Question

A bank currently has $50 million in deposits, $6 million in cash in the vault, $4 million on deposit with Fed, and $5 million in government securities. The reserve ratio is 20 percent. A new deposit is made million. What is the maximum size loan the bank can make once the check clears?

a.$800,000
b.$5.8 million
c.0
d.$1 million

Answer 1

A) $800,000

Step-by-step explanation:

Since the current reserve ratio is 20%, and the bank has no excess reserves, then the maximum it can lend if it receives $1 is $800,000.

The bank has currently $50 million in deposits and $10 million in reserves ($6 million in cash and $4 million in the Fed), so its reserves are exactly 20% of its total deposits. So if any new deposits are received, the bank will have to keep as reserves 20% of it (= $1,000,000 x 20% = $200,000).

This type of banking system is called the fractional banking system because banks are only required to keep a fraction of the money they receive as deposits and they can lend the rest to other clients.