Reading a Bank Balance Sheet: The T-Account
- Construct a simplified bank T-account with reserves, loans, deposits and net worth
- Compute required and excess reserves from a reserve ratio
- Trace a deposit through the money creation process
Two sides that must balance
A T-account puts assets on the left and liabilities plus net worth on the right, and the two sides are equal by construction. A bank's assets are reserves (cash in the vault and deposits at the central bank), loans it has made, and securities it owns. Its main liability is customer deposits — money it owes to depositors. The counterintuitive part, and the one that produces wrong answers, is that your deposit is the bank's liability, not its asset. The bank owes it to you.
How lending creates money
When a bank makes a loan it does not hand over someone else's cash — it credits the borrower's deposit account. Both sides of the T-account grow: a new loan asset and a new deposit liability. Since demand deposits are part of the money supply, the loan created money. This is the single most important idea in the unit, and it is why the money supply is largely determined by bank lending rather than by the printing press.
One bank versus the banking system
A single bank can lend only its excess reserves. But the borrower spends that money and it is deposited at another bank, which now has new reserves and can lend a fraction of them onward. Repeating this gives the money multiplier, 1/reserve ratio, and a total expansion of excess reserves × multiplier. Two things shrink the real-world multiplier below that ceiling: cash leakage, when people hold currency instead of depositing, and banks choosing to hold excess reserves rather than lend them.
A bank has $10,000 in reserves and $50,000 in demand deposits, with a 10% reserve requirement. Find required reserves, excess reserves, the maximum this bank can lend, and the maximum expansion for the whole system.
- 1.Required reserves = 0.10 × $50,000 = $5,000.
- 2.Excess reserves = $10,000 − $5,000 = $5,000.
- 3.This bank alone can lend up to its excess reserves: $5,000.
- 4.Money multiplier = 1/0.10 = 10.
- 5.System-wide maximum expansion = $5,000 × 10 = $50,000.
The multiplier applies to excess reserves, not to total reserves and not to the deposit. Multiplying the whole $10,000 by 10 overstates the expansion, because $5,000 of it is legally frozen.
On a commercial bank's balance sheet, customer demand deposits are:
A bank holds $40,000 in deposits and $6,000 in reserves with a 10% requirement. Its excess reserves are:
When a bank makes a new loan by crediting the borrower's account, the money supply:
T-account free responses want the actual two-column layout with entries in the right columns. Draw it. A prose description of what changed rarely earns full credit even when the reasoning is right.
Answer the 3 checkpoints as you read.
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