Question

8a.  Until fairly recently, the FED did not pay interest on bank reserves but a few years ago the FED changed its policy and currently pays interest on bank reserves.  Under its original policy, for every $100 in checkable deposits how much did banks sacrifice in lost interest income due to reserve requirements if a bank charged 11% on their loans to the public when the required reserve ratio was set at 8%?  

8b.  For every $100 in checkable deposits, how much would a bank lose in interest income (opportunity cost) due to reserve requirements if banks charged 16% on their loans to the public when the required reserve ratio was 15%?  Finally, if you were an investor holding shares of common stock in a commercial bank, how are bank profits (and therefore your returns) affected by changes in the required reserve ratio?  Similarly, how are bank profits affected by changes in the market interest rates which your bank charges on loans to the public?  

Answer 1

8a) Given: reserve requirement = 8%, Interest on loan charged = 11%

This implies, for every $100 in checkable deposits, Bank needs to keep $8 with the FED and this amount can not be lent. On this $8, Bank loses 11% interest income which is equal to $[(11/100)*8)] or $0.88 or 88 cents. For every $100 in checkable deposits, Bank will lose 88 cents interest income.

8b) Now, reserve requirement = 15%, Interest on loan charged = 16%

This implies, for every $100 in checkable deposits, Bank needs to keep $15 with the FED and this amount can not be lent. On this $15, Bank loses 16% interest income which is equal to $[(16/100)*15)] or $2.4. For every $100 in checkable deposits, Bank will lose $2.4 interest income.

For a given market interest rates, as the reserve requirements increase, lesser amount of checkable deposits is available with Banks to loan to public and therefore, higher is the loss in interest income reducing the bank profits (also, reducing the returns for investors holding common stock in a commercial bank).

for a given reserve requirements, as the market interest rates increase, banks get higher return per dollar for the loan given to the public. This increases bank profits and the the returns for investors holding common stock in a commercial bank.