and Study Tools ptions Success Tips Success Tips FOR YOU ly Tools for Principles of eedback 1. "Too Big to Fail" and banks' ability to create money Consider the following dialog between Maria, a student studying a chapter on "Money and the Banking System and Hilary, her teaching assistant. MARIA: Hi Hilary. Before I begin my homework, I'd like to make sure that I understand how banks create money. MARIA: I'm glad you asked this question, Maria. When I began studying money and banking, I was fascinated by the banks' ability to create money. It does look like a trick when banks use excess reserves to lend money, and thus increase their assets. Borrowers then deposit new loans, which increases both bank deposits and excess reserves. This process is called deposit expansion. As a result, the money supply will increase. HILARY: By the same logic, when required reserves fall, banks This process is called granting new loans, which causes As a result, the money supply will decrease. to decrease. MARIA: I also wan