Jun
29
2012

How do I start a bank and create money out of thin air?

Image from Pixabay (PD)

The details differ from country to country, but you can create money out of thin air like this:

First you get a banking license (i.e. permission from your government to be a bank), which is not easy.

Then, you get someone to deposit money with you. Let’s say they deposit $10000.

If the legal fractional reserve is 10%, your country’s central bank will lend you $100,000 with your $10000 (i.e. 10%) as  collateral..

That money comes from the central bank as a “book entry for a loan” at the central bank’s current rate of interest. Your bank then makes a “book entry” to put the money into your borrowers’ accounts. Your borrowers can withdraw that money as and when they need it.

If your borrowers want their funds in cash rather than by check, it’s no problem. The central bank will freely swap the balance that it created out of nothing and lent to your bank for freshly printed banknotes or coins, and your bank can give those to its borrowers.

Eventually the borrowers pay back the loan with interest. Your bank can then pay back its loan from the central bank at the central bank’s lower rate of interest. The different in interest rates is profit for the bank.

But suppose you have lent out all of your funds, and your original depositor withdraws half of their money. Now you only have a reserve of $5000, and are only allowed to lend out $50,000 (due to the reserve ratio requirement). Yikes! Either you can recall half of the loans that you made, or borrow money from another bank on the interbank market, or you go to the central bank to get some special treatment (because politically it doesn’t look good for the government if people see a run on a bank).

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