Final answer:
Banks can increase their actual reserve ratio by selling securities, borrowing, calling in loans, or raising additional capital, with selling securities generally being the least expensive option. During economic uncertainty, banks tend to hold more excess reserves due to fears of loan defaults and potential bank runs.
Step-by-step explanation:
When a bank has insufficient excess reserves to meet its deposit outflows, it can utilize several options to raise the actual reserve ratio. The options can be ranked based on their cost to the bank during normal times:
- Selling securities
- Borrowing from the Federal Reserve or another bank
- Calling in or selling loans
- Raising additional capital, such as through new equity or debt
The least costly option is typically selling securities, which can be done quickly and at a relatively low transaction cost. Borrowing is more expensive due to interest costs. Calling in loans has a medium cost but can harm customer relationships and the bank's reputation. Raising additional capital is often the most expensive and time-consuming option.
Economic Uncertainty:
During economic uncertainty, banks are more likely to hold onto excess reserves due to the increased risk of loan defaults and the possibility of bank runs. Thus, they might be more hesitant to lend and more cautious about ensuring adequate reserves are on hand to meet their obligations.