3. Suppose that FirstBank has the following simplified balance sheet. Assume tha

Question

3. Suppose that FirstBank has the following simplified balance sheet. Assume that all other components of the balance sheet are equal to zero. (numbers in millions) Assets reserves 490 3510 4000 Liabilities demand deposits 4000 loans 4000 Assume that the reserve ratio is r = .10 (10%) a. Does FirstBank have excess reserves? If so, of how much? b. Suppose that FirstBank desires to hold no excess reserves, so it loans out its excess reserves to borrowers. How does the balance sheet change? Either use T-accounts or a new balance sheet to show. c. Starting back in a), what is the maximum deposit outflow that FirstBank can sustain without affecting other parts of the balance sheet?

Explanation / Answer

a) Since reserve ratio is 10%(10% of money the bank will have to keep as cash)

Requirement of reserve = 10% of Assets = 10% x 4000 = 400 mn

Bank has 490 mn in cash, hence it has access cash of 90mn

b) After the bank will use these extra 90 mn of cash in loans the Asset side will look like this:

Cash: 400

Loans: 3600

Assets: 4000

(no change in deposits side)

c) If the bank will reduce deposits, cash size will decrease (as loans are long term)

Let say the reduction in deposit is x

Deposits now = 4000 - x = Liabilities

In Assets side only cash can change

new cash = 490 - x

Loans = 3510

Assets = 4000 - x

In order to keep the Reserve ratio at 10%

(490 -x)/(4000-x) = 10%

Solving for x we get, x = 100 mn

hence 100 mn max deposits can be allowed to flow out

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