Certified Financial Management Specialist Practice Exam

What process allows banks to generate money through fractional reserve banking?

1. Liquidity Assurance

2. Money Creation

3. Capital Accumulation

4. Asset Valuation

The correct answer is: Money Creation

Fractional reserve banking is a foundational concept in modern banking systems that allows banks to lend out a portion of the deposits they receive while maintaining a fraction as reserves. This process is crucial for money creation in the economy. When a bank receives a deposit, it is required to keep only a fraction of that deposit in reserve, which means the remaining amount can be loaned out to borrowers. By lending out still more than the actual deposits, banks effectively create new money. When the money is loaned and then spent, it can be deposited in other banks, which can then also lend a portion of those deposits, further expanding the money supply. This cycle continues through multiple rounds of lending until the initial deposit gives rise to a significantly larger amount of money in circulation. The process emphasizes the role of banks in not only holding deposits but actively participating in the growth of the money supply through lending practices. In contrast, the other options do not directly relate to the banking process that facilitates money creation. Liquidity assurance might refer to measures that banks take to ensure they can meet withdrawal demands, but it does not specifically involve the generating of money itself. Capital accumulation deals with building wealth over time, while asset valuation pertains to assessing the worth of assets. Neither of