Suppose a customer makes a fresh cash deposit of \text{₦}100,000 into a commercial bank. I… — JAMB UTME

Suppose a customer makes a fresh cash deposit of $\text{₦}100,000$ into a commercial bank. If the central bank mandates a cash reserve ratio of $25\%$ , what is the maximum total deposit expansion that the banking system can generate?

$\text{₦}400,000$ Answer
B
$\text{₦}300,000$
C
$\text{₦}25,000$
D
$\text{₦}125,000$

Answer

The maximum total deposit expansion that the banking system can generate is

\text{₦}400,000

The total deposit expansion generated by commercial banks is calculated using the formula

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

. Given an initial deposit of

\text{₦}100,000

and a cash reserve ratio of

25\%

(

0.25

), the calculation gives

\frac{100,000}{0.25} = \text{₦}400,000

Step-by-Step Solution

Calculate the credit multiplier

K

K = \frac{1}{\text{Cash Reserve Ratio}} = \frac{1}{0.25} = 4

The credit multiplier determines the extent to which commercial banks can expand total deposits from an initial primary deposit.

Compute the total deposit expansion

\text{Total Deposit Expansion} = \text{Initial Deposit} \times K = \text{₦}100,000 \times 4 = \text{₦}400,000

Multiplying the primary deposit by the credit multiplier gives the cumulative expansion across the entire commercial banking system.

Key Concept

Credit Creation Multiplier and Total Deposit Expansion

Estimated Time:45s

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