Question

Suppose in the banking system as a whole, demand deposits are equal to $80,000,000 and reserves are equal to $17,000,000 with a legal reserve ratio of 10%. If the Fed doubles the required ratio, by how much will the money-creating potential (also known as the maximum lending potential) of the banking system as a whole drop?

Answer 1

Because the required reserve ratio is 10%, the banking system as a whole must be having required reserves equivalent to 10% of 80 million which is 8 million. Reserves are 17 million out of which 8 millions are required and therefore 9 millions are excess reserves. So the lending capacity is 9 million.

When the required reserve ratio becomes 20%, required reserves will be 20% of 80 million which is 16 million. Now the banking system will have only 1 million as excess reserves. This indicates that the lending capacity has reduced from 9 million to 1 million.

Manik creating potential of the banking system as a whole will drop by 8 million dollar.