How much credit can the banks create?

Credit Creation Calculator

Initial Deposit (€): Reserve Ratio (%):

How do banks actually 'create' credit?

To illustrate how €1,000 of reserves can create €9,000 of deposits, we'll assume a reserve requirement of 10% and a single bank in the Eurozone.

Step-by-step illustration

• Initial Deposit: A customer deposits €1,000 into the bank.
• Reserve Requirement: The reserve requirement set by the European Central Bank (ECB) is 10% of total deposits.
• Excess Reserves: The bank must keep 10% of the initial deposit as reserves, which is €100 (10% of €1,000). This leaves the bank with €900 in excess reserves that can be used for lending.
• Credit Creation: The bank lends out the €900 to a borrower.
• New Deposit: The borrower receives the €900 loan, which is then deposited into another bank (possibly the same bank, but for the sake of simplicity, let's assume it's a different bank).
• New Reserve: The receiving bank must hold 10% of the new deposit as a reserve. Since the new deposit is €900, the reserve is €90 (10% of €900).
• Repeat: The process can continue as long as there are excess reserves. When the receiving bank lends the remaining €810 (€900 - €90) to another borrower, that amount becomes a new deposit, and the cycle continues.
• Click here to use my credit creation calculator.

To summarise the changes after each round of lending and deposit:

Round 1:

Initial Deposit: €1,000

Excess Reserves: €900 (€1,000 - €100)

New Loan: €900

Total Deposits: €1,900 (€1,000 + €900)

New Reserve: €190 (10% of €1,900)

Round 2:

New Deposit: €900 (from the loan in Round 1)

Excess Reserves: €810 (€900 - €90)

New Loan: €810

Total Deposits: €2,710 (€1,900 + €810)

New Reserve: €271 (10% of €2,710)

Round 3:

New Deposit: €810 (from the loan in Round 2)

Excess Reserves: €729 (€810 - €81)

New Loan: €729

Total Deposits: €3,439 (€2,710 + €729)

New Reserve: €344 (10% of €3,439)

This process can continue, and after several rounds, the deposits will reach approximately €9,000. As you can see, a single €1,000 deposit has resulted in a significant increase in total deposits through the creation of credit by the banking system. It's important to note that the process may not reach exactly €9,000 due to rounding and other factors, but this illustration demonstrates the idea of how banks can create credit and expand the money supply in the Eurozone.

Have a look at this short video on the concept.