Question

Which of the following acts as a constraint on the ability of banks to create loans?

a) The need to hold liquid reserves

b) The fact that consumers frequently withdraw part of newly created bank deposits in the form of currency

c) Both a) and b)

d) Neither a) nor b)

Answer 1

a) The need to hold liquid reserves

Step-by-step explanation:

Liquid reserves or reserve requirement refers to the amount of cash that banks need to keep in their vaults or the nearest federal reserve bank. The liquid reserve is a requirement by the Federal Reserve. It is set as a percentage of the bank's deposits.

The federal reserves use the reserve requirement as a monetary tool to influence the money supply in the economy. Reserve requirement puts a limit on the amount a bank can loan out. An increase in the percentage of reserve requirement implies that a bank will lend out a lesser proposition of its deposits.