High School Economics Quiz: Banking And Fractional Reserve
20 questions · exam conditions
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Banking And Fractional ReserveQuestion 1 of 20

If the public decides to hold less currency and deposit more of their money into checking accounts, what is the likely impact on the banking system's ability to create money, assuming banks lend out all excess reserves?

It will have no impact because total M1 remains unchanged.
It will decrease the ability to create money because banks must hold more required reserves.
It will decrease the ability to create money by reducing the velocity of money.
It will increase the ability to create money because banks will have more reserves to support lending.
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High School Economics Quiz

High School Economics Quiz: Banking And Fractional Reserve

Practice Banking And Fractional Reserve in High School Economics with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Banking And Fractional Reserve, giving you a quick way to practice the rules, question types, and explanations that matter most for High School Economics.

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Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

If the public decides to hold less currency and deposit more of their money into checking accounts, what is the likely impact on the banking system's ability to create money, assuming banks lend out all excess reserves?

  1. It will have no impact because total M1 remains unchanged.
  2. It will decrease the ability to create money because banks must hold more required reserves.
  3. It will decrease the ability to create money by reducing the velocity of money.
  4. It will increase the ability to create money because banks will have more reserves to support lending. (correct answer)
Explanation: When the public holds less currency and more deposits, the commercial banking system gains reserves. Currency held by the public is outside the banking system's control, but when it is deposited, it becomes part of the reserves that can be multiplied through the fractional reserve lending process. More reserves mean more excess reserves, which directly increases the banking system's capacity to create new loans and money.

Question 2

A commercial bank has checkable deposits of $500,000 and total reserves of $80,000. The required reserve ratio is 12%. A customer then withdraws $10,000 in cash. Immediately after this withdrawal, what are the bank's excess reserves?

  1. $10,000
  2. $11,200 (correct answer)
  3. $18,800
  4. $20,000
Explanation: Initially, required reserves are 0.12 * $500,000 = $60,000. Initial excess reserves are $80,000 - $60,000 = $20,000. After the withdrawal, deposits become $490,000 and total reserves become $70,000. The new required reserves are 0.12 * $490,000 = $58,800. The new excess reserves are the new total reserves minus the new required reserves: $70,000 - $58,800 = $11,200. Distractor A incorrectly subtracts the full withdrawal amount from the initial excess reserves. Distractor C subtracts the change in required reserves from the initial excess reserves. Distractor D is the initial amount of excess reserves.

Question 3

Suppose the reserve requirement is 20%. A customer withdraws $10,000 from a checking account and holds it as currency. If all banks in the system were previously 'fully loaned up', what is the maximum potential contraction of the M1 money supply resulting from this action?

  1. $10,000
  2. $40,000 (correct answer)
  3. $50,000
  4. $8,000
Explanation: The banking system loses $10,000 in deposits and $10,000 in reserves. This initiates a reverse multiplier effect. The total decrease in checkable deposits will be $10,000 × (1/0.20) = $50,000. However, the M1 money supply includes both checkable deposits and currency in circulation. Deposits decrease by $50,000, but currency held by the public increases by the $10,000 that was withdrawn. The net change in M1 is a decrease of 40,000(–40,000 (–50,000 + $10,000).

Question 4

A bank's balance sheet shows the following: Total Reserves: $60,000; Government Securities: $140,000; Loans: $300,000. Its only liability is checkable deposits. If the required reserve ratio is 10%, this bank is currently able to extend new loans up to a maximum of:

  1. $10,000 (correct answer)
  2. $50,000
  3. $60,000
  4. $100,000
Explanation: First, determine the bank's total checkable deposits. Assets must equal liabilities. Total assets are Reserves (60k)+Securities(60k) + Securities (140k) + Loans ($300k) = $500,000. Therefore, checkable deposits must be $500,000. Required reserves are 10% of deposits, so $500,000 × 0.10 = $50,000. The bank has $60,000 in total reserves, so its excess reserves are $60,000 - $50,000 = $10,000. A bank can lend out its excess reserves.

