CHAPTER 13 Banking and the Management of Financial Institutions 319 The key characteristic of banks is their ability to buy assets by issuing their own deposit liabilities Suppose that the First Bank has found some profitable loans that it wants to add to its portfolio It makes a loan in the amount of $100 to a business and credits the business s chequable deposit in that amount The business accepts the First Bank s deposit liabilities because they have the characteristic of being the medium of exchange and are accepted as money by others The T-accounts for the First Bank and the business look like these: First Bank Assets Loans *$100 Business Liabilities Chequable deposits Assets *$100 Chequable deposits Liabilities Bank loans *$100 *$100 Note that the transaction is simply an exchange of assets and liabilities, with no change in the net worth of both the First Bank and the business The bank s act of making a new loan to the business increases chequable deposits, and thus the money supply, by the amount of the loan Note, however, that the bank s objective is not to create deposits and increase the money supply; the bank is in the business of making a profit for its shareholders and the creation of deposits occurs as a byproduct of the bank s financing decisions Acquiring income-producing assets is not the only way in which the First Bank can create new chequable deposits Let s say that Jane Brown has heard that the First Bank provides excellent service, so she opens a chequing account with a $100 bill She now has a $100 chequable deposit at the bank, which shows up as a $100 liability on the bank s balance sheet The bank now puts her $100 bill into its vault so that the bank s assets rise by the $100 increase in vault cash The T-account for the bank looks like this: First Bank Assets Vault cash Liabilities *$100 Chequable deposits *$100 Because vault cash is also part of the bank s reserves, we can rewrite the T-account as follows: Assets Reserves Liabilities *$100 Chequable deposits *$100 Note that Jane Brown s opening of a chequing account leads to an increase in the bank s reserves equal to the increase in chequable deposits If Jane had opened her account with a $100 cheque written on an account at another bank, say, the Second Bank, we would get the same result The initial effect on the T-account of the First Bank is as follows: