Question

Assets- reserves: 75000 loans : 430000

liabilities : deposites : 500000 net worth : 5000

a) Suppose that a bank has the following balance sheet and you deposit $5000 in currency into your cheque account at such bank. Use a T-account to show the initial impact of this transaction on the bank’s balance sheet. What is the impact of this transaction on M1?

(b) If the bank holds a reserve ratio of 0.1, what is the maximum amount the bank can loan out. Suppose that the bank intends to loan out the maximum amount it can. Show the impact of the loan on the balance sheet.

Answer 1

Here, given that assets (Debit side) include: Reserves- 57000 and loans- 430,000

And, Liabilities (credit side) include: Deposits- 500,000 and net worth- 5,000

a) If a person deposit $5000 in currency into his cheque account, it will increase the total deposits as well as the total reserves of the bank with the same amount, and the effect of this transaction in the balance sheet is given below:

Assets	Liabilities
Reserves -    80,000 Loans -    430,000	Deposits-    505,000 Net worth -    5,000

M1 is the primary and a narrow concept of money supply that only include the physical money such as currency in circulation, demand deposit, cheque accounts, traveler’s check and other checking accounts.

Deposit of $5,000 will increase the amount in cheque account and at the same time is decrease the currency in circulation with the same amount. Therefore, there the value of M1 money supply will be unchanged.

b) It is given that the bank holds reserve ratio of 0.1 therefore, bank has to maintain the 10 percent of total deposit as required reserve and the rest of the deposit, that are considered as excess reserves, can be loaned out.

Here, total deposits are $505,000. Therefore, the required reserve would be:

And the excess reserves would be:

Therefore, the bank can loan out $29,500.

Hence, the impact of this loan on balance sheet would be:

Assets	Liabilities
Reserves-   50,500 Loans -    459,500	Deposits-       505,000 Net worth-     5,000

=Total depositxreserve ratio 10 =$505,000 x 100 = $50,500

=Total reserve- required reserve =$80,000-$50,500 = $29,500