Understanding Reserve Ratio and New Loan Calculation

When dealing with the concept of reserve ratio and its impact on lending capacity, it is crucial to understand how banks manage their deposits and maintain reserve requirements.

The Calculation Process

Initial Deposit: Bank ABC receives a new deposit of $100,000.

Reserve Ratio: The bank has a target reserve ratio of 10%, which means they must keep 10% of deposits as reserves.

New Loan Calculation: To determine the largest new loan amount, we calculate 90% of the new deposit, as the bank retains 10% as reserves.

Explanation

For the new deposit of $100,000, Bank ABC would need to hold $10,000 (10% of $100,000) as reserves to meet the reserve ratio requirement. Therefore, the remaining 90% of the deposit, which is $90,000, can be used for new loans.

Essentially, the maximum new loan that Bank ABC can issue with the $100,000 deposit is $90,000. This amount represents the lending potential created through the deposit, showcasing the money multiplier effect in action.

It's important to note that banks do not lend out their reserves when issuing loans. Instead, they create new money in the economy through the lending process, contributing to economic growth and activity.