To illustrate how a bank’s balance sheet operates, let’s begin with a fictional scenario: Ms. Sharon deposits ₹1,000 into a newly established bank. This initial deposit creates liabilities (the bank owes this amount to the depositor) and assets (reserves held by the bank). Here’s a simplified representation of the bank’s balance sheet:

In this scenario, the total assets (reserves) equal the liabilities (deposits), making it a balanced sheet with no net worth initially. Assuming no currency is in circulation, the total money supply in the economy is the sum of currency and deposits:

M1=Currency+Deposits=0+1,000= 1,000

In this example, the entire money supply is made up of the deposit amount, as there’s no physical currency in circulation. This basic setup explains how a bank’s balance sheet functions and its impact on the money supply in the economy.

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