Chapter 12: Problem 422

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?

Short Answer

Expert verified

The bank's actual reserves are $\$60,000$.

Step by step solution

Find the required reserves

First, we need to calculate the required reserves, which is the percentage of deposits that the bank must keep as reserves. We can find this by multiplying the total deposits by the required reserve ratio: Required reserves = Total deposits × Required reserve ratio

Substitute the values into the formula

Now, we can substitute the given values for total deposits and the required reserve ratio into the formula: Required reserves = $\$250,000 \times 20 \%$

Calculate the required reserves

With the given values, we can now calculate the required reserves: Required reserves = $\$250,000 \times 0.20 = \$50,000$

Find the actual reserves

Finally, to find the actual reserves, we need to add the excess reserves to the required reserves: Actual reserves = Required reserves + Excess reserves

Substitute the values and calculate the actual reserves

Now, we can substitute the values of required reserves and excess reserves into the formula: Actual reserves = $\$50,000 + \$10,000 = \$60,000$ Thus, the bank's actual reserves are $\$60,000$.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Required Reserve Ratio

The required reserve ratio is a central banking regulation that specifies the minimum amount of reserves a bank must hold relative to customer deposits. It is expressed as a percentage and acts as a safeguard to ensure banks have sufficient funds available to meet withdrawal demands. This ratio is crucial in maintaining the stability of the banking system.

For example, with a 20% required reserve ratio, a bank must keep $20 of every $100 deposited on hand. This amount cannot be used for lending or investing purposes. If a bank receives $250,000 in deposits, as in our exercise, the required reserves would be 20% of that sum, which is $50,000.

Excess Reserves

Excess reserves are the funds that a bank holds beyond the minimum required reserves mandated by the central bank. These reserves represent additional liquidity that banks can use for lending, investing, or as a buffer against unexpected withdrawals.

In our textbook exercise, the bank has $10,000 in excess reserves. This means the bank has not only met its required reserve level but has an extra $10,000 on top of this which it is free to utilize in potentially profit-making activities. Banks with higher excess reserves are often better positioned to extend credit and grow their business.

Actual Reserves

Actual reserves are the total amount of funds a bank has on hand and includes both the required reserves and any excess reserves. It represents the total buffer available to a bank to fulfil its obligations. To calculate actual reserves, simply combine the required reserves with the excess reserves.

Referring back to our original exercise, the computation of the bank's actual reserves required adding the $50,000 required reserves to the $10,000 in excess reserves, yielding a total of $60,000 in actual reserves. This figure is essential for understanding a bank's capacity to handle deposits and withdrawals, as well as its capability to provide new loans.

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?