Question

QUESTION 2 [5 MARKS]

Explain briefly what the reserve requirement refers to and how it can be used to stimulate economic activity in a country

Answer 1

In fractional banking system, reserve requirement in the market refers to the amount that the banks in the market have to keep aside for meeting emergency funds demand, for example, if the bank received a deposit of $1000 and reserve requirement is 10% then banks will have to keep aside $100 as reserve and they can lend the other $900.

If the reserve requirement is high then the banks in the market will have to keep more money as reserve and this will reduce their lending capability, if the reserve requirement is low then they can lend more and stimulate the economy more.