MHM Bank currently has $750 million in transaction deposits on its balance sheet

Question

MHM Bank currently has $750 million in transaction deposits on its balance sheet. The current reserve requirement is 8 percent, but the Federal Reserve is increasing this requirement to 10 percent. a. Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to MHM Bank as transaction deposits. b. Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts 80 percent of its excess reserves to loans and borrowers return 85 percent of these funds to MHM Bank as transaction deposits.

Explanation / Answer

PART A:  Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to MHM Bank as transaction deposits

Initial Balance Sheets: (IN MILLIONS)
FED
Assets- Securities: $60
Liabilities- Reserve Accounts: $60
MHM Bank
Assets- Loans: $690
Reserve Deposits at Fed: $60
Liabilities- Transaction deposits: $750

After All Changes: (IN MILLIONS)
New initial required reserves = 0.10 × $750 million = $75 million
Change in bank deposits = (1/(0.10 + (1 0.50))) × ($60 million - $75million) = $25.000 million
Loans:
$725.000 million $72.500 million = $652.500 million
Transaction deposits:
$750 million + ($15 million × (1/(0.10 + 0.50))) = $725.000 million
Reserve deposits at Fed:
$725.000 million × 0.10 = $72.500 million

BALANCE SHEET AFTER ALL CHANGES (in Millions)

FED

Assets- Securities: $72.500

Liabilities- Reserve Accounts: $72.500
MHM Bank
Assets- Loans: $652.500
Reserve Deposits at Fed: $72.500
Liabilities- Transaction deposits: $725.000

PART - B Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts 80 percent of its excess reserves to loans and borrowers return 85 percent of these funds to MHM Bank as transaction deposits.

After All Changes: (IN MILLIONS)
New initial required reserves = 0.10 × $750 million = $75 million
Change in bank deposits = (1/(0.10 + (1 0.85))) × ($60 million - $75million)*0.8 = $48.000 million
Loans:
$702.000 million $70.200 million = $631.800 million
Transaction deposits:
$750 million + ($15 million ×0.8 (1/(0.10 + 0.15))) = $702.000 million
Reserve deposits at Fed:
$702.000 million × 0.10 = $70.200 million

BALANCE SHEET AFTER ALL CHANGES (in Millions)

FED

Assets- Securities: $70.200

Liabilities- Reserve Accounts: $70.200

MHM Bank
Assets- Loans: $631.800
Reserve Deposits at Fed: $70.200
Liabilities- Transaction deposits: $702.000

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