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Difficulty: EasyCommercial Banks: Functions, Services, and Credit Creation

A commercial bank receives a fresh cash deposit of N400,000\text{N}400,000. If the central bank mandates a Cash Reserve Ratio of 25%25\%, what is the total volume of deposits created across the banking system?

  1. A
    N100,000\text{N}100,000
  2. B
    N300,000\text{N}300,000
  3. C
    N1,200,000\text{N}1,200,000
  4. N1,600,000\text{N}1,600,000Answer

Answer

The total volume of deposits created across the commercial banking system is N1,600,000\text{N}1,600,000.
The total credit expansion capability of commercial banks depends inversely on the cash reserve ratio set by the regulatory authority. With a 25%25\% reserve requirement, the credit multiplier is 10.25=4\frac{1}{0.25} = 4. Multiplying the initial deposit of N400,000\text{N}400,000 by 44 yields the total created deposit volume of N1,600,000\text{N}1,600,000.

Step-by-Step Solution

1
Determine the credit multiplier
The credit multiplier is 44
The credit multiplier is the reciprocal of the Cash Reserve Ratio (CRRCRR): Multiplier=1CRR=10.25=4\text{Multiplier} = \frac{1}{CRR} = \frac{1}{0.25} = 4.
2
Calculate the total expansion in deposits
N1,600,000\text{N}1,600,000
Multiply the initial cash deposit by the credit multiplier: Total Deposit Expansion=Initial Deposit×Multiplier=N400,000×4=N1,600,000\text{Total Deposit Expansion} = \text{Initial Deposit} \times \text{Multiplier} = \text{N}400,000 \times 4 = \text{N}1,600,000.

Key Concept

Credit Creation and the Deposit Multiplier
Estimated Time:45s
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Topics

Commercial Banks: Functions, Services, and Credit Creation

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