Question

First National bank with Assets(Reserves: 20, Loans: 80), Liabilities(Deposits: 90, Share Capital: 10)

Require reserve ratio by the Fed is 10%

If the bank experiences a deposit outflow of 15mn

a. what is the new level of deposits?

b. what is the new level of reserves?

c. what is the resulting reserve ratio?

d. if ratio is less than 10%, what would bank do for bringing more reserves?

Answer 1

a) An outflow of 15mn would mean a reduction of $15 mn from deposits which means the total deposits left is$90-15=$75mn.

b)The reserves would also reduce be the same amount. So new reserves =$20-15=$5 mn

c)The resulting reserve ratio is 5/75 =6.67%.

But the required reserve should have been $7.5 ie 10%

d) The bank can-do various actions to bring in more reserves.

1) It could transform one type of asset to another ie transform loans to reserves.

2) Borrow the deficit (short of required reserve) ie$2.5mn from federal funds market which would increase the liabilities by borrowings and increase the asset by Reserve.

3). Sell loans of worth$2.5mn and increase the reserves.

4) Borrow $2.5 mn from federal reserve discount window. So liabilities would have a new head of federal reserve of the same amount and assets would have an increase of reserve by the Same amount.

(You can comment for doubts)