A customer deposits \text{N}50,000 in cash into a commercial bank. If this initial deposit… — JAMB UTME

A customer deposits $\text{N}50,000$ in cash into a commercial bank. If this initial deposit results in a total credit expansion of $\text{N}250,000$ throughout the commercial banking system, what is the Cash Reserve Ratio mandated by the central bank?

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

Answer

The Cash Reserve Ratio mandated by the central bank is

20\%

The relationship between total credit expansion, initial cash deposit, and the Cash Reserve Ratio (CRR) is expressed as

\text{Total Expansion} = \frac{\text{Initial Deposit}}{\text{CRR}}

. Rearranging to isolate the CRR gives

\text{CRR} = \frac{\text{N}50,000}{\text{N}250,000} = 0.20

, which translates to

20\%

Step-by-Step Solution

Recall the credit expansion formula relating Total Credit Expansion, Initial Cash Deposit, and Cash Reserve Ratio (CRR).

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

Commercial bank credit creation operates as the inverse of the cash reserve requirement.

Rearrange the credit expansion formula to solve for the Cash Reserve Ratio.

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

To find the reserve fraction, the initial deposit is divided by the maximum secondary deposit expansion.

Substitute

\text{N}50,000

for the Initial Cash Deposit and

\text{N}250,000

for the Total Credit Expansion into the equation.

\text{Cash Reserve Ratio} = \frac{50,000}{250,000} = 0.20 = 20\%

Performing the division yields

0.20

, which converts to

20\%

Key Concept

Credit Multiplier and Cash Reserve Ratio Relationship

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