Question

Initial deposit --> university bank ---> loan --> bank #2. --loan--> bank #3---loan -->

($100).                                                Deposit--> Deposit--> Deposit-->

a. What volume of loans can the banking system in the figure support? _____________

b. If the reserve requirement were 45 percent rather than 75 percent, what would the system’s lending capacity be?  ____________

Answer 1

Initial deposit is $100.

Reserve requirement = 75%.

Thus, university bank have to keep $75 ($100*75%) as reserve and the balance of $25($100-$75) can be lent to Bank # 2. Similarly Bank 2 will keep 75% of $25 as reserve and balance will be lent to Bank #3.

The same is depicted as below till bank 3. Bank 3 will further lend to bank 4 and this will continue in the banking chain till the stage there is no money available for further lending. The total banking system's capacity can be identified mathematically with the multiplier equalling 1/reserve requirements:

Reserve requirement	(RR)	75%	45%
Additional deposit placed with University Bank	(A)	$100.00	$100.00
Required reserve to be kept by University Bank	(B)=(A)*(RR)	$75.00	$45.00
Excess reserve lent to Bank 2	(C)=(A)-(B)	$25.00	$55.00
Required reserve to be kept by Bank 2	(D)=(C)*(RR)	$18.75	$24.75
Excess reserve lent to Bank 3	(E)=(C)-(D)	$6.25	$30.25
Required reserve to be kept by Bank 3	(F)=(E)*(RR)	$4.69	$13.61
Excess reserve lent by Bank 3	(G)=(E)-(F)	$1.56	$16.64
Multiplier	(H)=1/(RR)	1.33	2.22
System's lending capacity	(C)*(H)	$33.33	$122.22

a. The volume of loans which the banking system in the figure support is $32.81 ($25+$6.25+$1.56). The systems total lending capacity with 75% reserve requirement will be $33.33

b. If the reserve requirement were 45 percent rather than 75 percent, the system’s lending capacity will be $122.22.