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FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A central bank previously relied on a required reserve ratio of 10% of deposits. A bank has deposits of USD 5 billion and holds USD 600 million of reserves. The central bank then cuts the ratio to 8%, and the bank holds reserves unchanged. By how much do the bank's excess reserves change, and what is the direction of effect on its lending capacity?

Excess reserves rise by USD 100 million and lending capacity increases. Required reserves drop from 500 million to 400 million when the ratio falls from 10% to 8% of 5 billion deposits, so with reserves unchanged at 600 million, excess reserves go from 100 million to 200 million.

  1. AExcess reserves rise by USD 100 million, increasing lending capacityCorrect
  2. BExcess reserves rise by USD 400 million, increasing lending capacity
  3. CExcess reserves fall by USD 100 million, reducing lending capacity
  4. DExcess reserves rise by USD 100 million, reducing lending capacity

Explanation

Required reserves fall from 10% × 5,000 = 500 to 8% × 5,000 = 400 million, a drop of 100 million. With actual reserves unchanged at 600, excess reserves rise from 100 to 200 million, an increase of 100 million, expanding lending capacity. The 400 million option confuses the new required level with the change.

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