Deposit multipliers are a strategy that is applied when it is necessary to identify the amount of money that is created in the money supply of a bank. The resulting figure helps to ensure that the bank is maintaining at least the minimum amount of funds on hand to comply with any government regulations regarding the operation of the institution. Calculating the deposit multiplier also helps the bank to know what surplus or excess funds are on hand to make loans to individuals and businesses.
To arrive at the deposit multiplier, it is important to know the current status of bank reserves as well as the deposits on hand. By determining the ratio between the reserves and the deposits, it is possible to arrive at the current reserve ratio that will apply in the current economic situation. The deposit multiplier is normally considered to be roughly one-fourth of the calculated reserve ratio, although the exact ratio will fluctuate as economic conditions change.
In the United States, regulations regarding the function of financial institutions make it necessary for the banks in the Federal Reserve System to operate with the function of a deposit multiplier. Other banking institutions in the country also function within these same guidelines. The benefit to this arrangement is that the banks maintain enough resources on hand to provide services to their customers and be able to write new loans and mortgages as a means of generating more revenue.
Assuming that the current reserve ratio is 25%, a bank in the United States would be required to take in $4.00 US Dollars for every dollar that is put to use for loans and other financial services offered by the banking institutions. This type of ratio helps to keep a degree of balance between the amount of reserves available for use and the amount of reserves that are utilized to extend mortgages and other loans as part of the process of making more money for the institution.
The deposit multiplier is not a fixed amount. Depending on the amount of reserves and deposits involved, the multiplier may be higher or lower. For this reason, the variables involved are evaluated on a continual basis, allowing banking institutions to make adjustments as needed.
