ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -How the Reserve Requirement Affects Interest Rates. Raising the reserve requirement reduces the amount of money that banks have available to lend. Since the supply of money is lower, banks can charge more to lend it. That sends interest rates up.

Detailed explanation-2: -A commercial bank’s free reserve is the amount that the bank can lend out. If commercial banks have more free reserves, greater amounts of credits are available to businesses and individuals. It means a lower cost of financing and may lead to inflation.

Detailed explanation-3: -Key Takeaways However, banks actually rely on a fractional reserve banking system whereby banks can lend more than the number of actual deposits on hand. This leads to a money multiplier effect. If, for example, the amount of reserves held by a bank is 10%, then loans can multiply money by up to 10x.

Detailed explanation-4: -Fractional-reserve banking is a system that allows banks to keep only a portion of customer deposits on hand while lending out the rest. This system allows more money to circulate in the economy.