A Commercial Bank has $20 Million in Deposit, $15 Million in Loans and $5 Million in Reserves....

Question:

A Commercial Bank has $20 Million in Deposit, $15 Million in Loans and $5 Million in Reserves. The Required Reserve Ratio (rr) is 0.20. Assume banks wish no excess reserves. What is the greatest amount of new money this one commercial bank can create?

Excess Reserve:

In a fractional reserve system, excess reserve is the amount of reserve a bank holds in excess of the legally required amount. If a bank loans out excess reserve, the aggregate supply of money will increase.

Answer and Explanation:

The greatest amount of new money this one bank can create is the amount of new loans that the bank can generate. The maximum amount of new loan the bank can generate is the excess reserve, which is computed as follows:

  • excess reserve = reserve - deposits * required reserve ratio
  • excess reserve = 5 million - 20 million * 0.2
  • excess reserve = 5 million - 4 million
  • excess reserve = 1 million

Therefore, the maximum amount of new money this one bank can generate is 1 million.


Learn more about this topic:

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Excess Reserves: Definition & Formula

from High School Business for Teachers: Help & Review

Chapter 4 / Lesson 6
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