Use the following balance sheet for the New Bank of Catawba to answer the next question. Assume the required reserve ratio is 0.10 and the bank receives $50,000 in new checking deposits.

Assets

Liabilities

Total Reserves

$50,000

Checking Deposits

$200,000

Loans

$150,000

If the banking system as a whole had been loaned up prior to the new deposit, how much new money can the banking system now create?

Question

Use the following balance sheet for the New Bank of Catawba to answer the next question. Assume the required reserve ratio is 0.10 and the bank receives $50,000 in new checking deposits.

Assets

Liabilities

Total Reserves

$50,000

Checking Deposits

$200,000

Loans

$150,000

If the banking system as a whole had been loaned up prior to the new deposit, how much new money can the banking system now create?

BlackTom AI · Accepted Answer

To tackle this question, I’ll walk through the effects of a $50,000 new checking deposit in a system that is already loaned up, using the reserve ratio of 0.10.
Option A: $5,000. This would be the amount of required reserves created by the new deposit (0.10 × $50,000 = $5,000). However, the question asks for how much new money the system can create, not how much of the deposit must be held as reserves. So this underestimates the potential expansion.
Option B: $450,000. This is the correct magnification if we consider the excess reserves and the money multiplier. After the $50,000 deposit enters the system, total reserves rise to $50,000. The required reserves for the new deposits are 0.10 × $50,000 = $5,000, leaving $45,000 of excess reserves awake for lending. With a reserve ratio of 10%, the potential money creation across the system is the excess reserves times the money multiplier (1/0.10 = 10), i.e., $45,000 × 10 = $450,000. This reflects the full recursive lending and depositing process once the system is not reserve-constrained. 
Option C: $45,000. This represents just the excess reserves created by the new deposit, not the total potential increase in deposits that can arise from the lending process. The money multiplier amplifies that amount substantially, so naming only $45,000 misses the subsequent rounds of deposit expansion.
Option D: $50,000. This would equal the initial increment to reserves/deposits, but it ignores the ability of banks to lend out their excess reserves and thus generate further deposits. It underestimates the cascading effect of loan creation and deposit creation in the system.
In summary, once the system is loaned up and a new $50,000 deposit arrives, $5,000 must be reserved immediately, leaving $45,000 as excess reserves. With a 10% reserve requirement, the total potential new money across the banking system is $45,000 × 10 = $450,000, reflecting the multiplier effect of lending and re-depositing.

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