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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

Banks in an economy are required to hold a cash reserve ratio (CRR) of 10% of deposits with the central bank. A bank receives a fresh deposit of Rs 1,000 crore and the central bank then raises the CRR to 12%. Assuming the bank previously held exactly the required reserve on this deposit and holds no excess reserves, by how much does the amount available for lending from this deposit change?

Lendable funds fall by Rs 20 crore. At a 10% CRR the bank lends Rs 900 crore from the Rs 1,000 crore deposit, while at 12% it must hold Rs 120 crore and lends only Rs 880 crore, so the CRR increase reduces lending capacity by 2% of the deposit.

  1. AIt falls by Rs 20 crore, from Rs 900 crore to Rs 880 croreCorrect
  2. BIt falls by Rs 120 crore, from Rs 1,000 crore to Rs 880 crore
  3. CIt rises by Rs 20 crore, from Rs 900 crore to Rs 920 crore
  4. DIt falls by Rs 200 crore, from Rs 900 crore to Rs 700 crore
  5. It is unchanged because CRR applies only to new deposits after the change

Explanation

At 10% CRR the bank can lend 1,000 - 100 = Rs 900 crore. At 12% it must hold Rs 120 crore, leaving Rs 880 crore. The change is a fall of Rs 20 crore. Option 2 compares with the full deposit instead of the earlier lendable amount, and option 4 treats the increase as 20% rather than 2 percentage points.

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