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Suppose that the banking industry is competitive and it has zero equity.The effective legal reserve requirement is 25%.Assume that there are three banks, A, B, and C.Bank A initially receives $2,500 in deposits.
-The legal reserve requirement is now changed to 20%.Bank A receives an initial deposit of $2,500.Bank A has excess reserves which will be deposited in Bank B, which in turn, has excess reserves which will be deposited in Bank C.What does Bank C have in excess reserves?
A)$2,000
B)$1,600
C)$1,280
D)$1,000
E)$880

Question

Use the following information for questions 
Suppose that the banking industry is competitive and it has zero equity.The effective legal reserve requirement is 25%.Assume that there are three banks, A, B, and C.Bank A initially receives $2,500 in deposits.
-The legal reserve requirement is now changed to 20%.Bank A receives an initial deposit of $2,500.Bank A has excess reserves which will be deposited in Bank B, which in turn, has excess reserves which will be deposited in Bank C.What does Bank C have in excess reserves?
A)$2,000
B)$1,600
C)$1,280
D)$1,000
E)$880

Quizplus · Accepted Answer

Bank A initially receives $2,500 in deposits, so they must hold $625 (25% of $2,500) as legal reserves. With the legal reserve requirement being changed to 20%, Bank A now only needs to hold $500 (20% of $2,500) as legal reserves. This means Bank A has excess reserves of $125, which it will deposit in Bank B.

Bank B now has an additional $125 in reserves, which means it now has $1,625 in total reserves. With the legal reserve requirement still at 25%, Bank B must hold $406.25 (25% of $1,625) as legal reserves. Therefore, Bank B has $1,218.75 in excess reserves, which it will deposit in Bank C.

Bank C now has an additional $1,218.75 in reserves, which means it now has $3,718.75 in total reserves. With the legal reserve requirement still at 25%, Bank C must hold $929.69 (25% of $3,718.75) as legal reserves. Therefore, Bank C has $2,789.06 in excess reserves.

Therefore, the answer is C) $1,280.

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