National Bank currently has $500 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 8 percent. a. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to National Bank as transaction deposits. b. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts 75 percent of its excess reserves to loans and borrowers return 60 percent of these funds to National Bank as transaction deposits.

See all the required balance sheets below.

Explanation:

a. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to National Bank as transaction deposits

a(1) The Initial Balance Sheet will look as follows:

Federal Reserve Bank

Balance Sheet

Particulars Amount                  ($' million)  

Assets

Treasury Securities (w.1)                 50

Liabilities

Reserves (w.1)                                  50

National Bank

Balance Sheet

Particulars                                    Amount ($' million)  

Assets

Reserve deposits at Fed (w.1)                  50

Loan                                                         450  

Total assets                                           500  

Liabilities

Deposit                                                   500  

Total liabilities                                        500

a(2) The Balance Sheet after all the changes will look as follows:

Federal Reserve Bank

Balance Sheet

Particulars Amount                  ($' million)  

Assets

Treasury Securities (w.5)                 41.38

Liabilities

Reserve (w.5)                                   41.38

National Bank

Balance Sheet

Particulars                           Amount ($' million)  

Assets

Reserve deposits at Fed (w.5)        41.38

Loan (w.6)                                      475.86  

Total assets                                   517.24  

Liabilities

Deposit                                           517.24  

Total liabilities                                517.24  

b. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts 75 percent of its excess reserves to loans and borrowers return 60 percent of these funds to National Bank as transaction deposits.

b(1) The Initial Balance Sheet will look as follows:

Federal Reserve Bank

Balance Sheet

Particulars Amount                  ($' million)  

Assets

Treasury Securities (w.1)                 50

Liabilities

Reserves (w.1)                                  50

National Bank

Balance Sheet

Particulars                           Amount ($' million)  

Assets

Reserve deposits at Fed (w.1)         50

Loan                                                450  

Total assets                                   500  

Liabilities

Deposit                                           500  

Total liabilities                                500

b(2) The Balance Sheet after all the changes will look as follows:

Federal Reserve Bank

Balance Sheet

Particulars Amount                  ($' million)  

Assets

Treasury Securities (w.5)                 41.38

Liabilities

Reserve (w.5)                                   41.38

National Bank

Balance Sheet

Particulars                                        Amount ($' million)  

Assets

Reserve deposits at Fed (w.10)                  41.25

Loan (w.11)                                                 474.38  

Total assets                                               515.63  

Liabilities

Deposit                                                      515.63  

Total liabilities                                           515.63  

Workings:

For part a

w.1: Treasury Securities = Reserves = Current transaction deposits * Current reserve requirement percentage = $500 million * 10% = $50 million

w.2: New initial required reserves = Current transaction deposits * New reserve requirement percentage = $500 million * 8% = $500 million * 8% = $40 million

w.3: Change in bank deposits = (1/(New reserve requirement percentage + (1 – Percentage returned by borrowers))) * (Old initial required reserves - New initial required reserves) * Percentage of excess reserves converted to loans by National Bank = (1/(8% + (1 - 50%))) * (50 million - $40 million) * 100 =  17.24 million

w.4: New transaction deposits = Current transaction deposits + Change in bank deposits = $500 million + $17.24 million = $517.24 million

w.5: Treasury Securities = Reserve deposits at Fed = New transaction deposits * New reserve requirement percentage = $517.24 million * 8% = $41.38 million

w.6: Loans = New transaction deposits - Reserve deposits at Fed = $517.24 million - $41.38 million = $475.86 million

For part b.

w.7: New initial required reserves = Current transaction deposits * New reserve requirement percentage = $500 million * 8% = $500 million * 8% = $40 million

w.8: Change in bank deposits = (1/(New reserve requirement percentage + (1 – Percentage returned by borrowers))) * (Old initial required reserves - New initial required reserves) * Percentage of excess reserves converted to loans by National Bank = (1/(8% + (1 - 60%))) * (50 million - $40 million) * 75% = 15.63 million

w.9: New transaction deposits = Current transaction deposits + Change in bank deposits = $500 million + $15.63 million = $515.63 million

w.10: Reserve deposits at Fed = New transaction deposits * New reserve requirement percentage = $515.63 million * 8% = $41.25 million

w.11: Loans = New transaction deposits - Reserve deposits at Fed = $515.63 million - $41.25 million = $474.38 million

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