The reserve requirement is 0 percent on the first $6.0 million in transaction deposits, 3 percent on amounts between $6.0 million and $42.1 million, and 10 percent on amounts above $42.1 million.The First Bank of Boston has the following assets and liabilities (all amounts in millions of dollars):
Assets Reserves$5.0
Loans$345.0
Securities$70.0
Liabilities + Capital Transaction deposits$75.0
Nontransaction deposits$315.0
Equity capital$30.0
?
a.Calculate the bank's excess reserves. Show your work. b.Suppose First Bank makes a loan to a customer equal to the amount of the excess reserves you found in part a. Calculate the bank's excess reserves before the customer spends the proceeds of the loan. Show your work. c.Now suppose the customer spends the proceeds of the loan. Calculate the bank's excess reserves. Show your work.
What will be an ideal response?
| a. | Because transactions deposits exceed $42.1 million, find amounts covered by each reserve requirement: | |
| Required reserves = | ||
| ($42.1 ? $6.0) × 0.03 | = $1.083 million | |
| + ($75.0 ? $42.1) × 0.10 | = $3.290 million | |
| = $4.373 million | ||
| Total reserves | = $5.0 million | |
| Excess reserves | = total reserves ? required reserves | |
| = $5.0 ? $4.373 | ||
| = $0.627 million = $627,000 | ||
| b. | Transaction deposits rise by $627,000; the reserve requirement on additional amounts is 10 percent, so required reserves rise by $627,000 × 0.1 = $62,700. No change in total reserves, so excess reserves reduced by $62,700: $627,000 ? $62,700 = $564,300. | |
| c. | Customer spends proceeds of loan; bank sends reserves of $627,000 to other bank, so total reserves are now $5 million ? $627,000 = $4.373 million. Transaction deposits are now back to $75.0 million, so required reserves are back to $4.373 million. Because total reserves = required reserves, excess reserves = 0. | |
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