You are given this balance sheet for a bank. Assets Liabilities Reserves $ 100 D

Question

You are given this balance sheet for a bank. Assets Liabilities Reserves $ 100 Deposits $ 1,000 Loans $ 900 The required reserve ratio is 10%. How much is its excess reserve? Suppose Ms. A deposits $500 to her account at this bank. Show the effect of this transaction on the bank's balance sheet. How much is its excess reserve after the transaction? How much will Ml increase when the money creation process (involving the whole banking sector) from the loan-making of this bank is completed. What is the fractional reserve system? Why is it prone to bank runs? What kind of protections are offered by the government to prevent bank runs? Suppose Bank A takes out a discount loan of $1 million from the Fed. Show the changes in the balance sheets of both Bank A and the Fed, and calculate the resulting change in Ml according to the simple money multiplier. The required reserve ratio is 20%.

Explanation / Answer

1. a) No excess reserves. b) Increases deposits and reserves by 500. The bank now has 500*.90= 450 excess reserves to make loans. c) 500/.10= 5000 2. Fractional reserve system means banks need only keep a portion of deposits on hand and can lend out the rest. It is prone to bank runs because people know if they don't get there early to take out their deposits, the bank won't have funds on hand to honor them. The government (specifically the FDIC) insures deposits to protect peoples money and prevent bank runs. 3. If a bank takes out a 1 million loan from the Fed it increases its excess reserves by 1 million. Potentially 1/.2= 5 million increase in M1 can result from this transaction.

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