IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy
A banking system has a required reserve ratio of 10% and no cash leakage or excess reserves. The central bank buys Rs 500 crore of government securities from banks, adding Rs 500 crore to their reserves. What is the maximum increase in deposits in the system?
The maximum increase in deposits is Rs 5,000 crore. With a 10% reserve ratio the deposit multiplier is 1 divided by 0.10, which equals 10, and multiplying the Rs 500 crore addition to reserves by 10 gives the total possible deposit expansion.
- ARs 50 crore
- BRs 500 crore
- CRs 2,500 crore
- DRs 5,000 croreCorrect
- Rs 4,500 crore
Explanation
The money multiplier is 1/0.10 = 10. Maximum deposit expansion = 500 x 10 = Rs 5,000 crore. Rs 4,500 crore is the expansion excluding the initial reserves, a common slip; here the reserves added are themselves backing the deposits so the full 5,000 applies.
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