Question

A single commercial bank in a multibank banking system can lend only an amount equal to its initial preloan ___________________. a. Total reserves. b. Excess reserves. c. Total deposits. d. Excess deposits.

Short answer

The correct answer is (b) Excess reserves.

Step-by-step solution

Define Key Terms

Before solving the exercise, it's essential to understand the terms used in the banking context. Total reserves are the full amount of funds that a bank holds, both in its vault and on account with a central bank. Excess reserves refer to the funds that a bank has over the required reserve limit, which it can lend out. Total deposits are the sum of all demand, savings, and time deposits held by the bank.

Identify Relevant Concept

In a multibank banking system, a single commercial bank can only lend an amount related to its reserves. Specifically, only the amount over the required reserves can be loaned out to customers. This amount is called 'excess reserves,' as it is surplus to the mandated required reserves.

Analyze Options

Let's analyze the options one by one: - (a) Total reserves: Includes required reserves and cannot be fully lent out. - (b) Excess reserves: Represents the additional amount available for lending after meeting the required reserve ratio. - (c) Total deposits: Consists of funds deposited, but lending is subject to reserve requirements. - (d) Excess deposits: Not a standard banking term.

Select the Correct Answer

Considering the definition and the problem context, a single commercial bank can lend an amount equal to its excess reserves. Therefore, the correct answer is (b) Excess reserves.

Key concepts

Excess Reserves

In the world of banking, reserves refer to the amount of cash that a bank keeps on hand to meet the demands of depositors. However, not all reserves are the same. Banks must hold a minimum amount of these reserves, known as required reserves, which is a regulated percentage of the bank's total deposits. This ensures that banks can accommodate withdrawal demands from customers without running into liquidity issues.

Excess reserves, on the other hand, are any reserves that surpass this required amount. These reserves represent the additional cash that banks can opt to lend to others or invest, potentially earning them more money. In this way, excess reserves play a critical role in determining a bank’s lending capacity. They form the buffer that banks use to extend more credit and thereby stimulate economic activity. So, when you hear someone in banking discuss lending opportunities, they're often talking about the scope granted by these excess reserves. Without excess reserves, a bank cannot engage in further lending, limiting its potential to generate interest income.

Commercial Bank

A commercial bank is a type of financial institution that accepts deposits, offers checking and savings account services, and provides loans to individuals and businesses. These banks are integral to the economy as they facilitate the flow of money, making it possible for businesses to access the funds they need to grow and individuals to manage their personal finances.

The primary function of commercial banks involves taking in deposits and using those deposits to make loans. By charging interest on these loans, banks can earn money while simultaneously providing necessary financial service to the community. Commercial banks must operate according to regulatory standards, which include holding a set ratio of their deposits as reserves, thus affecting how much money they can lend out. Furthermore, they play a crucial role in maintaining the money supply within an economy and are key players in implementing monetary policy through their lending activities.

• Offer loans to individuals and businesses
• Accept deposits, which can be used for providing loans
• Regulated to ensure liquidity and stability within the financial system
• Important for both personal financial management and broader economic activity

Total Deposits

Total deposits at a bank refer to the sum of all types of deposits that the institution is holding. These can include demand deposits, such as those in checking accounts that customers expect to access quickly, often without notice. They also cover savings deposits designed for long-term savings, where funds can grow over time. Additionally, total deposits encompass time deposits, like certificates of deposit (CDs), which require that funds are left on deposit for a fixed amount of time.

The amount a commercial bank holds as total deposits is critical because it directly influences the bank's lending power. To clarify, in many banking systems, reserve requirements dictate that a set percentage of these deposits must be held back as reserves. Once these required reserves are set aside, what remains can potentially be lent out, thus generating revenue for the bank and providing capital for economic activities. Understanding how total deposits operate helps decode the reserve dynamics because they form both the basis for calculating required reserves and the potential source for obtaining excess reserves.

• Total deposits comprise various types of accounts
• Influences the amount banks hold as required reserves
• Central to understanding a bank's capability to lend and support the economy
• Reflects customer trust and banking activity