The fraction of a deposit that a bank can loan out or invest is called excess reserves. It is through its excess reserves that a bank can grow its total reserves. For example, if a bank has $1 million in deposits and the required reserve ratio is 10%, the excess reserves for the bank is $900,000.The process of deposit expansion does not end with that first bank loaning out its excess reserves because the borrower is likely to deposit the money in another bank for use in transactions. The second bank can use this deposit to expand the money supply again. For example, if an initial deposit made with Bank 1 is $100,000 and the required reserve ratio is 10%, the bank must hold 10% of $100,000 (or $10,000) in required reserves. This means Bank 1 has $90,000 in excess reserves, which it can lend out. If the bank lends out all $90,000 and $90,000 is deposited in Bank 2, which has the same required reserve ratio, then Bank 2 can lend out $81,000 of the deposited sum. If the maximum amount of money is lent out and deposited in Bank 3, this bank can lend out $72,900. In this way, starting from an initial deposit of $100,000, over the course of just three deposits, the money supply could potentially increase by . This process continues on, so the total new money created is the value of the money multiplier times the initial deposit. In this example, the total new money created is 1 divided by 0.1, or 10 (money multiplier) times $100,000 (initial deposit), which equals $1,000,000. This continued expansion of the money supply that occurs when money created by fractional reserve banking is redeposited, which creates more money, which can itself be redeposited, and create further economic growth is called the multiple expansion of deposits.
Expansion of Deposits
|New Deposits||Required Reserves (10%)||Excess Reserves|
|Final impact on money supply||$1,000,000||$100,000||$900,000|