Question

Suppose that an Irish Sweepstakes winner deposits $10 million in cash into her transactions account at the Bank of America. Assume a reserve requirement of 25 percent and no excess reserves in the banking system prior to this deposit. Show the changes on the Bank of America balance sheet when the $10 million is initially deposited.

Answer 1

When Irish Sweepstakes will deposit $10 million into his transaction account at the Bank of America, Bank of America will keep 25% of this deposit as required reserves and rest will be kept as excess reserves.

Required reserves are a certain percentage of the deposits of the bank which it is required to keep with itself in the form of reserves. These reserves cannot be used to extend loans and advances. It is calculated as-

Required reserves= deposits x required reserve ratio

Required reserves= $10,000,000 x 25%

Required reserves= $10,000,000 x 25/100

Required reserves= $10,000,000 x 0.25

Required reserves= $2,500,000

Excess reserves are the reserves which are over and over the required reserves. The amount of deposit in excess of required reserves is called excess reserves.

Excess reserves= deposits - required reserves

Excess reserves= $10,000,000 - $2,500,000

Excess reserves= $7,500,000

Balance sheet of Bank of America

Assets	Liabilities
Reserves: Required reserves- $2,500,000 Excess reserves- $7,500,000	Demand deposits. $10,000,000