Which of the following correctly explains the deposit expansion process of the banking system?
A) When a bank loans out its excess reserves, the loan typically ends up being deposited, increasing the total deposits.
B) When banks receive interest on loans, that extra revenue from interest raises deposits.
C) Commercial banks are issuers of currency. When they print additional currency, the extra funds eventually are deposited.
D) If a bank buys additional gold to store in its vault, then it can make additional loans, which end up as deposits.

Question

Quizplus · Accepted Answer

A) The deposit expansion process in the banking system works through the mechanism of banks lending out their excess reserves. When these loans are made, the money is typically deposited in some form in the banking system, either by the borrower or by those who receive payments from the borrower. This process increases the total deposits within the banking system, illustrating the multiplier effect where initial deposits lead to a multiple increase in total deposits through repeated rounds of lending and depositing. Choices B, C, and D do not accurately describe the deposit expansion process. Banks earning interest on loans affects their revenue but does not directly increase deposits in the manner described by the deposit expansion model. Commercial banks do not issue currency; that is the role of the central bank or monetary authority. Buying gold does not directly allow banks to make additional loans in the context of deposit expansion; loans are primarily made based on the bank's reserves and regulatory requirements.

Which of the Following Correctly Explains the Deposit Expansion Process