Crazyboy's Banking Lectures: Creation of Money

Replies

• 

  Anil Jain

  Strange, 35 view for the post and no reply.. 😔
  
  Anyways I will give it a go, first I will make an attempt to explain the flow of money:
  
  Suppose, user A has deposited $100 in bank X. Now as per the CRR / SLR (try to find out meaning on web 😁) suppose bank X will keep the 10% of amount ($10) as storage and give the remainig amonut ($90) as loan to user any other bank / user B.
  
  Now User B deposit the amount ($90) in Bank Y and similarly Bank Y keeps the 10% as storage ($9) and give $81 as loan and chain goes on ...
  
  Now lets try to calculate the total money in the market. $100 + $90 + $81 + .....
  
  Banks made the $100 of one user in lots of money. Also in the same process the difference of interest rate (bank give 3.5% to user on saving account and give loan @ 7.5 %) is the profit of the banks.
  
  This is one of the method how banks earn the money.
  
  I tried to break the ice, now can I expect any more method by which banks earns the money?
  
  -CB
• 

  Saandeep Sreerambatla

  In India there are different types of loans available , personal loan , home loan , vechicle loan etc..
  
  So Banks earn money in that way.
  
  More over there are many ways of investing money in the bank like keeping an recurring deposit, fixed deposits and many more!
  
  There are even mutual funds in which we invest!
  
  But it is a very big topic. I am not aware of it..
  
  But can you tell how the mutual fund system helps banks?
  
  For example ICICI hasmany types of mutual funds how does it work actually?
• 

  Manish Goyal

  When you ask about money from money
  then only way that comes in my mind is interest,...further interest on interest..
  2nd way ie banks are adopted now a days is by mutual funds..i love that way..but highly risky it includes taking money from people and invested in market on behalf of people.
• 

  Anil Jain

  English-Scared

  In India there are different types of loans available , personal loan , home loan , vechicle loan etc..
  
  So Banks earn money in that way.
  
  More over there are many ways of investing money in the bank like keeping an recurring deposit, fixed deposits and many more!
  
  There are even mutual funds in which we invest!
  
  But it is a very big topic. I am not aware of it..
  
  But can you tell how the mutual fund system helps banks?
  
  For example ICICI hasmany types of mutual funds how does it work actually?

  I appreciate ES, I am happy that atleast somebody stood up and came for the discussion on the forum. Thanks !!!
  
  ES - You are right that there are n number of loans that bank provides to end customers like you and me. But have you think how bank money out of these.
  
  Do you think that the interest we are paying (complete 8 or 10 or whatever % it is) are the earning of banks?? No it is not.
  
  To provide us loan Banks requires money (liquidity), this is the same money which we deposits in the banks. Bank also gives us some interests on this (Generally its 3.5% for saving accounts in India). So banks profits is;
  
  Profit = Loan interest rate taken - Saving account interest given - Processing fee
  
  You are absolutely right that we have n number of deposit schemes in bank, but just think why banks give us different interest rates on those, like an example: In Indian context if its 4% on 6 month fixed deposit, 7.5 % on 5 yr fixed deposit to 3.5% on saving accounts.
  
  Longer the term of your fixed deposit more would be the interest rate (As banks would be sure that they can use your money for much more time without having tension that you will not ask for your money for that duration. At the same time bank time utilize that money in giving loans at higher rates, Now again, difference in the interest rates is the income of the banks.)
  
  Regarding Investments, Mutual funds... Its a vast topic and I have to start a new thread to explain them. I would do it a little later at-least after explaining the basics of banking.
  
  -CB
• 

  tashirosgt

  The topic of "inflation" is related to the fact that banks can create money. ( In fact, it would be interesting to discuss what restrictions ( legal or "natural") there are on the amount of money that a bank can create.
  
  Also, "business cycles" are related to how banks and other things create money and monetary value. (Strictly speaking, if someone sells stock for a certain monetary value, no money is created. But if the stock rises in price, then the wealth of the owner is increased, at least on his books. This might let him use the stock as collateral for a loan.)
• 

  Manish Goyal

  The topic of "inflation" is related to the fact that banks can create money

  😕😕
• 

  tashirosgt

  In a free market, the prices of a product will rise if consumers desire to buy more of it but the production of it remains the same.
  
  If banks offer lower interest rates, people borrow more money and there is more money in circulation. The added money lets them buy more goods. The act of borrowing money is simpler and faster than the actions needed to increase the production rate of a factory. So you have the situation where consumers want more of products but the production rate has not increased. So, temporarily, there will be an increase in prices.
  
  Increasing the production rate of a factory often requires that the owner borrow money. So even more money is created. The net effect is that the prices of all goods rise, the price of the good the factory makes, the prices the owner pays for materials and labor to make the good, etc.
• 

  Anil Jain

  @tashirosgt - Well said, agree with you. Hope, you have cleared the doubt of Goyal.
  
  I should have kept the thread's name as Profit for banks 😁, By this thread I wanted to explain the ways by which banks can earn profits.
  
  -CB
• 

  Manish Goyal

  Okk You mean
  inflation rate=more demand of money
  
  more demand of money =loans from banks with lower or high interest rates..
  
  Thanks buddy
• 

  tashirosgt

  I don't think "inflation" can be equated with a demand for money.
  
  Imagine this fairy tale: Suppose the government of a country were to announce that every unit of currency entitled the owner to get, free of charge, 9 additional units of currency. So ( since I am in the US) every $1 that I have in a bank account or in my pocket "expands" into $10. Will merchants keep their prices the same? No, since if they did, they would run out of products because people can buy 10 times as much as they could using the old prices. So prices on all products would rise. You would expect them to rise by a factor of 10. The changes in the amount of money and the subsequent change in prices don't indicate any technological progress. They are not due to any discoveries of how to made products quicker or easier. It is simply a sort of slight-of-hand with numbers.
  
  The usual way to measure "inflation" is to measure the increase in prices of goods that have approximately the same "worth" over the time period being considered. So inflation is not simply a measure of the total amount of money in circulation. The rise in price of a good that has approximately the same "worth" is regarded as an indication of how the amount of money in circulation has increased WITHOUT any accompanying increase in the "worth" of goods.
  
  In reality, the increase in the amount of money is not accomplished in the simple manner of my fairy tail. It is accomplished through banks and other institutions that can create money. Not every citizen gets the money that is created, only those who are willing to borrow will get it.
  
  The new money does not necessarily result in inflation. For example, suppose a company borrows a million dollars from a bank. It uses the money to discover a new way of making fertilzer quicker and cheaper. The result of this discovery tends to decrease the cost of fertilizer, hence of crops, hence of food sold in grocery stores. If the new money creates new "worth" then prices may go down and there may be "deflation" instead of "inflation".
  
  The scenario for new money resulting in "inflation" is that the borrowers, on the whole, do not use the money to create anything of sufficient "worth" to justify the creation of the money.
• 

  tdave

  How bank make money ? Basically We give a bank our money to keep it safe for us(deposits), and then the bank turns around and gives it to someone else in order to make money for itself(loan). So when group of people can't /unable to pay back the bank loan (almost the same time). If the amount is too big .BANK gonna close down because lack of money . Like Subprime mortgage crisis in the United States
• 

  tashirosgt

  The bank's actually loan out more money that they hold in deposits. There wouldn't be any creation of money if they didn't.