Explain how commercial banks ‘create money’ and what transactions lead to money creation. Discuss the impact on our financial system of a new 100,000 deposit (assuming a 10% reserve requirement), and in theory, how much this deposit will expand the total money supply. Discuss the ledger entries, and how exactly money is created.

Prof sayers described banks as "Important manufacturers of money". Commercial Banks are known as creator of money. The main functuon of Commercial Banks are accepting deposits and lending money to the general public. Banks are financial intermediaries. This concept states that bank need not possess what it lends. If you want some money then u can approach your friend and your friend can lend the money only if he has. But in case of Banks position is totally different. Bank can lend the money even if it doesn't possess. Now we will discuss two types of deposits.

1. Primary deposits : These are the deposits which is created by depositing cash or coins. Like in above question 100,000 is primary deposits.

2. Secondary deposits : Whenever a bank without actually receiving cashbopens an account in favour of a client authorizing him to draw a particular amount, Secondary or derivative deposit is created.

Now we will discuss the assumptions of money creation which is also known as credit creation.

1. People hold as much currency as they need and they keep additional amounts in Banks.

2. The reserve requirement is 10% whichbis given in the question.

3. No Commercial Bank keeps excess reserves of cash than the required cash reserve ratio which is 10%.

4. Time liabilities of the commercial banks remain unchanged.

Credit multiplier : 1 / Reserve requirement ratio

i.e. . 1 / 10 = 0.10 or 0.10 X 100 = 10 (credit multiplier)

Credit multiplier brings out inverse relationship between credit and reserve requirement ratio.

Please see below attached page for process and Ledger accounts.

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