Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

The Credit Expansion Process 203Or to put it another way:[3] x =d (1 – c)1 + k(c – 1)As formula [3] makes clear, the reserve ratio, c, and theaverage percentage of loans which remain unused, k, haveopposite effects on an isolated bank’s capacity to create loansand deposits. That is, the lower c is and the higher k is, thehigher x will be. The economic logic of formula [3] is thereforevery plain: the higher the reserve ratio estimated necessary bythe bank, the fewer the loans it will be able to grant; in contrast,if the reserve ratio or requirement remains unchanged,the fewer the loaned funds the bank believes, on average, willbe withdrawn by borrowers, the more money it will haveavailable for expanding loans.Up until now we have assumed k to be the average percentageof loans unused by borrowers. However, according toC.A. Phillips, k can include other phenomena which have thesame ultimate effect. 21 For instance, k can stand for the verygreat likelihood that, in a market where few banks operate, aborrower will make payments to some other customers of hisown bank. It is assumed that when this happens, these customerswill deposit their checks in their own accounts at thesame bank, thus keeping money from leaving the bank. Thisphenomenon has the same ultimate effect as an increase in theaverage percentage of loans unused by borrowers. The fewerthe banks operating in the market, the higher k will be; thehigher k is, the less money will leave the bank; the less moneyleaves the bank, the greater the bank’s capacity for expandingloans. One of the strongest motivations behind the trendtoward bank mergers and acquisitions which has always beenobvious in fractional-reserve banking systems is precisely thedesire to increase k. 22 In fact, the more banks merge and the21 Phillips, Bank Credit, pp. 57–59.22 Other forces exist to explain the process of bank mergers. They allstem from banks’ attempt to minimize the undesirable consequences