Fractional Reserve Banking Through Multiple-Choice Questions
Test Your Knowledge
Fractional Reserve Banking
Click on the letter choices to test your
understanding
Question 1
•
Fractional reserve banking is a concept
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Banks in almost all countries of the world
practice this form of banking.
Back
Try again!
•
According to a common story about the origin
of banking, fractional reserve banking has
been practiced since the 17
th
century.
Depositors of gold and silver coins would
receive bank notes as a claim on their deposit
from the depositories (banks). As bankers
realized all depositors would not make claims
on their gold or silver at one time, they began
issuing interest bearing loans against a
fraction of the gold and silver deposits.
Back
Correct!
•
According to a common story about the
origins of banking, fractional reserve banking
dates back to the 17
th
century. This practice
enables banks to hold only a fraction of all
deposits as reserves that are available for
withdrawals. Banks use the remaining
fraction of deposits to make new loans;
charging interest on those loans.
Next
Question 2
Banks earn profits by
Correct!
•
Known as the
net interest spread
, banks
charge higher rates of interest for lending than
they pay customers for interest bearing
deposits. Banks earn profits through this
business practice.
Next
Try again!
•
Increasing bank holdings of reserves and
decreasing bank lending will result in higher
nominal interest rates and lower levels of
borrowing by businesses and individuals. This
will lead to lower overall bank revenues.
Back
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The Federal Reserve charges banks interest on
overnight lending, also known as the discount
rate. The Federal Reserve serves as the
lender of last resort to financial institutions
that face financial difficulties.
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Question 3
•
The money supply includes
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•
All currency in circulation is
only one
component of the money supply.
Back
Try again!
•
All currency
in circulation is only one
component of the money supply.
Back
Correct!
•
M-1, one standard measure of the money
supply, includes all currency in circulation plus
the demand deposits, checkable deposits, at
depository institutions (financial institutions
that acquire their deposits from the public, i.e.
commercial banks, credit unions, savings and
loan associations, and savings banks).
Next
Question 4
•
Required reserves are the fraction of deposits
Correct!
•
In order to meet customer demands for cash
withdrawals banks are required to hold a
fraction of all deposits as bank reserves. This
enables banks to meet the liquidity demands
for their customers.
Next
Try again!
•
Banks earn profits by charging a higher
interest rate on money loaned than the
interest rate paid on deposits held.
Back
Try again!
•
The
FDIC, the Federal Deposit Insurance
Corporation,
does not
set the required
reserve ratio which establishes the fraction of
deposits that banks must hold to meet
customer demands for liquidity.
Back
Question 5
•
The required reserve ratio
Correct
•
The Board of Governors of the Federal
Reserve has the sole authority to set the
required reserve ratio thus making changes to
the reserve requirements.
Next
Try again!
Based on limits that have been established by
law, state governments do not have the
authority to set reserve requirements.
Back
Try again!
•
The least commonly used tool of monetary
policy is making changes to the required
reserve ratio. The last time the Fed used this
tool to implement an expansion of the money
supply was in April 1992.
Back
Question 6
•
Excess reserves are
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•
Excess reserves
are not
determined by the
capacity of a bank’s vaults.
Back
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•
While the majority of currency in circulation is
held outside the United States this currency
does not represent the excess reserves banks
hold.
Back
Correct!
•
After banks have met their reserve
requirements the amount of money that is
available for lending is known as excess
reserves.
Next
Question 7
•
Which of the following is correct?
Correct!
•
When the reserve requirement is lowered by
the Fed banks are required to keep a smaller
fraction of their deposits on reserve. This
increases the amount of excess reserves that
will be available for lending. This will result in
an expansion of the money supply.
Next
Try again!
•
The money supply contracts when the reserve
requirement is raised by the Fed.
Back
Try again!
•
When the Fed raises the reserve requirement
the money supply contracts. The increase in
the reserve requirement results in less money
being available as excess reserves that can be
in turn lent out by financial institutions.
Back
Question 8
•
The simple money multiplier is calculated as
Try again!
•
This would lead to a greater increase of the
money supply relative to a corresponding
expansion of the monetary base.
•
Banks may lend out only a fraction of all
monies deposited.
Back
Correct!
