Suppose that a bank does NOT hold excess reserves and the reserve ratio is 20%. If Molly deposits $1,000 of cash in her checking account and the bank lends $600 to Freda, the bank can lend an additional:

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The reserve ratio is 20%, so the bank is required to hold 20% of Molly's deposit in reserves, which is $200. The bank has lent out $600 to Freda, which reduces the amount of reserves held by the bank to $200 - $600 = -$400. This means that the bank is short of required reserves and cannot lend any further. Therefore, the bank can only lend the initial $600 to Freda and cannot lend any additional amount.

Suppose That a Bank Does NOT Hold Excess Reserves and the Reserve