Why Banks Make Money - The Federal Reserve Requirement

Ever wonder why banks are able to make so much money?

If you put $1000 in a bank checking account, the bank is only required by law to keep a certain amount of that money within the bank. If the reserve requirement was

"If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81."

Below shows the historical reserve requirements of several countries.

Country 1968 1978 1988 1998
United Kingdom: 20.5 15.9 5.0 3.1
Turkey: 58.3 62.7 30.8 18.0
Germany: 19.0 19.3 17.2 11.9
United States: 12.3 10.1 8.5 10.3

http://en.wikipedia.org/wiki/Reserve_requirement

"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As this fractional-reserve banking process continues, the banks can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity."

Essentially, each dollar in a bank can compound by a factor of (Amount/Reserve Requirement)

You can do this too! With credit cards!!!

Why is it that the banks get the advantage and the little guy gets stiffed?

Because that is the way the system works.

The key is to understand the system so that you can make responsible decisions (no credit card debt) to avoid problems and smart decisions (ROTH IRA) to help you use the system to your advantage.

Until next time,
Thor