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

A commercial banking system maintains cash reserves of N1,500,000\text{N}1,500,000, which fully satisfies a mandatory Cash Reserve Ratio (CRR) of 15%15\%. If the Central Bank reduces the CRR to 12%12\%, what is the maximum additional credit expansion, in Naira, that the banking system can generate from the resulting excess reserves?

Answer: 2500000 Naira

Answer

The maximum additional credit expansion that the banking system can generate is 2,500,000 Naira.
When the Central Bank lowers the Cash Reserve Ratio from 15% to 12%, the total deposits supported by N1,500,000 in reserves increases from N10,000,000 (N1,500,000 / 0.15) to N12,500,000 (N1,500,000 / 0.12). The maximum additional credit expansion achievable by the banking system is the difference between the new total deposit capacity and the initial total deposits, which equals N2,500,000.

Step-by-Step Solution

1
Determine the initial total deposits in the commercial banking system.
Initial Total Deposits = N10,000,000
Since N1,500,000 represents 15% of total deposits, total deposits = N1,500,000 / 0.15 = N10,000,000.
2
Calculate the new total credit expansion capacity under the 12% reserve ratio.
New Total Deposit Capacity = N12,500,000
With N1,500,000 reserves and a 12% CRR, the system can support total deposits of N1,500,000 / 0.12 = N12,500,000.
3
Subtract the initial total deposits from the new total deposit capacity to find additional expansion.
Additional Expansion = N2,500,000
N12,500,000 - N10,000,000 = N2,500,000.

Key Concept

Excess Reserves and Credit Creation Multiplier
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Topics

Commercial Banks: Functions, Services, and Credit Creation

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