withdraw. Similarly, commercial banks like State Bank keep their deposits with the bank and these are called reserves.

Assets = Reserves + Debts Liabilities for any firm are its debts or loans given to others. For a bank, the main liability is the deposits that people keep with it. Liabilities = Deposits

Accounting rules say that both sides of the account must be balanced. So if assets are more than liabilities, they are recorded on the right side as Net Worth. Net worth = Assets – Liabilities

The information given above is giving you an idea of ​​how the money banking system is created