Banks are fantastic wealth-creation machines. Here’s how it works:
- I create the Bank of Elaine with zero assets.
- Foodstamp Fred shows up and asks for a $100 loan.
- The bank creates an account for Fred with a $100 deposit. The bank now has $100 worth of assets in the form of a loan.
- Banks have a 10% capital requirement for loans, so I sell some shares of the bank for $10.
- Fred would like to withdraw his $100 deposit in small unmarked bills.
- Bank of Elaine doesn’t have $100, so it borrows the money from another bank. Actually, ElaineBank borrows $300, using this $100 loan asset as collateral.
And that is how wealth is created.
Basics of Banking: Loans Create a Lot More Than Deposits –CNBC