Question

1. Imagine that you deposit $25,000 in currency into your checking account at the bank. Assume that this bank has a required reserve ratio of 25%. As a result of this deposit, what is the maximum amount increase in deposits in all the banks in the banking system?

   	a.	$18,750
   	b.	$25,000
   	c.	$31,250
   	d.	$100,000

4

Answer 1

Answer- Option d. $100,000

Explanation and working- When you deposit $25,000 in currency into your checking account, the bank's deposit will increase by $25,000. As mandatory, banks are required to keep certain percentage of deposits as reserves known as required reserves. As the required reserve ratio is 25%, the banks are required to keep 25% of your deposits as reserves with them.

So, Required reserves= required reserve ratio x deposits

= 25% of $25,000

= 25/100 x $25,000

= 0.25 x $25,000

Required reserve= $6,250

Hence banks are required to keep with themselves $6,250 as required reserves. The excess reserve is the reserve which the bank can lend out.

So, Excess Reserve= Deposit - Required reserves

=$25,000 - $6,250

Excess Reserves = $18,750

This is the amount that this bank will loan out. But this is the amount of money loaned out by this particular one bank.This money loaned out will again get deposited and the process of laoning out and depositing will continue until the last amount deposited is too small to lend out. The maximum amount of increase in deposits in all the banks in the banking system as a result of this deposit can be calculated as-

New deposits= 1/RR x D ( where RR is the required reserve ratio and D is initial change in deposit )

Here in the question, RR(required reserve ratio) = 25% and D is $25,000.

So, New deposits= 1/25% x $25,000

= 1/0.25 x $25,000

= 4 x $25,000

New deposits= $100,000 ( answer)

This is the maximum amount of increase in deposits in all the banks in the banking system. Hence with an initial deposit of $25,000, the banking system as a whole is able to generate a deposit of $100,000.