Even if you've never heard the term "money multiplier," you likely know the process it refers to: When you put your money in the bank, that money isn't actually put in a vault and held for you. It goes into the general pool, and the bank is only allowed to lend as much money as the Federal Reserve will allow. The money that must be held by banks is called "reserves," and that money must be held aside in a predefined ratio of reserves to deposits. This ratio is determined using a simple money multiplier.
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How It Works
A bank manager is responsible for keeping track of the current reserve ratio. Each day, as money drops into accounts, that bank manager is responsible for ensuring a certain percentage of that money is set aside as reserves. So if a bank has a 10 percent reserve ratio, that means for every dollar deposited, the bank must set aside $0.10 in reserves. A bank with $100 million in total deposits would have $10 million that it could not lend in any form.
The current reserve amount is public information and changes incrementally. As of November 2017, the first $16 million a bank takes in is exempt from reserve requirements. After that, a 3 percent reserve ratio is assessed up to $122.3 million. A bank that has more than $122.3 million must set aside 10 percent as reserves. The money must be held in a vault as cash, deposited in a Federal Reserve bank or deposited in a pass-through account at a corresponding institution.
Money Multiplier Formula
To calculate the formula under current regulations, take the full amount of money in your bank and eliminate the first $16 million. So if your bank had $100 million, you would subtract $16 million, for a total of $84 million. This amount would be the total every day susceptible to reserve requirements. Because your $84 million does not exceed $122.3 million, you would only need to apply the 3 percent rule.
As long as your total deposits remain below $122.3 million, you only need to set aside 3 percent in reserves. A bank with a total of $100 million would apply the 3 percent multiplier daily to make sure all but $16 million of the deposits are covered with the reserves you have in your vault or with a Federal Reserve-approved institution. On the day you had $84 million in deposits, $2.52 million would be required to be held as reserves. This means $81.48 million of your $100 million in deposits is available for lending to your account holders.