Suppose First Main Street Bank, Second republic bank, and third fidelity bank al

Question

Suppose First Main Street Bank, Second republic bank, and third fidelity bank all have excess reserves. The required ratio is 25%. The Federal Reserve buys a government bond worth $900,000 from Brian, a client of First Main Street Bank. He deposits the money in his checking account at First Main Street Bank.

On the Assets side of First Main Street Bank's balance sheet (before the bank makes any new loans), this (increases/decreases) First Main Street Bank's (building and furniture/net worth/demand deposits/reserves/loans) by (1,800,000/675,000/225,000/900,000). On the Liabilities side First Main Street Bank's balance sheet, (increases/decreases) Fist Main Street Bank's (building and furniture/net worth/demand deposits/reserves/loans) by (1,800,000/675,000/225,000/900,000).

Because the required reserve ratio is 25%, the $900,000 deposit (increases/decreases) First Main Street Bank's excess reserves by (33,700/ZERO/675,000/450,000), and (decreases/increases) First Main Street Bank's required reserves by (225,000/900,000/1,125,000/450,000).

Now, suppose First Main Street Bank loans out all of its new excess reserves to Ana, who immediately uses the finds to write a check to Daesun. Daesun deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Tim, who write a check to Karen, who deposits the money in her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves as well. AND PLEASE FILL OUT THIS T-TABLE.




Assume this process continues, with each successive loan deposited in a checking account and no banks keeping and excess reserves. Under these assumptions, the $900,000 injections into the money supply allows banks to make (360,000/22,500,000/2,700,000/3,600,000) in new loans of (270,000/3,600,000/22,500,000/2,700,000) in checking account deposits.

Explanation / Answer

(1) When you deposti $100 in a bank account, to the bank that is a liability - the bank owes you. When you borrow $100 from a bank, to the bank it is an asset - you owe them.
(2)Fractional-reserve banking is a form of banking where banks maintain reserves (of cash and coin or deposits at the central bank) that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction (called the reserve ratio) of the quantity of deposits as reserves. Some of the funds lent out is subsequently deposited with another bank, increasing deposits at that second bank and allowing further lending. As most bank deposits are treated as money in their own right, fractional reserve banking increases the money supply, and banks are said to create money. Due to the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank. That multiple (called the money multiplier) is determined by the reserve requirement or other financial ratio requirements imposed by financial regulators, and by the excess reserves kept by commercial banks.[1][2]
Central banks generally mandate reserve requirements that require banks to keep a minimum fraction of their demand deposits as cash reserves. This both limits the amount of money creation that occurs in the commercial banking system,[2] and ensures that banks have enough ready cash to meet normal demand for withdrawals. Problems can arise, however, when depositors seek withdrawal of a large proportion of deposits at the same time; this can cause a bank run or, when problems are extreme and widespread, a systemic crisis. To mitigate this risk, the governments of most countries (usually acting through the central bank) regulate and oversee commercial banks, provide deposit insurance and act as lender of last resort to commercial banks.
Fractional-reserve banking is the most common form of banking and is practiced in almost all countries. Although Islamic banking prohibits the making of profit from interest on debt, a form of fractional-reserve banking is still evident in most Islamic countries.

Bank Increase in Demand Deposits Increase in Required Reserves


Firt Main Street Bank 225000 900000
Second Republic Bank 180000 450000
Third Fidelity Bank 1125000 450000

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