28. Explain why a single commercial bank can safely lend only an amount equal to its excess reserves but the commercial banking system can lend by a multiple of its excess
When a bank grants a loan- it can expect that the borrower will not leave the proceeds of the loan sitting idle in his or her account. Most people borrow to spend. Therefore the lending bank can expect that checks will be written against the loan and that the bank will shortly lose reserves to other banks- as the checks are presented for payment- to the full extent of the loan. In short- when a bank grants loans to the full extent of its excess reserves- it can shortly expect to lose these excess reserves to other banks. From this it can be seen why a bank cannot safely lend more than its excess reserves. If it did- it would soon find that its cash reserves were below its legal reserve requirement. From the above it can be seen why the commercial banking system can safely lend a multiple of its excess reserves. Whereas one bank loses reserves to other banks- the system does not. With a legal cash reserve requirement of- say- 20 percent- Bank ―B‖ on receiving as a new deposit the $100 loaned by Bank ―A‖ (the excess reserves of Bank ―A‖)- may safely lend $80 (80 percent of $100). Bank ―C‖-on receiving as a new deposit the $80 loan of Bank ―B‖- loans 80 percent of that- namely $64. Note that the $100 initial excess reserves of the banking system have already resulted in the money supply increasing by $244 (= $100 + $80 + $64). The money supply will continue to increase- at a diminishing rate (Bank ―D‖ will increase the money supply by $51.20 in loaning this amount), until the total increase in the money supply is $500. From the above it can be seen why the commercial banking system can safely lend a multiple of its excess reserves.