In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system. Most often, it measures an estimate of the maximum amount of commercial bank money that can be created, given a certain amount of central bank money. That is, in a fractional-reserve banking
system, the total amount of loans that commercial banks are allowed to
extend (the commercial bank money that they can legally create) is equal
to an amount which is a multiple of the amount of reserves. This
multiple is the reciprocal of the reserve ratio, and it is an economic multiplier.
Although the money multiplier concept is a traditional portrayal of
fractional reserve banking, it has been criticized as being misleading.
The Bank of England and the Standard & Poor's
rating agency (amongst others) have issued detailed refutations of the
concept together with factual descriptions of banking operations. Several countries (such as Canada, the UK, Australia and Sweden) set no legal reserve requirements.
Even in those countries that do (such as the USA), the reserve
requirement is as a ratio to deposits held, not a ratio to loans that
can be extended. Under the Basel III global regulatory standard, it is the level of bank capital that determines the maximum amount that banks can lend. Basel III
does stipulate a liquidity requirement to cover 30 days net cash
outflow expected under a modeled stressed scenario (note this is not a
ratio to loans that can be extended) however liquidity coverage does not
need to be held as reserves but rather as any high-quality liquid
assets
If banks lend out close to the maximum allowed by their reserves,
then the inequality becomes an approximate equality, and commercial bank
money is central bank money times the multiplier. If banks instead lend
less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.
