Money multiplier
This is one of the key principles underpinning the entire banking system. That's because it's the basis of 'credit creation'.
This is one of the key principles underpinning the entire banking system. That's because it's the basis of 'credit creation'.
Imagine I walk into a bank with £100 and deposit it. The bank sets aside 10%, or £10, in case I need that back. It reckons I won't ever ask for more than that, so it then lends out the rest £90. Let's then say the borrower spends the £90, and the person he gave it to puts it back in the bank. The bank then keeps 10% back, or £9, and lends the remaining £81.
This process can continue. The bank is using a single deposit of £100 to create a lot more credit. It works, provided all of its depositors do not simultaneously march into the bank and demand all of their money back an unlikely event in practice. The lower the retention rate here, 10% the more credit the £100 generates.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
See Tim Bennett's video tutorial: How banks create credit
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
-
Rachel Reeves faces £23 billion capital gains tax “black hole” – will she be forced to look elsewhere?
The fiscal watchdog has downgraded its forecast for capital gains tax revenues, leaving chancellor Rachel Reeves with £23 billion less than previously expected
By Katie Williams Published
-
Protests erupt in Turkey after the arrest of Erdogan's rival
Turkey's president has jailed his main political opponent, Ekrem Imamoglu
By Emily Hohler Published