A commercial bank receives a new cash deposit of \text{N}250,000. Following multiple round… — JAMB UTME

A commercial bank receives a new cash deposit of $\text{N}250,000$ . Following multiple rounds of lending across the banking system, the total credit created in the economy expands to $\text{N}1,250,000$ . What is the Cash Reserve Ratio enforced by the monetary authority?

$20\%$ Answer
B
$25\%$
C
$80\%$
D
$5\%$

Answer

The Cash Reserve Ratio enforced by the monetary authority is

20\%

The relationship between initial cash deposits, total credit expanded, and the reserve ratio is given by

\text{Total Credit Created} = \frac{\text{Initial Deposit}}{\text{Cash Reserve Ratio}}

. Substituting

\text{N}1,250,000 = \frac{\text{N}250,000}{\text{Cash Reserve Ratio}}

and solving for the ratio gives

\frac{\text{N}250,000}{\text{N}1,250,000} = 0.20

, or

20\%

Step-by-Step Solution

Recall the credit creation formula linking initial deposit, total credit created, and the cash reserve ratio.

\text{Total Credit Created} = \frac{\text{Initial Deposit}}{\text{Cash Reserve Ratio}}

The total volume of credit created by commercial banks depends inversely on the stipulated reserve percentage.

Rearrange the formula to isolate the Cash Reserve Ratio.

\text{Cash Reserve Ratio} = \frac{\text{Initial Deposit}}{\text{Total Credit Created}}

Dividing initial deposit by total credit expanded gives the reserve ratio directly.

Substitute the given numerical values into the equation and calculate.

\text{Cash Reserve Ratio} = \frac{\text{N}250,000}{\text{N}1,250,000} = 0.20 = 20\%

Executing the division yields

0.20

, which converts to

20\%

Key Concept

Credit Multiplier and Reserve Requirements in Commercial Banking

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