Consider the following situation in the Canadian banking system: • The Bank of Canada purchases $5 million worth of government securities
From an investment dealer with a cheque drawn on the Bank of Canada.
• The dealer deposits this cheque at Bank XYZ,a commercial bank.
• The target reserve ratio for all commercial banks is 25%.
• All commercial banks operate with no excess reserves.
• There is no cash drain.
TABLE 26-4
Refer to Table 26-4.Bank XYZ is immediately in a position to expand its loans by

Question

Quizplus · Accepted Answer

When the Bank of Canada purchases $5 million worth of government securities, it increases the reserves of the banking system by $5 million. The dealer who receives the cheque drawn on the Bank of Canada will deposit it at Bank XYZ, increasing its reserves by $5 million.

The target reserve ratio for all commercial banks is 25%. This means that for every dollar of deposits, banks are required to hold 25 cents in reserve. The remaining 75 cents can be lent out.

Since Bank XYZ operates with no excess reserves, it must hold the required 25% reserve against the $5 million increase in deposits. Thus, it must hold $1.25 million in reserves and can loan out the remaining $3.75 million.

Therefore, Bank XYZ is immediately in a position to expand its loans by $3.75 million. The correct answer is B.

Consider the Following Situation in the Canadian Banking System: •