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Chapter 12: Problem 419

What are "required reserves"? What are "actual reserves" and "excess reserves"?

Short Answer

Expert verified
Required reserves are the minimum amount of cash a bank must hold by law or regulations, usually set by central banks. Actual reserves are the total cash and cash-equivalent assets a bank has at any given time. Excess reserves are the difference between a bank's actual and required reserves, representing the available funds for lending, investing, or meeting other obligations.

Step by step solution

01

Required Reserves

Required reserves are the minimum amount of cash that a bank is required to hold by law or regulations to ensure that it has enough funds to pay customers in case of withdrawals. Central banks, like the Federal Reserve in the United States, set the required reserve ratio depending on the total amount of deposits at the bank. The required reserve ratio is expressed as a percentage of the total deposits, and it represents the portion of deposits that cannot be loaned out by the bank. For example, if a bank has \(100,000 in total deposits and the required reserve ratio is 10%, the required reserves would be \)10,000, and the bank could loan out the remaining $90,000 to borrowers.
02

Actual Reserves

Actual reserves are the total amount of cash and cash-equivalent assets that a bank holds at any given time. Actual reserves include cash on hand, cash in vaults, and deposits held with the central bank. Actual reserves are important because they represent the total amount of money that banks have available to meet demands for withdrawals, pay off debts, and make new loans. For example, if a bank has \(12,000 in cash on hand, \)5,000 in cash in vaults, and \(8,000 in deposits with the central bank, its actual reserves would be \)25,000.
03

Excess Reserves

Excess reserves are the difference between a bank's actual reserves and its required reserves. Excess reserves represent the amount of money that a bank has available for lending, investing, or meeting other obligations beyond what is legally required. Banks typically hold excess reserves to ensure they have enough liquidity to cover any unexpected withdrawals or other cash outflows. For example, if a bank has \(25,000 in actual reserves and \)10,000 in required reserves, it has $15,000 in excess reserves available for lending, investment, or other purposes.

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Most popular questions from this chapter

Suppose a bank has \(\$ 250,000\) in deposits, and \(\$ 10,000\) in excess reserves. If the required reserve ratio is \(20 \%\), what are the bank's actual reserves?

In the extreme case, \(\$ 1,000\) of new reserves put into a bank will ultimately result in an increase of \(\$ 5,000\) of bank deposits, assuming that the reserve ratio is \(20 \%\). But in reality this is rarely the case. What stops the extreme case from being realized?

What features of commercial banking make banks unique among financial institutions in their ability to expand the money supply?

True or false: Because of "multiple expansion of bank deposits," individual commercial banks are able to lend several dollars for each dollar deposited with them.

Suppose that the public wishes to hold 15 percent of its total money balances as cash, the remainder in the form of bank deposits, and banks hold cash reserves equal to 12 percent of the deposits. What total amount of cash will be required, for use both by the banks and the public, for a total money supply of \(\$ 200\) billion?
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