How Banks Create Money? 1. Fractional Reserve Banking 2. Creating Credit 3. Investment banking 4. Securitization
banks make money

How Banks Create Money

1. Bank creates money by Fractional Reserve Banking:

Banks create money by loaning out more money than they have on deposit. Banks are only required to hold a fraction of their customers’ deposits as liquid reserves while lending out the rest, known as fractional reserve banking.

2. Bank creates money by Creating Credit:

Banks create money by creating credit. They lend money to individuals and businesses in the form of credit, which is a form of money. In addition, Banks create money by creating credit through a process called fractional reserve banking. Banks are allowed to hold only a fraction of deposited funds as reserves and then lend out the remaining amount as credit or loans, which creates an asset to the borrower and a liability to the bank. This asset/liability transaction creates new money and expands the money supply in the economy.

Moreover, When a customer deposits into their account, the bank first sets aside a portion of that deposit. The borrower then uses the loan money to make purchases or investments, which the bank records as an asset on its balance sheet. This newly created credit is then deposited into another account, and the process begins again. The new credit created in this way can go on to circulate throughout the economy. This is one of the primary ways banks create money in our economy.

3. Investment Banking:

Banks create money through investment banking services. They provide capital and advice to businesses so that they can expand or acquire other businesses.

In addition, Banks create money through investment banking by utilizing their deposit and loan accounts to finance various projects and investments. Investment banking refers to a type of banking that deals with large-scale financial transactions and investments for businesses and governments.

Moreover, when businesses or governments require financing for a project, they will approach an investment bank to raise capital. The investment bank then assesses the risk associated with the project and sets terms for the loan.

Overall, the proceeds from these sales are given to the borrower in exchange for interest payments. By issuing these securities, the investment bank has effectively created money out of thin air. This is known as fractional reserve banking. The money that the investment bank creates through this process is then used to finance the borrower’s project or investment. The investment bank also earns profits from the interest payments, fees, and commissions associated with the deal. Over time, this type of banking has become an integral part of how banks create money.

4.  Securitization:

Banks create money

Banks create money by securitizing assets such as mortgages, car loans, and student loans. These assets are then sold to investors, creating additional money for the bank.

Furthermore, Banks create money through securitization by packaging and selling off their loans to investors in the form of securities. The bank originates a pool of loans, such as mortgages or car loans, and groups them into a portfolio. The process of securitization allows banks to generate more money than they would be able to by simply holding the loans on their balance sheet. It also allows them to diversify their lending profile and attract more investors.

5. Bank creates money by Overdraft Fees:

Banks create money

Overdraft fees occur when you don’t have enough money in your account to cover your transactions. The cost for overdraft fees varies by bank, but they may cost around $35 per transaction. These fees can add up quickly and can have costly ripple effects. Banks create money by charging overdraft fees when customers withdraw more money than they have in their accounts.

6.  Credit Card Services:

banks create money

The primary way that banks make money is interest from credit card accounts.  They also charge fees for late-payments and annual membership fees.

7. Bank creates money by Market Accounts:

Banks create money by offering money market accounts, which are short-term investments that pay higher interest rates than other forms of savings. Banks typically calculate interest on a money market account daily and make a monthly credit to the account. In general, money market accounts offer slightly higher interest rates than standard savings accounts.

8. Foreign Exchange (Forex):

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Banks facilitate forex transactions for clients and conduct speculative trades from their trading desks. When banks act as dealers for clients, the bid-ask spread represents the bank’s profits. Traders execute speculative currency trades to profit from currency fluctuations. So Banks create money by facilitating international transactions and speculation on foreign currencies.

9. Merchant Services:

Banks create money

Merchant account providers make money based on their bank association fees and setup fees. When a company, such as a retailer, registers with a merchant account company, which may be a bank or an Independent Sales Organization (ISO), there is an application fee and yearly bank fees. So Banks create money through merchant services, by charging businesses a fee for processing debit and credit card payments.

10. Bank makes money through ATM Transactions:

The ATM business model is simple and works on a split between the ATM owner, the processor, and the vendor location. The processor or bank charges a fee for each transaction. The fee varies significantly by the institution and a range of 20- to 50 cents is not uncommon. The vendor location also takes a cut in most cases. So Banks create money by charging customers a fee for using ATMs and providing cash withdrawals.

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