A bank balance sheet, drawn in class as a T account, lists what a bank owns on the left and what it owes on the right. AP Macroeconomics Unit 4 uses it to show how a deposit becomes required reserves, excess reserves, and new loans, and how much the money supply can grow as a result. This page walks through the layout, three standard exam scenarios, and the mistakes that cost points. Educational only, not investment advice. All numbers are classroom examples, not data.
The layout of a T account
Draw a large letter T. Write Assets on the left and Liabilities and owner's equity (often just called capital) on the right. The two sides must always balance, because every asset the bank holds was paid for either with money it owes to someone or with the owners' own funds.
| Assets (what the bank owns) | Liabilities and capital (what the bank owes) |
|---|---|
| Reserves: cash in the vault plus balances at the central bank | Demand deposits: customers' checking accounts |
| Loans to households and firms | Borrowing from other banks or the central bank |
| Securities, such as government bonds | Owner's equity (capital) |
The detail students mix up most is that a customer's deposit is a liability for the bank, because the bank owes that money back on demand, while a loan the bank makes is an asset, because the borrower owes the bank.
Required reserves and excess reserves
In the AP model, a required reserve ratio tells the bank what share of its demand deposits it must hold as reserves. The rest of its reserves are excess reserves, which the bank can lend.
- Required reserves equal demand deposits times the required reserve ratio.
- Excess reserves equal total reserves minus required reserves.
- A single bank can lend at most its excess reserves.
- The simple money multiplier is 1 divided by the required reserve ratio, so a 10 percent ratio gives a multiplier of 10.
Try it: build a T account
Enter a new deposit and a required reserve ratio. The tool shows the bank's T account right after the deposit, then after it lends all of its excess reserves, plus the maximum change in the money supply for both a cash deposit and a central bank bond purchase from the public. For the full deposit chain across many banks, use the money multiplier calculator.
Three exam scenarios
Each scenario below uses a 10 percent required reserve ratio and a $1,000 transaction. The question wording decides the answer, so read who sold what to whom.
1. A customer deposits $1,000 of cash
Demand deposits rise by $1,000 and reserves rise by $1,000. Required reserves rise by $100 and excess reserves by $900. The money supply does not change at the moment of the deposit, because the cash was already counted in M1 and has just moved from a pocket into a checking account. Lending can then raise the money supply by at most $900 times 10, which is $9,000.
2. The central bank buys $1,000 of bonds from the bank
On the bank's asset side, securities fall by $1,000 and reserves rise by $1,000. Deposits do not change, so required reserves do not change, and all $1,000 is excess reserves. The maximum increase in the money supply is $1,000 times 10, which is $10,000.
3. The central bank buys $1,000 of bonds from the public
The seller deposits the $1,000 payment. Deposits and reserves both rise by $1,000, and this deposit is brand new money, so the money supply rises by $1,000 right away. Excess reserves rise by $900, which can add up to $9,000 more through lending. The maximum total change is $10,000, the same total as scenario 2 but reached a different way.
A central bank bond sale works in reverse: reserves fall, and the maximum decrease in the money supply follows the same arithmetic.
How this fits today's banking system
The T account arithmetic is a teaching model. On 15 March 2020 the Federal Reserve announced that reserve requirement ratios would fall to zero percent, effective 26 March 2020, so US banks no longer face a required reserve ratio. The Fed now runs an ample reserves system, in which it steers interest rates mainly through the interest it pays on reserve balances. The reserve market and ample reserves explainer draws that graph. In the United Kingdom, a Bank of England Quarterly Bulletin article from 2014 explains that banks mostly create deposits when they make loans, rather than lending out a fixed multiple of reserves.
The College Board course still expects you to calculate required reserves, excess reserves, and the money multiplier, so learn the model, and know that the real world multiplier is looser. The M1 and M2 page explains what counts as money.
Common AP exam mistakes
- Putting deposits on the asset side. Deposits are liabilities of the bank.
- Saying a cash deposit increases the money supply. It only changes the form of money until the bank lends.
- Multiplying the whole deposit, not the excess reserves, when the question asks how much lending can add.
- Forgetting the initial $1,000 when the central bank buys bonds from the public.
- Letting the two sides of the T account stop balancing after a change.
Short definitions sit in the glossary under M1 and quantitative easing. The full unit list is on the AP Macro review hub.
Sources
- Federal Reserve, Reserve Requirements
- Federal Reserve, press release of 15 March 2020 on reserve requirements and other actions
- Bank of England, Money creation in the modern economy, Quarterly Bulletin 2014 Q1
- College Board, AP Macroeconomics course page
Common questions
Is a deposit an asset or a liability for a bank?
A deposit is a liability, because the bank owes the money back to the customer on demand. The reserves the deposit brings in, and any loans the bank makes with them, are assets.
How do you calculate excess reserves?
Multiply demand deposits by the required reserve ratio to get required reserves, then subtract required reserves from total reserves. With $1,000 of new deposits and a 10 percent ratio, required reserves are $100 and excess reserves are $900.
Does a cash deposit change the money supply?
Not at the moment of the deposit, because the cash was already part of M1. The money supply can grow afterwards when the bank lends its excess reserves, by up to excess reserves times the money multiplier.
Why is the answer different when the Fed buys bonds from the public instead of from a bank?
When the public sells the bonds, the payment is deposited as new money, so the money supply rises by the full amount at once and only the excess reserves are multiplied. When a bank sells the bonds, its reserves rise but deposits do not, so the whole amount is excess reserves and is multiplied.