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25 April, 22:20

A commercial bank has $1,000,000 of demand deposits and actual reserves of $300,000. If the required reserve ratio is 10 percent, what is the maximum amount of new loans the bank can extend?

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  1. 26 April, 00:17
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    The maximum amount of new loans the bank can extend=$900,000

    Explanation:

    Demand deposits form part of an account in a commercial bank or a financial institution that the depositor can withdraw at any time without prior notice. A larger demand deposit usually denotes a bigger required reserve.

    The required reserve ratio is the total amount that commercial banks have to hold on to. This amount can not be withdrawn or invested.

    We can determine the maximum amount of new loans the bank can extend as follows;

    Step 1: Determine total amount in the bank

    Using the expression;

    T=D+A

    where;

    T=total amount

    D=demand deposits

    A=actual reserves

    In our case;

    T=unknown

    D=$1,000,000

    A=$300,000

    replacing;

    T=1,000,000+300,000=$1,300,000

    Total amount in the commercial bank=$1,300,000

    Step 2: Determine the required reserve for the demand deposits

    Required reserve=reserve ratio*demand deposits

    where;

    reserve ratio=10%=10/100=0.1

    total amount in the commercial bank=$1,000,000

    replacing;

    required reserve=0.1*1,000,000=$100,000

    required reserve=$100,000

    Step 3: Determine Maximum amount of new loans the bank can extend

    Total reserve=actual reserve+required reserve

    total reserve=300,000+100,000=$400,000

    Maximum amount of new loans=Total amount in the commercial bank-total reserve=1,300,000-400,000=$900,000

    The maximum amount of new loans the bank can extend=$900,000
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