In a fractional reserve banking system, which action by banks creates new money?

• A. Loans made by banks create new deposits.
• B. Banks hold all deposits as reserves.
• C. The central bank prints new money.
• D. Customers withdrawing cash increases deposits.

Answer: (A)

In a fractional reserve system, money is created when banks make loans. When a bank approves a loan, it credits the borrower’s account with the loan amount, creating new deposits in the banking system. This isn’t simply moving existing money around; it’s an accounting entry that adds new money to the economy. The bank must hold enough reserves for its deposits, but the initial loan creates new deposits that can then be spent and redeposited, allowing further lending and a larger money supply through the process known as the money creation multiplier. Other actions—holding all deposits as reserves, the central bank printing money, or withdrawals—do not generate new deposits in the same way.