The maximum amount that we can subtract from both

the maximum amount that we can subtract from both reserves and demand deposits, so
that the bank still has enough to meet its reserve requirements?
Review:
R = actual reserves
RR = required reserves
r = reserve ratio
D = demand deposits
ER = excess reserves
In general, RR = r x D. If a bank holds no excess reserves, then ER = 0 and RR = R. If
ER < 0, then the bank has deficient reserves.
So once the maximum deposit outflow occurs, then R = r x D.
Let x = deposit outflow. How much can we subtract from both reserves and deposits and
still meet reserve requirements?
R – x = r ( D – x )
This will show the maximum deposit outflow such that reserves still meet reserve
requirements.
Here, R = 180, r = .1, and D = $900. So
180 – x = .1 ( 900 – x ) and 180 – x = 90 – 0.1x so
90 = 0.9x and x = 100.
Construct a balance sheet to prove to yourself that $100 is the maximum deposit outflow
that can be sustained without changing other parts of the balance sheet.
Meeting deficient reserves
Let’s return to poor RiskBank. Since they held no excess reserves, they were not able to
cover the $50 deposit outflow. Since the required reserves are 0.1 x 850 = $85, and
actual reserves are $40, then RiskBank has deficient reserves of $45. It will be forced to
find reserves by rearranging different parts of its balance sheet. There are several
options, but they are neither easy nor cheap.
95

Econ 350 U.S. Financial Systems, Markets and Institutions Class 10
1. Hope for the best. One way to solve the problem of deficient reserves is to
find a deposit inflow sufficient to bring reserves back to where required. As
an exercise, how much of an inflow is required for RiskBank? A deposit
inflow may be accomplished through advertising or other marketing
techniques, but it is unlikely to be able to raise deposits in time to meet the
requirements of regulators.
2. The bank can increase its borrowings from other banks or corporations
through such instruments as federal funds or commercial paper. This option,
obviously, will carry interest costs.
3. The bank can sell securities, but then it loses the income stream provided by
those securities, and it may incur high brokerage costs.
4. The bank can borrow from the Fed in the form of a discount loan. But then
the bank will have to pay the discount rate, and may face increased scrutiny
by the Fed because the Fed often sees the discount window as a lender of last
resort. If a bank has to continually borrow discount loans, that is a sign of
weakness in the eyes of the Fed. Since 2008, banks can also borrow from the
Term Auction Facility and other temporary facilities.
5. It can reduce the quantity of loans through callback, or when a bank retains
the right to demand that a loan be repaid in entirety before maturity.
Commercial loans may have a callback procedure in exchange for a lower
interest rate on the loan. When a loan is called back, the bank then loses the
interest that the loan would have provided. Loans are the biggest source of
revenue for a bank, so callbacks are expensive in terms of lost revenue. Also
callbacks can be costly in terms of lost customer goodwill.