Explain how a banks ability to create transaction accounts t

Solution

The main function of a bank accepts money from people who want to save and lend money as loans to the people who need money. Bank lend money for short or long term. Interest is charged on the actual amount sanctioned on the basis of amount, the period of time and depends on the purpose of the loan. If banks can give more loan money supply in the economy is increased. By giving loan bank creates money. For an example, if the bank gives someone $10000 as a loan for 5 years with 7% interest rate and this will be compounded yearly. The borrower should pay back $14025 by the end of 5 years. In this process, the bank creates $4025.

Bank gives interest on the saving account. But this interest is lower than loan interest. If someone keeps $10000 in savings the account. The interest rate is 3% on this savings and this will be counted as a simple interest rate. In 5 year bank will give $1500 in this account.

Net money creates (4025-1500)=$2525 in 5 years.

In this process, the bank creates money by giving a loan.