Practice Quiz 5: How Banks Create Money

Some students have been having difficulty with this quiz so I will demonstrate how to do the problems.

6.

Use the following balance sheet for the ABC National Bank in answering the next question(s). Assume the required reserve ratio is 20 percent.

Assets
Liabilities and net worth

Reserves$27,000

Demand deposits$110,000

Loans50,000

Capital stock200,000

Securities33,000

Property200,000

R-1 REF14033

Refer to the above data. This commercial bank has excess reserves of:

A.

$0.

B.

$3,000.

C.

$12,000.

D.

$5,000.

E.

$7,000.


Required Reserves = the Required Reserve Ratio (RR) x DEPOSITS

Excess Reserves (ER) = Total Reserves - Required Reserves

Required Reserves = .20 x $ 110,000 = $ 22,000

ER = $ 27,000 - $ 22,000 = $ 5,000 (Answer D)


7.

Use the following balance sheet for the ABC National Bank in answering the next question(s). Assume the required reserve ratio is 20 percent.

Assets
Liabilities and net worth

Reserves$27,000

Demand deposits$110,000

Loans50,000

Capital stock200,000

Securities33,000

Property200,000

R-1 REF14033

Refer to the above data. This bank can safely expand its loans by a maximum of:

A.

$7,000.

B.

$25,000.

C.

$12,000.

D.

$5,000.

E.

$35,000.


Banks use their excess reserves to:

  1. make loans
  2. buy securities
  3. pay back depositors

Since this bank has $ 5,000 in excess reserves, it can safely expand its loans by a maximum of: $ 5,000 (Answer D)


8.

Use the following balance sheet for the ABC National Bank in answering the next question(s). Assume the required reserve ratio is 20 percent

Assets
Liabilities and net worth

Reserves$27,000

Demand deposits$110,000

Loans50,000

Capital stock200,000

Securities33,000

Property200,000

R-1 REF14033

Refer to the above data. Assuming the bank has a check cleared against it for the amount loaned in the previous question, its reserves and demand deposits will now be:

A.

$25,000 and $122,000 respectively.

B.

$22,000 and $110,000 respectively.

C.

$32,000 and $115,000 respectively.

D.

$22,000 and $105,000 respectively.


If this bank then makes a loan for $ 5,000 the balance sheet now looks like:

Assets
Liabilities and net worth

Reserves $27,000

Demand deposits $115,000
($ 5,000 more in demand deposits because the loan is deposited in the borrowers's checking account. NOTE: This $ 5,000 is NEW MONEY)

Loans 55,000
($ 5,000 more in loans)

Capital stock 200,000

Securities 33,000

Property 200,000

When that new $ 5,000 loan is spent and the Demand Deposits go back to $ 110,000. When the check clears this bank has to send $ 5,000 of its Reserves to the bank where the $ 5,000 was deposited, so the reserves are now $ 22,000.

After the loan is made, spent, and the check is cleared, the new balance sheet will look like:

Assets
Liabilities and net worth

Reserves $22,000
($ 5,000 less in reserves, because it was sent to another bank to cover the check)

Demand deposits $110,000
($ 5,000 less in demand deposits because the loan was spent)

Loans 55,000

Capital stock 200,000

Securities 33,000

Property 200,000

Answer B


9.

Use the following balance sheet for the ABC National Bank in answering the next question(s). Assume the required reserve ratio is 20 percent.

Assets
Liabilities and net worth

Reserves$27,000

Demand deposits$110,000

Loans50,000

Capital stock200,000

Securities33,000

Property200,000

R-1 REF14033

Refer to the above data. After the transaction described in the previous question is completed, the bank will now have excess reserves of:

A.

$0.

B.

$3,000.

C.

$12,000.

D.

$5,000.


Assets
Liabilities and net worth

Reserves $22,000

Demand deposits $110,000

Loans 50,000

Capital stock 200,000

Securities 33,000

Property 200,000

Now the Required Reserves are .20 x $ 110,000 = $ 22,000

Total Reserves - Required Reserves = Excess Reserves

$ 22,000 - $ 22,000 = $ 0 (Answer A)


10.

Use the following balance sheet for the ABC National Bank in answering the next question(s). Assume the required reserve ratio is 20 percent.

Assets
Liabilities and net worth

Reserves$27,000

Demand deposits$110,000

Loans50,000

Capital stock200,000

Securities33,000

Property200,000

R-1 REF14033

Refer to the above data. If the original bank sheet was for the commercial banking system, rather than a single bank, loans and deposits could have been expanded by a maximum of:

A.

$8,000.

B.

$15,000.

C.

$48,000.

D.

$25,000.


Change in the Money Supply (Deposits) = Excess Reserves x the Money Multiplier

MS = initial ER x money multiplier

Money Multiplier = 1 / Required Reserve Ratio

multiplier = 1 / RR

multiplier = 1/.20 = 5

MS = initial ER x money multiplier

MS = $ 5,000 x 5 = $ 25,000 (Answer D)