•
The simple money multiplier is the reciprocal of
the reserve requirement. The higher the
reserve requirement the lower the simple
money multiplier. The lower the reserve
requirement the higher the simple money
multiplier. When banks have to hold a larger
fraction of deposits as required reserves the
amount by which the money supply can expand
relative to the monetary base is diminished.
Next
Try again!
•
This would result in a greater corresponding
increase in the money supply.
Back
Question 9
•
The “Money Creation” formula is stated as
Try again!
•
The
simple
money multiplier
is calculated as 1
divided by the required reserve ratio.
Back
Try again!
•
Dividing excess reserves by the simple money
multiplier will result in a number 100 times
less than the correct application of the money
creation formula has the potential to
generate.
Back
Correct!
•
When there are no leakages to the money
creation process multiplying excess reserves
by the simple money multiplier will result in
an expansion of the money supply greater
than a corresponding increase in the
monetary base.
Next
Question 10
•
Calculate the maximum money creation
potential of a $1000 deposit when there is a
20% required reserve ratio.
Correct!
The simple money multiplier for a 20%
required reserve ratio is 5.(The reciprocal of
the required reserve ratio.) When that 5 is
multiplied by the $800 of excess reserves
available for lending the result is $4,000 of
money added to the initial $1,000 deposit for
a total potential money creation of $5,000.
Next
Try again!
•
A 10% required reserve ratio would have the
potential to turn a $1,000 deposit into
$10,000 new money through a $9,000
expansion.
Back
Try again!
•
An expansion of a $1,000 deposit by $2,000
for a potential $3,000 of new money would
indicate that the required reserve ratio is 50%
resulting in a simple money multiplier of 2.
Back
Thank You for participating in
“Test Your Knowledge”
Test your knowledge of fractional reserve banking with a series of questions covering topics such as its history, profit mechanisms for banks, the money supply, reserve requirements, excess reserves, and the impact of reserve ratio changes on the money supply. Explore concepts related to commercial banking and the role of the Federal Reserve in influencing the economy.
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Presentation Transcript
Test Your Knowledge Fractional Reserve Banking Click on the letter choices to test your understanding A B C
Question 1 Fractional reserve banking is a concept A A that is predominantly used only in the U.S. that was created by the Federal Reserve during the Great Depression. B B that dates back to the 17thcentury and is still used worldwide. C C
Question 2 Banks earn profits by charging a higher interest rate on money loaned than the interest rate paid on deposits held. A A increasing their holdings of reserves and decreasing their lending. B B C C lending to the Federal Reserve at the discount rate.
Question 3 The money supply includes A A all currency in circulation. B B a fraction of currency in circulation all currency in circulation plus the total deposits in depository institutions. C C
Question 4 Required reserves are the fraction of deposits that commercial banks hold to meet customer demands for liquidity. A A B B that commercial banks lend out to earn profits. that commercial banks hold as required by the FDIC. C C
Question 5 The required reserve ratio is set by the Federal Reserve s Board of Governors. A A B B varies by state. C C is a regularly used tool of monetary policy.
Question 6 Excess reserves are A A reserves that exceed the capacity of a bank s vaults. the total amount of money in circulation outside the United States. B B the amount of money left for lending after the reserve requirement is met. C C
Question 7 Which of the following is correct? A A a decrease in the reserve requirement means there is more money available to lend, so the money supply expands. B B a decrease in the reserve requirement means there is less money available to lend, so the money supply contracts. C C an increase in the reserve requirement means there is more money available to lend so the money supply expands.
Question 8 The simple money multiplier is calculated as A A 10 times the initial deposit amount. B B 1 divided by the required reserve ratio. the required reserve ratio divided by the initial deposit amount. C C
Question 9 The Money Creation formula is stated as A A 1 divided by the required reserve ratio. B B Excess reserves divided by the simple money multiplier C C The simple money multiplier times excess reserves.
Question 10 Calculate the maximum money creation potential of a $1000 deposit when there is a 20% required reserve ratio. $1,000 is expanded by $4,000 to become $5,000 of potential money creation. A A $1,000 is expanded by $9,000 to become $10,000 of potential money creation. B B $1,000 is expanded by $2,000 to become $3,000 of potential money creation. C C
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