Question 5

The fundamental assumption that allows the fractional reserve banking system to function is that:

  1. the central bank will act as a lender of last resort to prevent bank failures.
  2. all banks in the system will choose to hold zero excess reserves.
  3. banks can earn a profit by charging higher interest on loans than they pay on deposits.
  4. not all depositors will demand to withdraw their funds at the same time. (correct answer)
Explanation: The entire system is built on the premise that only a fraction of deposits will be withdrawn on any given day. This allows banks to safely lend out the rest of the deposited funds. While the other statements are related to banking, they are not the core assumption underpinning the existence of fractional reserve banking itself.

Question 6

The First Bank of Econland is 'fully loaned up,' meaning it holds no excess reserves. Its checkable deposits are $2,000,000 and its total reserves are $250,000. Based on this information, what is the required reserve ratio?

  1. 8.0%
  2. 10.0%
  3. 12.5% (correct answer)
  4. 25.0%
Explanation: If the bank is fully loaned up, its total reserves are equal to its required reserves. The required reserve ratio is calculated as Required Reserves / Checkable Deposits. Therefore, the ratio is $250,000 / $2,000,000 = 0.125, or 12.5%.

Question 7

With a 10% reserve requirement, Amy deposits $500 of currency into Bank A. Bank A makes the maximum possible loan to Ben, who buys a product from Chloe. Chloe deposits the entire payment into Bank B. Bank B then makes the maximum possible loan to David. What is the amount of David's loan?

  1. $500.00
  2. $450.00
  3. $405.00 (correct answer)
  4. $400.00
Explanation:
  1. Bank A receives a 500deposit.Itmustreserve10500 deposit. It must reserve 10% (50) and can lend out the remaining $450. This is the loan to Ben. 2. Ben pays Chloe $450, and she deposits this into Bank B. 3. Bank B now has a new deposit of 450.Itmustreserve10450. It must reserve 10% of this (45) and can lend out the remaining $405. This is the loan to David.

Question 8

A banking system has $1 trillion in deposits. The central bank lowers the required reserve ratio from 20% to 15%. This action, by itself, immediately gives commercial banks:

  1. an additional $50 billion in excess reserves. (correct answer)
  2. an additional $50 billion in required reserves.
  3. an additional $500 billion in total deposits.
  4. a reduction of $50 billion in total reserves.
Explanation: Initially, required reserves were 20% of $1 trillion, which is $200 billion. After the change, required reserves are 15% of $1 trillion, which is $150 billion. The amount of total reserves in the system has not changed, but the amount that is required has dropped by 50billion(50 billion (200B - $150B). This $50 billion is reclassified from required reserves to excess reserves, making it available for new lending.

Question 9

A commercial bank is currently meeting its reserve requirement exactly and has no excess reserves. The central bank then conducts an open market purchase of securities from this bank. The immediate effect of this transaction is that the commercial bank now has:

  1. fewer securities and more required reserves.
  2. fewer securities and more excess reserves. (correct answer)
  3. more securities and fewer required reserves.
  4. more securities and more excess reserves.
Explanation: When the central bank purchases securities from the commercial bank, it pays for them by crediting the bank's reserve account. This means the bank's securities holdings (an asset) decrease, and its total reserves (another asset) increase. Because the bank's deposits have not changed, its required reserves are unchanged. Therefore, the entire increase in total reserves becomes excess reserves, which can be used for new lending.

Question 10

When a bank with excess reserves originates a new $20,000 auto loan, it typically credits the borrower's checking account with $20,000. What is the immediate result of this single transaction on the bank's balance sheet?

  1. Assets increase by $20,000, while liabilities remain unchanged.
  2. Liabilities increase by $20,000, while assets remain unchanged.
  3. Assets in the form of reserves decrease, and assets in the form of loans increase.
  4. Assets in the form of loans increase, and liabilities in the form of deposits increase. (correct answer)
Explanation: The creation of a loan is an accounting entry. The bank acquires a new asset, the borrower's IOU ('Loans'), valued at $20,000. Simultaneously, it creates a new liability for itself, the 'Checkable Deposit' for the borrower, also for $20,000. Both sides of the balance sheet increase by $20,000. Distractor D describes what happens later, when the borrower spends the money and the funds are transferred to another bank.

