ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -An individual bank can only lend an amount equal to its pre-loan excess reserves. There’s a possibility that the lending bank has to clear the checks for the entire amount loaned. In such a case, the bank will lose the whole amount it lent. If the bank loans beyond its excess reserves, it might be short of credit.

Detailed explanation-2: -The Fed has created trillions of dollars of excess reserves to the account of member banks. One frequently reads that the banks are not lending out those reserves, which is bad for the economy. But banks cannot lend out reserves. Only the Fed can create or destroy reserves.

Detailed explanation-3: -As described above, a bank holding excess reserves in such an environment will seek to lend out those reserves at any positive interest rate, and this additional lending will decrease the short-term interest rate.

Detailed explanation-4: -Excess reserves are a safety buffer of sorts. Financial firms that carry excess reserves have an extra measure of safety in the event of sudden loan loss or significant cash withdrawals by customers. This buffer increases the safety of the banking system, especially in times of economic uncertainty.

Detailed explanation-5: -Excess Reserves = Total Reserves-Required Reserves For example, suppose a bank has $20 million in deposits. If its reserve ratio is 10%, then it’s required to keep at least $2 million on hand. However, if the bank has $3 million in reserves, then $1 million of it is in excess reserves.