Understanding Deposit Multipliers: How Banks Manage Reserves

The deposit multiplier is essentially the amount of money kept in the reserve account of a bank (as a requirement) to allow for continued functionality, to meet the withdrawal demands of their clients, and to limit the potential risks associated with the depletion of their supplies. The deposit multiplier is the ratio of the checkable deposit to the amount in the reserves.

Generally, banks hold a maximum amount of money that they can create as a percentage of their reserves, which is set forth by the fractional reserve banking systemFractional BankingFractional Banking is a banking system that requires banks to hold only a portion of the money deposited with them as reserves. The reserves are held as balances in the bank’s account at the central bank or as currency in the bank.. As banks loan out their reserves, they produce checkable deposits and estimate the amount of money that is available to be lent out by using their reserve requirement ratio. Hence, the deposit multiplier can be seen as the opposite of the reserve requirement ratio, because it is a ratio of the checkable deposit to the amount in the reserves.

An example of such an inverse relationship is when a bank posts a required reserve ratio of 24%, the deposit multiplier would be 76%. The deposit multiplier allows for the bank to ensure that there is sufficient cash to cater for withdrawals, as needed by the customers. In some instances, the deposit multiplier can be presented as the deposit multiplier ratio.

The deposit multiplier aids in ensuring the basic money supply in an economy.

Summary

• Also known as the simple deposit multiplier or the deposit expansion multiplier, the deposit multiplier is essentially the amount of money kept in the reserve account of a bank (as a requirement) to allow for continued functionality. It allows banks to meet the withdrawal demands of their clients and to limit the potential risks associated with the depletion of their supplies.
• The deposit multiplier can be seen as the opposite of the reserve requirement ratio because it is a ratio of the checkable deposit to the amount in the reserves.
• The deposit multiplier aids in ensuring the basic money supply in an economy.

Understanding Deposit Multiplier

Also known as the simple deposit multiplier or the deposit expansion multiplier, the deposit multiplier is essentially the amount of money kept in the reserve account of a bank (as a requirement) to allow for continued functionality. It allows the bank to meet the withdrawal demands of their clients, and to limit the potential risks associated with the depletion of their supplies.

As a pivotal part of the banking system, central banks (e.g. the U.S. Federal ReserveFederal Reserve (The Fed)The Federal Reserve is the central bank of the United States and is the financial authority behind the world’s largest free market economy.) put forth a required reserve. The required reserve is the minimum amount of money to be held by a bank, which can be lent out to the bank’s respective customers. Banks are expected to maintain the required reserve in an account that is held at the central bank.

The deposit multiplier, as emphasized before, is the opposite of the required reserve. It is the ratio of a bank’s checkable deposits, and it sets forth the foundation for the money multiplier, but the money multiplier is significantly smaller.

Understanding Checkable Deposits

Bank accounts against which checks can be written out to facilitate a withdrawal are known as checkable deposits. Such accounts can be considered to be liquid assets as they provide ease of access for their clients. Examples include money market accountsMoney Market FundsMoney market funds are open-ended fixed income mutual funds that invest in short-term debt securities, such as Treasury bills, municipal bills, and, interest-bearing accounts, and deposit accounts.

Understanding Money Multiplier

The amount of money generated by banks in conjunction with each dollar of reserves is known as the money multiplier. To better understand the concept, consider a country where the central bank imposes a 15% reserve requirement. The reserve ratio is 1/15; it means that for every $1 deposit in the bank, $0.85 can be loaned out. Thus, given a bank with $200 million worth of deposits can loan out $170 million. It increases the money supply from $200 million to $370 million.

The money multiplier can provide information on how quickly the money supply (from a bank’s lending) will grow. A high reserve ratio indicates that fewer deposits are available for lending, thus producing a lower money multiplier. It presents an inverse relationship between the reserve ratio and the money multiplier.

Deposit Multiplier Formula

The following is the formula for determining the deposit multiplier ratio:

For comprehensive purposes, consider the example of Bank ABC, which keeps a required reserve ratio of 12%. How does one determine the deposit multiplier? The deposit multiplier can be computed by dividing 1 by the reserve ratio of 10% to get the deposit multiplier of 10. It shows that for every $100; $1,000 is created.

More Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

Bank ReservesBank ReservesBank reserves are the minimum cash reserves that financial institutions must keep in their vaults at any given time. The minimum cash reserve requirements

Checking Accounts vs Savings AccountsChecking Accounts vs Savings AccountsA bank client can choose to open checking accounts vs savings accounts depending on several factors, such as purpose, ease of access, or other attributes. A checking account is a type of bank account that is used for everyday transactions. It is the most basic account that banks, credit unions, and small lenders offer.

Financial Statements for BanksFinancial Statements for BanksFinancial Statements for Banks differ from those of non-banks in that banks use much more leverage than other businesses and earn a spread

Reserve RatioReserve RatioThe reserve ratio – also known as bank reserve ratio, bank reserve requirement, or cash reserve ratio – is the percentage of deposits a financial institution must hold in reserve as cash. The central bank is the institution that determines the required amount of reserve ratio.