Tuesday, 22 December 2020

A bank's ability to provide loans

 A bank's ability to provide loans is limited by only 2 things:

  • the amount of its deposits and
  • its reserve requirements. 

The reserve requirements are determined by the central bank or monetary authority.

Most banks are required to put a minimum percentage of their funds - 10% of deposits, for example - on reserve and are prohibited from lending these funds back to customers.

If a central bank increases the reserve requirement, it effectively reduces the money supply, since banks then have less to lend to businesses and consumers.

On the other hand, by reducing the reserve requirements - as several central banks around the world did during the Great Recession of 2008 - they allow the country's banks to lend more, stimulating the economy and releasing even more money for lending.

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