Variable reserve requirement, Managerial Economics

Assignment Help:

Variable Reserve Requirement (Cash and Liquidity Ratios)

The Central Bank controls the creation of credit by commercial banks by dictating cash and liquidity ratios.  The cash ratio is:

Cash Reserves

 Deposits

The Central Bank might require the commercial banks to maintain a certain ratio, say 1/10. Hence:

Cash Reserves   =  1

 Deposits                 10

Deposits = 10  x  Cash Reserves

This means that the banks can create deposits exceeding 8 times the value of its liquid assets.  The liquidity ratio can be rewritten as:

 Cash + Reserves Assets   =   Cash           +          Reserves Assets

Deposits                                      Deposits                  Deposits

                                                =  Cash Ratio + Reserve Assets Ratio

If the liquidity ratio is 12.5, then:

Cash              +          Reserved Assets           =  1

Deposits                            Deposits                      8

Deposits = 10 x cash + 2.5 x Reserve Assets.

In most countries the Central Bank requires that commercial banks maintain a certain level of Liquidity Ratio i.e. Cash reserves (in their own vaults and on deposit with the Central Bank) well in excess of what normal prudence would dictate.  This level shall be varied by the Central Bank depending on whether they want to increase money supply or decrease it.

This is potentially the most effective instrument of monetary control in less developed countries because the method is direct rather than via sales of securities or holding bank loans and advances.  The effects are immediate.  This method moreover does not require the existence of a capital market and a variety of financial assets.  However, increased liquidity requirements may still be offset in part if the banks have access to credit from their parent companies.  A further problem is that a variable reserve asset ratio is likely to be much more useful in restricting the expansion of credit and of the money supply than in expanding it:  if there is a chronic shortage of credit-worthy borrowers, the desirable investment projects, reducing the required liquidity.  Ratio of the banks may simply leave them with surplus liquidity and not cause them to expand credit.  Finally, if the banks have substantial cash reserves the change in the legal ratio required may have to be very large.


Related Discussions:- Variable reserve requirement

Open economy, Open Economy None of the three economies considered so f...

Open Economy None of the three economies considered so far are engaged in trade with Foreign Countries.  Such economies are often referred to as Closed Economies.  In contrast

Least cost factor combination, Producers Equilibrium or Optimal Combination...

Producers Equilibrium or Optimal Combination of Inputs  The analysis of production function has demonstrated that alternative combinations of factors of production that are tech

Disadvantages of perfect competition, Disadvantages of Perfect Competition ...

Disadvantages of Perfect Competition There is a great deal of duplication of production and distribution facilities amongst firms and consequent waste. Economies of sc

Surplus, Suppose market demand and supply are given by Qd = 100 – 2P and QS...

Suppose market demand and supply are given by Qd = 100 – 2P and QS = 5 + 3P. If a price floor of $20 is set, what will be the size of the resulting surplus?

What are the essential conditions for perfect completion, What are the esse...

What are the essential conditions for perfect completion? Two essential conditions for perfect competition are as given below: a. Various producers, none of whom have a hug

[email protected], #queCase Study Labor standards Geeta & Company ha...

#queCase Study Labor standards Geeta & Company has experienced increased production costs. The primary area of concern identified by management is direct labor. The company is co

Short-run and long-run, 1. Explain the industry and describe the general pa...

1. Explain the industry and describe the general pattern of change of the particular market model. 2. Hypothesize the basic short-run and long-run behaviours of the model in the

State about demand theory, What is Demand theory Demand theory demonstr...

What is Demand theory Demand theory demonstrates the relationship between demand for services andgoods. Demand theory is the building block of demand curve- a curve which estab

Income elasticity of demand, Income elasticity of demand The income el...

Income elasticity of demand The income elasticity of demand measures the degree of responsiveness of the quantity demanded of a product to changes in income.  Its co-efficient

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd