Question

If a bank has total reserves of $200,000 and $1 million in deposits, how much money can it lend if the required reserve ratio is 4 percent

a) $800,000
b) $960,000
c) $1,040,000
d) $1,200,000

Answer 1

The correct answer is a) $800,000.

Required Reserves: First, calculate the required reserves based on the reserve ratio and total deposits:

Required reserves = Reserve ratio * Total deposits

Required reserves = 0.04 * $1,000,000

Required reserves = $40,000

Excess Reserves: Subtract the required reserves from the total reserves to find the excess reserves available for lending:

Excess reserves = Total reserves - Required reserves

Excess reserves = $200,000 - $40,000

Excess reserves = $160,000

Loanable Funds: The bank can lend out the entire amount of excess reserves:

Loanable funds = Excess reserves

Loanable funds = $160,000

Therefore, the bank can lend out $800,000, which is option (a).

The other options are incorrect because:

Option (b): $960,000 is too high. It exceeds the total excess reserves of $160,000.

Option (c): $1,040,000 is also too high. It assumes the bank can lend out more than its total excess reserves.

Option (d): $1,200,000 is much too high. It assumes the bank can lend out more than its total deposits.

Answer 2

The bank can lend out the difference between its total deposits and the required reserves. With a required reserve ratio of 4%, the bank must keep $40,000 as reserves, and the remaining $960,000 of its $1 million in deposits is available to lend out.

Step-by-step explanation:

To calculate how much money a bank can lend out, we need to determine the minimum amount of reserves it is required to hold. Since the required reserve ratio is 4 percent, the bank must keep 4 percent of the total deposits as reserves. Therefore, the bank's required reserves are 4 percent of $1 million, which is $40,000. The bank already has total reserves of $200,000, so it has excess reserves (total reserves minus required reserves) that can potentially be loaned out.

The excess reserves that the bank has available to lend are calculated by subtracting the required reserves from the total reserves: $200,000 - $40,000 = $160,000. However, considering the bank's total deposits, it's important to understand that the bank cannot lend out the entirety of its deposits; it can only lend out the amount that exceeds its required reserves. Hence, the maximum amount the bank can lend is the difference between the total deposits and the required reserves: $1 million - $40,000 = $960,000.

So, the correct answer to the question of how much the bank can lend is $960,000 (Option b).