Current reserves equal $100,000, whereas loans equal $400,000.
Total Deposits = (100,000 + 400,000) = $500,000
Because the Reserves Requirement is 5%, this means that the bank will keep 5% of total deposits. Hence, (5/100x 500,000) Equals $ 25,000.
Considering that reserves equal $100,000 and 5% of total deposits equal $25,000,
Surplus Reserves = $100,000 minus 25,000 = $75,000
For a bank that suffers from bad loans like First National Bank, protecting the interest of shareholders and customers while abiding by the Federal laws at the same time without interfering with the legal requirement is a challenge (Carlson & Wheelock, 2016). In order to address the issue of bad loans and worsening economic situations, the alternatives adopted in First National Bank can be able to use the following alternatives;
Adopting Zero Excess Reserve Approach
Since the economic performance is low, the Federal Bank can improve its performance by stimulating growth through increased money supply (Carlson & Wheelock, 2016). By choosing zero excess reserves, the bank will lend out $ 75, 000 to customers in the form of loans. Due to the multiplier effect, $75,000 will increase the money supply in the economy by (75000x1/0.05) = $ 150,000. Customers will access loans due to increased money supply while banks will not suffer from bad loans due to stimulated economy and improved economic performance.
Purchase Government Bonds from Fed
Since the bank is worried about the bad loans, purchasing government bonds from Fed will reduce the amount of excess reserves available in the bank (Carlson & Wheelock, 2016). For instance, purchasing government bonds worth $ 50,000 will reduce the excess reserves from $ 75000 to $ 70000. The amount of money available for lending to customers will be reduced thus reducing the risk of bad loans.
Conclusion
In order to address the issue of bad loans, Bob can only adopt zero excess reserves or purchase government bonds from Fed. Zero excess reserves will increase the amount of money supply in the economy hence stimulating growth. Both the bank stakeholders will benefit from this decision alternative. Conversely, purchasing government bonds will reduce the amount of money that can they loan out to customers, hence reducing the risks from bad loans.
Reference
Carlson, M., & Wheelock, D. C. (2016). Interbank Markets and Banking Crises: New Evidence on the Establishment and Impact of the Federal Reserve. The American Economic Review, 106(5), 533-537.
