A commercial bank has $1,000,000 of demand deposits and actual reserves of $300,000. If the required reserve ratio is 10 percent, what is the maximum amount of new loans the bank can extend?

The maximum amount of new loans the bank can extend=$900,000

Explanation:

Demand deposits form part of an account in a commercial bank or a financial institution that the depositor can withdraw at any time without prior notice. A larger demand deposit usually denotes a bigger required reserve.

The required reserve ratio is the total amount that commercial banks have to hold on to. This amount can not be withdrawn or invested.

We can determine the maximum amount of new loans the bank can extend as follows;

Step 1: Determine total amount in the bank

Using the expression;

T=D+A

where;

T=total amount

D=demand deposits

A=actual reserves

In our case;

T=unknown

D=$1,000,000

A=$300,000

replacing;

T=1,000,000+300,000=$1,300,000

Total amount in the commercial bank=$1,300,000

Step 2: Determine the required reserve for the demand deposits

Required reserve=reserve ratio*demand deposits

where;

reserve ratio=10%=10/100=0.1

total amount in the commercial bank=$1,000,000

replacing;

required reserve=0.1*1,000,000=$100,000

required reserve=$100,000

Step 3: Determine Maximum amount of new loans the bank can extend

Total reserve=actual reserve+required reserve

total reserve=300,000+100,000=$400,000

Maximum amount of new loans=Total amount in the commercial bank-total reserve=1,300,000-400,000=$900,000

The maximum amount of new loans the bank can extend=$900,000