Explain how financial institutions create money, and describe the means
by which financial institutions are regulated.
Possible Answer: The money supply expands because banks can loan out
most of the money they take in from deposits. The new loans create additional
deposits as follows: Out of a deposit of $100, the bank may hold $10 in reserve
and loan 90 percent—$90—to borrowers. There will still be the original $100 on
deposit, and borrowers will also deposit the $90 loans in their banks. Now the
borrowers’ banks have another $81 of new deposits available for new loans (90%
of the $90). Banks, therefore, have turned the original $100 deposits into $271
($100 + $90 + 81) of deposits. Further, the government regulates banks to
ensure a sound financial system. The Federal Deposit Insurance Corporation insures
deposits and guarantees the safety of all deposits up to the current maximum of
$100,000. To ensure against failures, the FDIC examines the activities and
accounts of all member banks.
Source: Business
Essentials, 8e (Ebert/Griffin) – Global Edition
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