Question 11

A customer deposits $10,000 in cash into a checking account at a bank. If the required reserve ratio is 20%, what is the maximum amount of new loans the entire banking system can create as a result of this single deposit?

  1. $8,000
  2. $10,000
  3. $40,000 (correct answer)
  4. $50,000
Explanation: First, the initial bank must hold 20% of the 10,000depositasrequiredreserves(10,000 deposit as required reserves (2,000). It can lend out the remaining excess reserves of $8,000. This initial loan, when deposited and re-lent throughout the banking system, is subject to the money multiplier, which is 1/0.20 = 5. The total amount of new loans created by the system is the initial excess reserves multiplied by the money multiplier: $8,000 × 5 = $40,000. Distractor A is only the first loan. Distractor D represents the total increase in deposits, not new loans.

Question 12

The money multiplier effect might not reach its theoretical maximum. Which of the following represents a decision by the public (non-bank individuals or firms) that would limit the money creation process?

  1. Choosing to hold more funds in currency rather than depositing them in banks. (correct answer)
  2. Increasing the frequency of withdrawals from checking accounts.
  3. Commercial banks choosing to hold reserves beyond the required amount.
  4. The central bank selling government securities on the open market.
Explanation: The money multiplier assumes that all loan proceeds are redeposited into the banking system. If the public chooses to hold some of these funds as cash (a 'currency drain'), that money leaks out of the fractional reserve process, and the multiplier effect is reduced. Distractor C is a decision by banks, not the public. Distractor D is an action by the central bank. Distractor B does not, by itself, reduce the money supply, as the withdrawn money is typically spent and redeposited.

Question 13

A central bank's open market sale of $5 million in government securities to the public will, assuming a reserve ratio of 10% and that all money is redeposited in the banking system, lead to a maximum potential:

  1. increase in the money supply of $50 million.
  2. decrease in the money supply of $50 million. (correct answer)
  3. increase in the money supply of $45 million.
  4. decrease in the money supply of $45 million.
Explanation: When the public buys securities from the central bank, they pay with checks drawn on their commercial bank accounts. This drains reserves from the banking system. A loss of 5millioninreserveswilltriggeramultiplecontractionofthemoneysupply.Themaximumchangeiscalculatedastheinitialchangeinreservestimesthemoneymultiplier:–5 million in reserves will trigger a multiple contraction of the money supply. The maximum change is calculated as the initial change in reserves times the money multiplier: –5,000,000 × (1/0.10) = –$50,000,000.

Question 14

A depositor moves $2,000 from a personal savings account to a personal checking account at the same bank. Assume the reserve requirement is 10% on checking deposits and 0% on savings deposits. What is the immediate impact of this transfer on the bank's required reserves and its ability to create new loans?

  1. Required reserves increase by $2,000, and its lending ability decreases.
  2. Required reserves increase by $200, and its lending ability decreases. (correct answer)
  3. Required reserves are unchanged, and its lending ability is unchanged.
  4. Required reserves decrease by $200, and its lending ability increases.
Explanation: The bank's total reserves do not change because this is an internal transfer of funds. However, the composition of its liabilities changes. The $2,000 is now in a checking account, which has a 10% reserve requirement. Required reserves increase by $2,000 × 0.10 = $200. Since total reserves are constant and required reserves have increased, the bank's excess reserves (the funds available for new loans) must decrease by $200.

Question 15

When a borrower repays the principal of a $5,000 loan to a bank using funds from a checking account at that same bank, what is the immediate effect on the bank's balance sheet?

