Week 2 - The Role of Reserves - Commercial Bank's Balance Sheet - Liquidity Management

What happens to a bank's reserves when a checking account is opened?

The bank's reserves increase by the amount of the checkable deposits.

What is the reserve requirement ratio in the example provided?

10%

How are required reserves calculated based on checkable deposits?

Required reserves are calculated as a percentage of checkable deposits (e.g., $100 * 10% = $10).

What are excess reserves?

Excess reserves are the amount of reserves held by a bank beyond the required reserves.

If a bank has $100 in checkable deposits and a reserve requirement of 10%, how much are its required reserves?

$10

What is the relationship between deposits and reserves when a bank loses deposits?

When a bank loses deposits, it loses an equal amount of reserves.

What is the impact of a $10 million deposit outflow on a bank's balance sheet?

The bank loses $10 million in both deposits and reserves.

After a $10 million deposit outflow, what are the new required reserves for a bank with $90 million in deposits?

$9 million

What is liquidity management in the context of banking?

Liquidity management is the acquisition of sufficiently liquid assets to meet the bank's obligations to depositors.

What is a liquidity crunch?

A liquidity crunch occurs when a bank cannot meet its obligations to depositors due to insufficient cash reserves.

How can banks use excess reserves to generate profit?

Banks can lend out excess reserves to earn interest, turning them into profitable loans.

What are the components of a bank's balance sheet in the liquidity management example?

Assets include reserves, loans, and securities; liabilities include deposits and bank capital.

What happens to a bank's assets and liabilities when it chooses to make loans instead of holding excess reserves?

The bank increases its loans and decreases its excess reserves, potentially increasing profits.

What is the significance of vault cash in a bank's reserves?

Vault cash is part of a bank's reserves and contributes to its liquidity.

What is the effect of a bank having ample excess reserves?

The bank can manage deposit outflows without facing liquidity issues.

How does a bank ensure it has enough cash to meet deposit withdrawals?

By engaging in liquidity management and maintaining sufficient reserves.

What is the formula for calculating required reserves?

Required reserves = (Total deposits) * (Reserve requirement ratio).

What does it mean for a bank to have a 'significant liquidity crunch'?

It means the bank cannot meet its obligations to depositors due to a lack of liquid assets.

If a bank's initial reserves are $20 million and required reserves are $10 million, how much are its excess reserves?

$10 million

What happens to a bank's required reserves after a deposit outflow?

Required reserves are recalculated based on the new total of deposits.

What happens to a bank's reserves after a $10 million deposit outflow?

The bank's reserves drop to $0.

What is the required reserve ratio after a deposit outflow of $10 million?

10% of the remaining $90 million in deposits, which equals $9 million.

What are the four basic options a bank has to cover a reserve shortfall?

1. Borrowing from other banks, 2. Borrowing from the Federal Reserve, 3. Selling securities, 4. Reducing loans.

How can a bank eliminate a reserve shortfall by borrowing?

By acquiring reserves from other banks in the overnight market or from corporations.

What is the cost associated with borrowing reserves from other banks?

The interest rate on these loans, such as the overnight interest rate.

How can a bank acquire reserves by borrowing from the Federal Reserve?

By borrowing advances from the Fed while keeping its securities and loan holdings the same.

What is the cost of borrowing from the Federal Reserve?

Interest payments based on the discount rate.

How can a bank cover a deposit outflow by selling securities?

By selling some of its securities to raise the necessary reserves.

What happens to a bank's securities after selling $9 million worth?

The bank's securities decrease from $10 million to $1 million.

What is the most costly way for a bank to acquire reserves?

By reducing its loans.

How does reducing loans affect a bank's reserves?

It allows the bank to acquire reserves, but it may lead to substantial discounts on the loans sold.

Why do banks hold reserves despite loans or securities earning higher returns?

To avoid costs associated with borrowing, selling securities, or calling in loans during deposit outflows.

What can a reserve shortfall indicate about a bank's liquidity management?

It may suggest that the bank is not managing its liquidity effectively.

What are the potential costs a bank faces due to a reserve shortfall?

Interest or penalties for borrowing to cover the shortfall.

What role do excess reserves play for a bank?

They act as insurance against the costs associated with deposit outflows.

What is the significance of the Silicon Valley Bank (SVB) case mentioned?

SVB had to sell substantial amounts of their assets to cover deposit outflows.

What is the traditional textbook framework used for in banking?

It illustrates liquidity management and helps solve exam-style problems.