What is the technique called 'Credit Creation' used by banks to create more loans from deposits..?

Question

How credit creation works ........its width and length in actual world ....or in an economy......

Answer 1

In the old days, a Money lender could only lend what they personally had to hand 'in gold'.

However when Banks got started, they were no longer restricted to lending their own money - they could lend out money from their Depositors and thus make money from all their customers.

Now consider what happens when you buy something on a Credit Card from a Retailer that banks at the same Bank as yourself.

You 'pay' the Retailer - so "money" is added to his account (a Deposit) - and "money" is deducted from your account (a Loan).. but no REAL money changes hands (it's all just figures in the Bank's computer) .. and if anyone asks where the money is, well there ISN'T any ! .. The Retailers Credit (= PLUS money) matches your Debit (= MINUS money) so it balances out (= ZERO money) ..

In theory, there is NO LIMIT to the number of 'balanced' Deposit/Loan transactions the Bank can make !

The problem comes when the Retailer banks at another Bank - or when you fail to pay back the Credit Card loan and the Retailer wants his money out .. and ACTUAL cash has to be paid out ...

If they lent out too much money, and the Depositors came along and asked for their money back, they would have to call in the Loans quick (or go bust) .. and (of course) not every Loan would be paid back - some lenders would go Bankrupt (so profit from other loans would have to cover losses).

Banks are able to calculate how much 'real' cash they are likely to need - and to prevent them going bust the Government mandates a minimum figure (I believe it's in the order of 5% .. so whan a new customer makes a new Deposit, they can 'lend' (grant Credit) up to 20 times the Deposit to their existing / other customers ..)