  1. The bank's total assets and total liabilities both decrease by $5,000. (correct answer)
  2. The bank's total assets increase, and its owner's equity increases.
  3. The composition of the bank's assets changes, but its total assets remain the same.
  4. The bank's total liabilities decrease, but its total assets remain the same.
Explanation: The loan is an asset to the bank. The checking deposit is a liability. When the borrower repays the loan from their account, the bank's 'Loans' asset account decreases by $5,000. Simultaneously, the bank's 'Checkable Deposits' liability account decreases by $5,000. This action causes both sides of the balance sheet (assets and liabilities) to shrink.

Question 16

If an initial injection of $5,000 in new excess reserves into the banking system leads to a total potential increase of $25,000 in new loans, what must the required reserve ratio be?

  1. 5%
  2. 10%
  3. 20% (correct answer)
  4. 25%
Explanation: The formula for the total potential increase in loans is: Change in Loans = Initial Change in Excess Reserves × Money Multiplier. The money multiplier is 1/RR. So, $25,000 = $5,000 × (1/RR). Dividing both sides by $5,000 gives 5 = 1/RR. Solving for RR gives RR = 1/5, or 20%.

Question 17

On a commercial bank's balance sheet, which of the following are both classified as assets?

  1. Reserves and checkable deposits
  2. Loans and owner's equity
  3. Reserves and loans (correct answer)
  4. Checkable deposits and owner's equity
Explanation: Assets represent what the bank owns or is owed. Reserves (cash in the vault or at the central bank) and loans made to customers are both assets. Liabilities represent what the bank owes to others. Checkable deposits are liabilities because the bank owes that money to depositors. Owner's equity is also on the liability/equity side of the balance sheet.

Question 18

Consider a deposit of $1,000. In which scenario is the potential for M1 money supply expansion the greatest, assuming a 10% reserve requirement?

  1. Scenario A: An individual deposits $1,000 of currency that was previously in circulation.
  2. Scenario B: The central bank buys a $1,000 bond from an individual, who then deposits the proceeds. (correct answer)
  3. The potential for expansion is identical in both scenarios.
  4. The potential for expansion cannot be determined without knowing the initial M1 money supply.
Explanation: In Scenario A, the initial deposit is a conversion of existing money (currency to deposit), so M1 is initially unchanged. The bank can lend $900, leading to a maximum new money creation of 9,000(9,000 (900 x 10). In Scenario B, the central bank's purchase creates $1,000 of new reserves and a new $1,000 deposit, increasing M1 by $1,000 immediately. The bank can then lend $900, creating an additional $9,000. The total expansion in Scenario B is $1,000 + $9,000 = $10,000, which is greater than in Scenario A.

Question 19

In modern economies, the primary purpose of setting a required reserve ratio is to:

  1. ensure banks have sufficient cash to satisfy all potential withdrawals.
  2. prevent commercial banks from earning excessive profits on loans.
  3. provide the government with a source of funds for deficit spending.
  4. influence the money supply as a tool of monetary policy. (correct answer)
Explanation: While reserve requirements were historically related to ensuring liquidity, their primary function in a modern economy is as a tool for the central bank to control the money supply. By changing the ratio, the central bank can alter the money multiplier and influence the amount of money commercial banks can create through lending. It cannot ensure solvency against a bank run (A) and is not primarily for limiting profits (B) or funding the government (C).

Question 20

Which statement most accurately describes the process of money creation in a fractional reserve banking system?

  1. Banks create money by printing new currency notes backed by their holdings of government bonds.
  2. Banks create money by taking deposits and holding the full amount in reserve to ensure liquidity.
  3. Banks create money when they use excess reserves to make loans, which become new deposits in the banking system. (correct answer)
  4. Banks create money by facilitating the transfer of existing funds from savers to borrowers.
Explanation: Money creation occurs not from printing currency (distractor A) or simply holding deposits (distractor B), but through the act of lending. When a bank makes a loan, it creates a new checkable deposit for the borrower. This new deposit is 'new' money (part of M1). This process is fueled by the bank's excess reserves. Distractor D describes intermediation, but not the creation of new money.