• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Fractional Reserve Banking

Extracts from this document...


´╗┐Fractional Reserve Banking By Grace Li Materials online about fractional reserve banking pg1~2 My thinking about how the system really works pg 3 My thinking about Ms.Aimee?s simulation pg4~5 Fractional Reserve Banking Fractional Reserve Banking refers to a banking system which requires the commercial banks to keep only portion of the money deposited with them as reserves. The bank pays interest on all deposits made by its customers and uses the deposited money to make new loans. In order to understand how fractional reserve banking works, let's look at the following example. Somebody deposits $1,000 with Bank A. Bank A is obligated by law to keep 10% of the deposited money as a reserve, that's why the bank keeps $100 and lends out $900. Somewhere down the road the $900 loan is deposited in another chequing account (it might or might not be with the same bank). This second bank also wants to make money by giving out loans, that's why it keeps the required $90 and lends $810. Fast forward to a deposit with a fourth bank and you'll get the following: Bank Deposit Reserve Loan Bank #1 $1,000 $100 $900 Bank #2 $900 $90 $810 Bank #3 $810 $81 $729 Bank #4 $729 $729 $0 ...read more.


Let initial deposit = x dollars, reserve requirement ratio is 20% Note: After bank 4 receive the deposit money, the system would be ended and a loan would not be given out by bank4, so it would be no need for Bank4 to calculate their reserve that would be kept and loans that would be given out in the next round Deposit reserve loan Bank 1 x 0.2x 0.8x Bank 2 0.8x 0.16x 0.64x Bank 3 0.64x 0.128x 0.512x Bank 4 0.512x total 2.952x 0.488x 1.952x What did we find? 1. 0.512x+ 0.488x= 1x Last deposit + reserve = initial deposit Why it was the reserve + last deposit = initial deposit? Why did reserve keep these parts of initial deposit? Why reserve is not double counted? Let?s look at fraction : Total reserve + last deposit = 1 =0.2 + 0.16 + 0.128 + 0.512 =0.2 + 0.2*(1-0.2) + 0.2*(1-0.2)2 + 0.83 =(0.2 + 0.2*0.8 + 0.2*0.82) + 0.83 = Total Reserve + last deposit So, reserve is the sum of numbers that has taken the fraction20% of the deposit, but the last deposit is the number that had taken the fraction80% in every step, so total reserve is effected by all the 3 steps of being ...read more.


complicacy, we assume in Round 1 the amount of money deposited in each bank is $a, $b, $c Round2 deposit Reserve Loans Bank1 a 0.2a 0.8a Bank2 b 0.2b 0.8b Bank3 c 0.2c 0.8c Bank4 32000-(a+b+c) 6400-0.2(a+b+c) 25600-0.8(a+b+c) To reduce complicacy, we assume a situation as below Round3 deposit Reserve Loans Bank1 0.8b 0.16b 0.64b Bank2 0.8c 0.16c 0.64c Bank3 25600-0.8(a+b+c) 5120-0.16(a+b+c) 20480-0.64(a+b+c) Bank4 0.8a 0.16a 0.64a As we can see above, the Ms.Aimee?s simulation is equivalent to the model we first saw in the first page. We can assume that there?s only one bank in each round. deposit reserve Loans Bank1 in Round1 40,000 8000 32000 Bank2 in Round2 32000 6400 25600 Bank3 in Round3 25600 5120 20480 Bank4 in Round4 20480 Total 118080 19520 78080 Note: In the table above, same color = things we have done in the same round. For example, at the end of round 2, all people made loans in bank2 and deposit it in Bank3, and in the end of round2, banks saved 20% reserve from the deposit they had before Round2 began( at the end of Round1), so 6400 reserve, 25600 Loans, 25600 deposit are in the same color: yellow. The total money created would be 118080-40000=78080 dollars= total loans ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Accounting & Financial Management section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Accounting & Financial Management essays

  1. A2 Business CourseWork

    These were incredibly successful for Tesco, and was one of the main reasons that helped Tesco get to where it is now. After these were taken out of the business Tesco followed the same idea and introduced a club card.

  2. The maintenance of accurate records supplies the company with the financial data that assists ...

    The Companies Act 1985 states that limited companies need to follow the accounting concepts; going concern, accruals, consistency and prudence within the accounting standards when preparing annual reports. When businesses follow the rules, it allows good comparison between the annual reports of different businesses.

  1. In this section I am going to be looking at various life stages and ...

    because it is the banks money they are handling on a small scale. Student Credit from The royal Bank of Scotland A credit card allows customers to purchase goods on credit. This means that the customer will not have to pay for the good at the time of the transaction.

  2. Autralia's Retail Loan Rate Changes

    Figure1 shows that there is a strong relationship between most interest rates, especially among shorter maturity. Changes in the cash rate indicate changes in the stance of the monetary policy, with the rises in the cash rate being tightening of the monetary policy, and falls in the cash rate being easing.

  1. U.S. Subprime loan Issue

    The main Sub-prime issue will be focused in the US, but global impact throughout the world and examples from the Australian Financial markets will also be discussed. Sub-prime lending originated in the US and had evolved with the realization of a demand in the marketplace and businesses providing a supply

  2. Introduction to banking.

    Presently the Bank has a very wide network of more than 200 branch offices and Extension Counters. The Bank has a network of over 1250 ATMs providing 24hrs a day banking convenience to its customers. This is one of the largest ATM networks in the country.

  1. The company I'm reporting on is Kraft Foods Incorporated - accounting principles.

    Earnings Per Share EPS stands for earnings per share. This is the amount of money stockholders get per share. More specifically it is the net income earned by each share of outstanding stock. As required by FASB (Financial Accounting Standards Board), companies must report two types of EPS: basic and diluted.

  2. Financial Ratio Analysis.

    * The ratios of different companies cannot be properly compared where each company employs different accounting policies. Strengths Despite of the limitations, it provides a useful tool for management, shareholders and any interested parties to assess the performance of the business.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work