Finance100aas: The Executive Of A Bank Of Thrift Institution

Finance100aas The Executive Of A Bank Of Thrift Institution You Are

As the executive of a bank of 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. The SIMPLEX financial system is characterized by a required reserves ratio of 11 percent; initial excess reserves are $1 million, and there are no currency or other leakages. a. What would be the maximum amount of checkable deposits after deposit expansion, and what would be the money multiplier? b. How would your answer in (a) change if the reserve requirement had been 9 percent?

Paper For Above instruction

In times of seasonal spikes in loan demand, financial institutions often face liquidity challenges as they strive to meet the increased need for loans without sufficient immediate funds. Central banks play an essential role in providing temporary liquidity assistance to mitigate such issues. This support often comes through various monetary policy tools, notably the adjustment of reserve requirements, open market operations, and discount facilities. These mechanisms help maintain stability within the banking system by ensuring that banks can continue to extend credit even when their reserves are temporarily strained.

Reserve banks can implement multiple strategies to assist thrift institutions during high demand periods. One common approach is the provision of discount window lending, where the bank of thrift can borrow reserves against collateral to meet immediate liquidity needs. This direct access to liquidity alleviates the pressure on reserve requirements and enables the bank to extend more loans to its customers. Furthermore, central banks may temporarily lower reserve requirements, reducing the amount of reserves banks must hold and freeing up additional funds for lending purposes. Open market operations also serve as crucial tools; by purchasing government securities, the reserve bank injects cash into the banking system, thereby increasing reserves available to member banks.

Specifically, in the context of the SIMPLEX financial system with a required reserve ratio of 11%, initial excess reserves of $1 million, and no currency leakages, it is necessary to evaluate how deposit expansion and the money multiplier are affected. The maximum potential expansion of checkable deposits can be calculated using the reserve ratio and excess reserves, revealing the limits of deposit creation under current reserve requirements.

The formula for the maximum deposit expansion with excess reserves is:

Maximum Deposits = Excess Reserves / Reserve Ratio

In this case:

Maximum Deposits = $1,000,000 / 0.11 = approximately $9,090,909.09

The money multiplier, which reflects the total amount of money that the banking system can generate from a single dollar of reserves, is the reciprocal of the reserve requirement:

Money Multiplier = 1 / Reserve Ratio

Therefore:

Money Multiplier = 1 / 0.11 ≈ 9.09

If the reserve requirement is lowered to 9 percent, the maximum deposit expansion and the money multiplier would change accordingly. The calculations are as follows:

New maximum deposits:

= $1,000,000 / 0.09 ≈ $11,111,111.11

New money multiplier:

= 1 / 0.09 ≈ 11.11

As the reserve ratio decreases, both the maximum potential deposit expansion and the money multiplier increase, indicating a greater capacity for banks to create money. This scenario underscores how reserve requirements serve as a critical tool in regulating the money supply and influencing the lending capacity of banking institutions. Lower reserve requirements promote higher deposit expansion, which can stimulate economic activity but may also increase the risk of excessive credit growth.

References

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