2 First Bank has cash reserves of 200000 loans of 800000 and

2. First Bank has cash reserves of 200,000 loans of 800,000 and deposits of 1,000,000.

If the bank maintains a reserve requirement of 12 percent, what is the largest loan it can make?

What is the maximum amount by which the money supple can be increased as a result of First Bank’s new loan?

Solution

Required reserves = Deposits x Required reserve ratio = 1,000,000 x 12% = 120,000

Largest possible loan = Excess reserves = Total reserves - Required reserves = 200,000 - 120,000 = 80,000

Increase in money supply = Increase in loan / Required reserve ratio = 80,000 / 0.12 = 666,666.67