Question

Assuming a reserve requirement of 20 percent, if a bank initially has no excess reserves and $10,000 cash is deposited in the bank, what is the maximum amount by which this bank may increase its loans?

a) $2,000
b) $8,000
c) $10,000
d) $20,000

Answer 1

The correct answer is option b) $8,000.

Step-by-step explanation:

When a bank with a reserve requirement of 20% receives a deposit, it must hold 20% of that deposit in reserves and can loan out the rest. In the case of a $10,000 cash deposit, the bank must keep $2,000 (20% of $10,000) in reserve and can use the remaining $8,000 for loans. Therefore, the maximum amount by which the bank may increase its loans is $8,000.

The reserve requirement is a tool used by the Federal Reserve to control the money supply by requiring banks to hold a certain percentage of deposits in reserve and not use them for lending. If the reserve requirement is increased, a bank must hold a higher percentage of its deposits, which reduces the amount available to loan out. If the reserve requirement is decreased, the opposite happens, and banks can lend more, potentially expanding the money supply.