Introduction to Finance

Bank A
Assets
Liabilities
Reserves
$10,000
Deposits
$10,000
A loan for $8,000 is made and credited as follows:
Bank A
Assets
Liabilities
Reserves
$10,000
Deposits
$18,000
Loans
$ 8,000
Assume that a check is drawn against this primary deposit almost immediately and 
deposited in Bank B. The books of the two banks would then show the following:
Bank A
Assets
Liabilities
Reserves
$2,000
Deposits
$10,000
Loans
$8,000
Bank B
Assets
Liabilities
Reserves
$8,000
Deposits
$8,000
The derivative deposit arising out of a loan from Bank A has now been transferred 
by check to Bank B, where it is received as a primary deposit. Bank B must now set aside 
20 percent as required reserves and may lend or reinvest the remainder. Its books after such a 
loan (equal to its excess reserves) would appear as follows:
Bank B
Assets
Liabilities
Reserves
$8,000
Deposits
$14,400
Loans
$6,400
Assume a check is drawn against the derivative deposit of $6,400 that was created due to 
the loan by Bank B. This reduces its reserves and deposits as follows:
Bank B
Assets
Liabilities
Reserves
$1,600
Deposits
$8,000
Loans
$6,400

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C H A PT E R 5 Policy Makers and the Money Supply
The check for $6,400 will most likely be deposited in a bank, in our example in Bank A or 
Bank B itself, since we have assumed that only two banks exist. In the U.S. banking system, it 
may be deposited in one of the thousands of banks or other depository institutions.
Deposit expansion as when a bank makes a loan can take place in the same way when it 
buys securities. Assume, as we did in the case of a bank loan, the following situation: