The ability of commercial banks to create money depends on the
Answer Details
The ability of commercial banks to create money depends on the reserve ratio.
When a commercial bank receives deposits from its customers, it is required to hold a certain percentage of those deposits in reserve, usually with the central bank. This reserve requirement is called the reserve ratio. The remaining portion of the deposits is available for the bank to lend out as loans or to invest in other assets.
When the bank makes loans, the borrower receives the loan amount in the form of a deposit in their account. This new deposit adds to the bank's liabilities, but it also increases the amount of money in circulation in the economy, as the borrower is now able to spend the loaned money. Therefore, by making loans, commercial banks can create new money.
The amount of new money that a bank can create through loans is dependent on its reserve ratio. A lower reserve ratio means that the bank can lend out more money and create more deposits, resulting in a greater increase in the money supply. Conversely, a higher reserve ratio means that the bank can lend out less money and create fewer deposits, resulting in a smaller increase in the money supply.
Overall, the reserve ratio plays a key role in determining the ability of commercial banks to create money through lending and investing.