Depository institutions are financial institutions, such as commercial banks, that accept deposits from the public and lend most of them out, tracking assets and liabilities on balance sheets. Through fractional reserve banking, their lending expands the money supply (AP Macro Topic 4.4).
A depository institution is exactly what it sounds like, a place where people deposit money. Commercial banks are the classic example. The institution takes your deposit (which becomes a liability on its balance sheet, since it owes you that money) and turns most of it into loans (which become assets, since borrowers owe the bank). That balance sheet logic comes straight from the CED (EK POL-2.A.1).
Here's the part AP Macro actually cares about. Depository institutions operate under fractional reserve banking, meaning they keep only a fraction of deposits on hand as reserves and lend out the rest. Reserves split into required reserves (the portion the central bank says you must hold) and excess reserves (anything beyond that, which the bank is free to lend). When banks lend excess reserves, those loans get re-deposited and re-lent across the banking system, and the money supply grows by a multiple of the original deposit. So depository institutions aren't just money warehouses. They're the machine that creates money.
This term anchors Topic 4.4 (Banking and the Expansion of the Money Supply) in Unit 4, the Financial Sector. Learning objective AP Macro 4.4.A asks you to define depository institutions and the vocabulary around them (reserves, the money multiplier, fractional reserve banking). Then 4.4.B and 4.4.C raise the stakes. You have to explain how the banking system creates money and calculate the effects of deposit or reserve changes using balance sheets. If you don't have a solid picture of what a depository institution does, the entire money-creation process, and later monetary policy in Topics 4.5 and 4.6, stops making sense. The Fed's tools only work because they change how much depository institutions can lend.
Keep studying AP® Macroeconomics Unit 4
Bank Balance Sheets (Unit 4)
The balance sheet is how you actually work with depository institutions on the exam. Deposits sit on the liability side, loans and reserves on the asset side, and every Topic 4.4 calculation starts from this T-account picture.
Excess Reserves and the Money Multiplier (Unit 4)
Excess reserves are the fuel for money creation. When a depository institution lends its excess reserves, the maximum total expansion equals the initial excess reserves times the money multiplier (1 divided by the required reserve ratio).
Central Bank and Monetary Policy (Unit 4)
The central bank doesn't deal with the public directly. It sets the rules for depository institutions, like the reserve requirement, and uses tools such as open market operations to change how much those institutions can lend. Monetary policy works through banks, not around them.
Money Supply Definitions (Unit 4)
Demand deposits held at depository institutions count as part of M1. That's why bank lending literally changes the money supply. A new loan becomes a new deposit, and a new deposit is new money.
Multiple-choice questions test this term at two levels. The easy version asks you to identify an example of a depository institution (commercial bank is the answer to look for) or to name the system where banks hold only a fraction of deposits as reserves (fractional reserve banking). The harder version makes you distinguish required reserves from excess reserves, or apply a reserve requirement, like recognizing that a rule forcing banks to hold 10% of deposits is the required reserve ratio. On FRQs, the term itself rarely appears verbatim, but the concept is everywhere. Topic 4.4-style FRQs hand you a deposit amount and a reserve ratio, then ask you to build or adjust a balance sheet, find excess reserves, and calculate the maximum change in the money supply. Knowing what a depository institution does is step one of every one of those calculations.
A depository institution (like a commercial bank) serves the public. It takes your deposits and makes loans to households and firms. A central bank (like the Federal Reserve) is the bank for banks and the government. It doesn't take deposits from regular people; instead it sets the reserve requirement, holds banks' reserves, and conducts monetary policy. Quick test: if you can open a checking account there, it's a depository institution, not a central bank.
Depository institutions, like commercial banks, accept deposits from the public and use those deposits to make loans.
On a bank's balance sheet, customer deposits are liabilities while loans and reserves are assets.
Depository institutions practice fractional reserve banking, holding only part of deposits as reserves and lending the rest.
Reserves split into required reserves (set by the reserve requirement) and excess reserves (available to lend).
Excess reserves are the basis of money supply expansion, and the maximum expansion equals excess reserves times the money multiplier.
The central bank is not a depository institution; it regulates depository institutions and uses them as the channel for monetary policy.
It's a financial institution, most commonly a commercial bank, that accepts deposits from the public and uses them to make loans. In Topic 4.4, depository institutions are the engine of money creation through fractional reserve banking.
No. The Fed is a central bank, which means it serves banks and the government rather than taking deposits from the public. Depository institutions like commercial banks are the ones holding your checking account; the Fed sets the rules they follow.
A depository institution is one bank; the banking system is all of them together. One bank can only lend its own excess reserves, but the whole banking system can expand the money supply by a multiple of those reserves as loans get re-deposited and re-lent.
No, and that's the whole point of fractional reserve banking. If the required reserve ratio is 10%, a bank receiving a $1,000 deposit must hold $100 as required reserves and can lend out the other $900 as excess reserves.
When a depository institution lends excess reserves, the borrower's spending becomes new deposits at other banks, which get lent again. With a 10% reserve ratio, $900 of initial excess reserves can expand the money supply by up to $9,000 ($900 × the multiplier of 10).
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Check this vocabulary in multiple-choice context.
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