6. A simplified balance sheet for the local bank is shown below. The required re

Question

6. A simplified balance sheet for the local bank is shown below. The required reserve ratio is 20%. All figures are in thousands. (2 points) Assets Liabilities and net worth Checkable eserves $1200deposits $5000 ecurities 750 Stock shares 1000 3500 550 oans roperty How much is this bank currently required to hold in reserve? How much does the bank currently hold in excess reserves? Suppose the bank lends out the full amount of its excess reserves. Modify the balance sheet to reflect the creation of the loan. a. b. c. By how much has the money supply increased as a result of the loan? d. Suppose the borrower of the new loan writes a check for the amount of the loan to purchase new equipment for her business. The equipment seller then deposits the check in an out-of-town bank. Show the new balance sheet for this local bank once the check has cleared. Once the check has cleared, does the local bank have any excess reserves? e.

Explanation / Answer

Ans. (a) The bank is required to 20% of its deposits in the form of reserves. Since its deposits are $ 5,000,000, its reserves should be minimum $ 1,000,000. But since it is holding $ 1,200,000 as reserves, so it has excess reserves of $ 200,000.00

Ans. (b). In case the bank lends the entire excess reserves of $ 200,000 - on the Assets side, it reduce the reserves to $1,000,000 and increase Loans to $3,700,000. However, since these loan funds shall now be deposited into the bank checkable account, on the Liability side the deposits shall increase to $ 5,200,000. On this higher deposit, the minimum reserve requirement will be $ 1,040,000. Now this excess of $200,000 in deposits shall be balanced by increasing the reserves by $ 200,000 however now the excess reserves will be only $ 160,000. The final balance sheet numbers (only the ones that change) shall be Reserves = $ 1,200,000, Loans = $ 3,700,000 and Deposits = $5,200,000.

Ans. (c) The money supply shall increase by $ 160,000 due to this loan (loan amount less the reserves)

Ans. (d). After the cheque for $200,000 is cleared, the deposits on the Assets side and Reserves on the Liability side shall stand reduced by $ 200,000 each. The loans shall continue to be at $3,700,000.

Ans. (e) No the bank will not have any excess reserves.

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