Question

According to Reuters, the People’s Bank of China has been using targeted increases in banks’ reserve requirement ratios (RRR) in recent months. Explain why central banks impose reserve requirements for commercial banks. Why do commercial banks try to avoid this requirement?

Short answer

The commercial banks try to avoid this requirement because Reserve Requirement Ratios permit the central bank to improve or reduce the money supply in the economy.

Step-by-step solution

Concept introduction

The reserve ratio is the piece of reservable penalties that commercial banks must maintain onto, instead of loan release or support. The rate is determined by the central bank of an economy.

Explanation

Central banks charge Reserve requirement Ratios For commercial banks because:

• Reserve Requirement Ratios permit the central bank to improve or reduce the money supply in the economy.
• With the help of needed reserves, central bank can influence Interest rates in the economy.
• Required Reserves are observed With the central bank to control a bank in case a bank does not maintain adequately cash to pay its customers, at those times Central bank accomplishes help the bank to avoid the problem by providing the liquid funds.
• With the help of required reserve ratios Central bank can operate its financial approach in the economy by controlling the funds available with the banks to supply loans.

Commercial banks attempt to avoid the requirement of reserve ratios because:

• It affects the numeral of funds known with the bank as to when reserve conditions are high, the banks have got fewer funds to provide loans.
• Since commercial banks do make from interests blessed on loans, With the help of Reserve needs central bank can influence the interest rates for loans, so that generates failures to commercial banks as they usually want to charge higher claims.
• A slight shift in such ratios leads to a major change in the supply of cash which is costly for the banking organizations

Final answer

The commercial banks try to avoid this requirement because Reserve Requirement Ratios permit the central bank to improve or reduce the money supply in the economy