Note: The following question may not be directly related to trading, but I would appreciate an explanation from the perspective of banking, and the financial system.
Main Question:
Is the total balance in all bank accounts (digital/deposit money/) necessarily equal to the total amount of physical currency and coins in existence or circulation, including currency and coins that have been lost, destroyed, or mutilated by individuals?
Answer by ChatGPT: No.
The total amount of bank deposits can be greater than the total amount of physical cash and coins actually circulating.
For example:
Suppose Customer A deposits â‚ą100 cash in Bank A.
Initially:
Bank A has â‚ą100 cash/reserves.
Customer A has a â‚ą100 bank deposit.
Now Bank A gives Ravi a â‚ą90 loan.
The bank does not necessarily need to receive another â‚ą90 cash deposit from someone else.
Instead, when it grants the loan, it records:
Bank A’s Assets:
â‚ą100 cash/reserves
â‚ą90 loan to Ravi
Total = â‚ą190
Bank A’s Liabilities:
â‚ą100 deposit of Customer A
â‚ą90 deposit of Ravi
Total = â‚ą190
So the balance sheet still matches:
Assets â‚ą190 = Liabilities â‚ą190
The important point is that the additional â‚ą90 bank deposit was created when the bank granted the â‚ą90 loan. It does not necessarily represent â‚ą90 of physical cash sitting somewhere in the banking system.
Therefore, bank deposits/digital money can exceed the amount of physical currency and coins in circulation.
But does this logic actually make sense? In other words, are banks legally and practically allowed to create a new deposit in this way when they grant a loan ?
Also, when we hear/read central bank “prints money”,
part of it is simply updating a number in some ledger against some entity.
Yes that is they way.
However, commercial banks cannot do so willy-nilly,
they need to operate within the thresholds defined by the central bank.
In most modern economies, both central banks and commercial banks create money. Central banks issue money as a liability, typically called reserve deposits, which is available only for use by central bank account holders. These account holders are generally large commercial banks and foreign central banks.
I think the key distinction is between physical cash and digital bank deposits. They’re not necessarily equal.
Most of the money we use today is actually bank deposits, and commercial banks create new deposits when they issue loans. The Bank of England explains this pretty well (Source)
So the amount of digital money can be much larger than the physical cash actually in circulation.
Makes you realise how much of the money we use today is basically just entries on a balance sheet rather than physical cash. All the hustle and chaos, just to end up as another number in a ledger.
If you look at how digital money actually works, most of the money we use today exists digitally, not as physical cash.
So, a large part of your savings, salary and investments exists as numbers in bank and financial accounts rather than physical notes. The system works because we trust banks and don’t all try to withdraw our money as physical cash at the same time.
Yes, its called “credit”. Its called fractional reserve banking. Only 8% of notes are printed which is called as base money, rest 92% money is generated in banks only. This money called “credit” which is generated in banks dont really exist in reality, they are just numbers in computers. The RBI releases bulletin of how much base money is under circulation, how much is in banks as credit i.e M1, M2 supply etc.
They control this credit by various tools. I can say lot of mumo jumbo and sound like a economist but here is the straightforward answer. If there is inflation, it is because people spending too much money so they will raise interest rates skyhigh so EMI is high or people default so that spending comes down and so does inflation. If they want to people to spend and stimulate the economy, they will reduce interest rates. If people stop spending even when interest rates are low which is what is every central banker’s nightmare, they start giving free cash printed directly in the hands of people . In india unlike US where they say things like Helicopter money or stimulus, the govt will give the cash under a social scheme called “XYZ” Yojana and people are that dumb to accept this.
Btw, if banks are allowed to operate to that extent, shouldn’t the banking business be extremely profitable? Or are there some caveats and limitations involved? If so, could u at least give me a hint about what I might be missing?
. In india unlike US where they say things like Helicopter money or stimulus, the govt will give the cash under a social scheme called “XYZ” Yojana and people are that dumb to accept this.