You are given this balance sheet for a bank. The required reserve ratio is 10%.

Question

You are given this balance sheet for a bank. The required reserve ratio is 10%. How much is its excess reserve? Suppose Ms A deposits $500 to her account at this bank. Show the effect of this transaction on the bank's balance sheet How much is its excess reserve after the transaction? How much will M1 increase when the money creation process (involving the whole banking sector and the general public) from the loan-making of this bank (using its excess reserve from part (b)) is completed Assume that there are no leakages of cash holding by the general public and excess reserve holding by banks.

Explanation / Answer

Question 1

(a) Deposits = $1,000

Required reserve ratio = 10% or 0.10

Required reserves = Deposits * Required reserve ratio = $1,000 * 0.10 = $100

With deposits of $1,000 and required reserve ratio being 10%, bank has to maintain $100 as required reserves.

The current reserves of bank is $100 which is equal to amount of required reserves needed by bank.

Reserves over and above required reserves are referred to as excess reserves.

Thus, there are no excess reserves with the bank.

(b) Amount of new deposit = $500

Following is the balance sheet after the new deposit -

Total deposits after new deposit is made = $1,500

Required reserve ratio = 10% or 0.10

Required reserves = $1,500 * 0.10 = $150

Excess reserves = Total reserves after new deposit - Required reserves = $600 - $150 = $450

The excess reserves with bank after this transaction is $450.

(c) Required reserve ratio = 10% or 0.10

Money multiplier = 1/Required reserve ratio = 1/0.10 = 10

Increase in M1 = Excess reserves * Money Multiplier = $450 * 10 = $4,500

The M1 will increase by $4,500 when the money creation process from the loan-making of this bank is completed.

Assets Liabilities Reserves $600 Deposits $1,500 Loans $900

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