Oct 27, 2021
The creation of endogenous currency through credit expansion is the source of bank profits and the root of risk. Creating money through credit is actually the currency multiplier. Banks generate deposits through loans, then make loans and generate new deposits. According to the deposit reserve ratio, banks can repeat this process unceasingly, and generate profits in this process, expanding the bank’s balance sheet at the same time.
At present, all countries are implementing a fractional reserve system, which means that banks keep a certain percentage of deposits in preparation for customer withdrawals, and other funds can be used for loans. Banks hope the reserve to be lower, so that they can have more funds for loans, and thus get more profits. However, a too low reserve ratio may cause banks to fail to meet the temporary withdrawal needs of deposit customers. In the event of an abnormal shock, if the bank cannot meet the withdrawal needs, a run will occur, which is an eternal threat to banks. Bank runs may have a chain reaction and eventually disrupt the operation of the financial system. In the worst case, panic and run in the banking industry may lead to a complete collapse of the financial system, pushing the economy into a deflationary spiral and severe recession.