Question

[Related to Solved Problem 13.1] Suppose that Bank of America pays a 2% annual interest rate on checking account balances while having to meet a reserve requirement of 10%. Assume that the Fed pays Bank of America an interest rate of 0.3% on its holdings of reserves and that Bank of America can earn 6% on its loans and other investments. How do reserve requirements affect the amount that Bank of America can earn on $1,000 in checking account deposits? Ignore any costs Bank of America incurs on the deposits other than the interest it pays to depositors. The 10% reserve requirement reduces the amount Bank of America can earn on $1,000 by $(Enter your answer rounded to two decimal places.)

Answer 1

With reserve requrement of 10%, reserves need to kept of $1000 balance is $100

Thus, interest earned = (interest earned on Reserves - interest paid on deposits)*Reserves + (interest earned on loans - interest paid on deposits)*(Deposits - Reserves)

=> Interest earned = (0.003 - 0.02)*100 + (0.06 - 0.02)*900 = -1.7 + 360 = $34.3

Interest earned if their were no reserves = (0.06-0.02)*1000 = $40

=> Forgone interest = 40 - 34.3 = $5.7

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