The Treasury Department has just announced a new program to encourage lending to small businesses, the State Small Business Credit Initiative. Selected states can access the $1.5 billion fund if they can demonstrate that each dollar provided by the Treasury will generate $10 in loans to small businesses. Exactly what factual information led the Treasury to conclude that this program was needed was not made clear. More likely it is a result of the incessant drum beat in Washington blaming the slow recovery on the reluctance of small banks to lend money to “creditworthy” (by Congressional and Treasury standards) firms.
If they can’t blame it on the banks then the impotence of the policy makers would be exposed.
This $10 to $1 multiple requirement is based on the textbook model of banking. If $100 is deposited in a bank and reserve requirements are 10%, then the bank has $90 it can lend out. The borrower of that money writes a check to someone who deposits it in another bank which is obliged to keep $9 as required reserves and can lend out $81 which will be spent. This check is deposited in another bank which must keep $8.10 in reserves and can lend out $72.90. Carried to its limit, loans will rise by 10 times the initial amount of excess reserves, 10 x $90 = $900 in loans. Notice of course that this is identical to the increase in checking accounts along the way which make up the bulk of the M1 measure of the money supply (which is the basis for concerns among those who see an inflation threat from Quantitative Easing).