As The Executive Of A Bank Or Thrift Institution You Are Fac

As The Executive Of A Bank Or Thrift Institution You Are Faced Wit

1. As the executive of a bank or thrift institution, you are faced with an intense seasonal demand for loans. Assuming that your loanable funds are inadequate to take care of the demand, how might your Reserve Bank help you with this problem?

2. Assume that Banc One receives a primary deposit of $1 million. The bank must keep reserves of 20 percent against its deposits. Prepare a simple balance sheet of assets and liabilities for Banc One immediately after the deposit is received.

3. Assume a financial system has a monetary base (MB) of $25 million. The required reserves ratio is 10 percent, and no leakages are in the system.

a. What is the size of the money multiplier (m)?

b. What will be the system’s money supply?

Paper For Above instruction

The role of the Reserve Bank is crucial in managing liquidity and ensuring financial stability, especially during periods of high seasonal demand for loans. When a bank faces an inadequate supply of loanable funds, the Reserve Bank can intervene through several measures. First, the Reserve Bank can provide discount window lending to the bank, offering short-term loans secured against collateral. This infusion of liquidity allows the bank to meet its increased loan demand without resorting to panic selling of assets or excessively tightening credit. Additionally, the Reserve Bank might engage in open market operations, purchasing government securities to inject liquidity into the banking system. These actions increase the overall reserves held by banks, enabling them to extend more loans to their customers, thus alleviating credit shortages during peak seasons. Moreover, the Reserve Bank can adjust the reserve requirements temporarily or signal monetary policy changes that promote lending activity, although these are more long-term strategies. Such interventions are vital for maintaining the stability of the financial system, supporting economic activity, and preventing undue credit crunches during periods of seasonal stress.

Regarding Banc One's initial deposit of $1 million, with a reserve requirement of 20 percent, the bank is required to hold reserves of $200,000 (20% of $1 million) and can lend out the remaining $800,000. Immediately after receiving the deposit, the bank's balance sheet can be summarized as follows:

  • Assets: Cash/Reserves: $200,000; Loans: $800,000
  • Liabilities: Deposits: $1,000,000

This simple balance sheet indicates that the bank's reserves are set at $200,000, with the rest of the deposit funded through loans. The immediate impact increases the bank’s assets and liabilities equally by $1 million, structured according to the reserve requirement.

In the context of the monetary system with a monetary base (MB) of $25 million and a reserve requirement ratio of 10 percent, the size of the money multiplier is calculated as:

Part A: Money Multiplier (m)

The money multiplier is given by the formula:

m = 1 / reserve ratio

Thus,

m = 1 / 0.10 = 10

This means that for every dollar of reserves, the banking system can support up to $10 of money supply through the process of deposit expansion.

Part B: Money Supply (M)

The total money supply is determined by multiplying the monetary base by the money multiplier:

M = MB × m

Replacing the known values, we get:

M = $25 million × 10 = $250 million

Therefore, the total money supply in the system, given the monetary base and reserve ratio, is estimated at $250 million. This expansion reflects the banking system’s capacity to multiply reserves into broader liquidity for economic uses, illustrating the significant influence of reserve requirements on overall money supply growth.

Conclusion

The interventions by the Reserve Bank to facilitate liquidity during seasonal loan demands, combined with the mechanisms of reserve requirements and the money multiplier effect, are fundamental components of monetary policy. They ensure that banks can extend credit efficiently while maintaining financial stability. Understanding these dynamics allows bank executives and policymakers to make informed decisions that balance liquidity needs with overall monetary control, fostering a healthy financial environment that supports economic growth and stability.

References

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  • Mishkin, F. S. (2015). The Economics of Money, Banking, and Financial Markets (10th ed.). Pearson.
  • Federal Reserve Bank of St. Louis. (2022). Reserve Requirements and the Money Multiplier. https://www.stlouisfed.org/
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  • Loan and Reserve Requirements. (2021). Federal Reserve Bank. https://www.federalreserve.gov/
  • Broaddus, J. A. (2020). Monetary policy strategies and banking liquidity. Journal of Banking & Finance, 115, 105775.
  • Brashares, M. (2019). How the Federal Reserve Implements Monetary Policy. Investopedia. https://www.investopedia.com/
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  • Bailey, M. J. (2018). The Role of Reserve Requirements in the Monetary Policy Framework. Journal of Economic Perspectives, 32(2), 159–182.

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