The balance sheet below is for the First Federal Bank. Assume the required reserve ratio is 20 percent. Refer to the above information. If the original bank balance sheet was for the whole commercial banking system rather than a single bank, loans and deposits could have been expanded by a maximum of:
A) $40,000
B) $100,000
C) $200,000
D) $300,000

Question

The balance sheet below is for the First Federal Bank. Assume the required reserve ratio is 20 percent.  Refer to the above information. If the original bank balance sheet was for the whole commercial banking system rather than a single bank, loans and deposits could have been expanded by a maximum of:
A) $40,000 
B) $100,000 
C) $200,000 
D) $300,000

Quizplus · Accepted Answer

The required reserve ratio is 20 percent, so the bank must hold 20% of deposits ($100,000) in reserve, leaving $400,000 in deposits that can be loaned out. Using the money multiplier formula (1/required reserve ratio), the maximum amount of loans that could be created is $400,000 x (1/0.2) = $2,000,000. Since the bank's loans are currently $1,400,000, there is room to expand loans by up to $600,000. However, since the question is asking about the maximum expansion for the whole commercial banking system, we need to assume that all banks are loaning out the maximum they can. Therefore, the total expansion would be limited by the initial deposit base of $500,000, which means that loans and deposits could have been expanded by a maximum of $200,000.

The Balance Sheet Below Is for the First Federal Bank