Question

26.2) Why are excess reserves and the process of multiple expansion of deposits important to commercial banking? Explain. (6.5 points)

Answer 1

Banks with excess reserves are considered to be safe than the banks with lesser reserves. As bank with excess reserves is fully capable in dealing with any future uncertainty like economy slowdown or defaults by some big borrowers or sudden surge in demand to withdraw funds. Excess reserves bank would be able to handle all these situations well so they are more safe.

Process of multiple expansion of deposits is also considered as money multiplier. It means bank is circulating deposits from the customers to provide loans to other customers who are in need of it. If bank has higher deposits but kept with bank it would be difficult for them to earn on these deposits and every deposit carry interest liabilities for a bank so bank has to circulates these deposits to give loans. This will increase money circulations in economy and also good for bank as they can earn interest on these loans.

As explained both excess reserves and higher expansion of deposits are good for banks