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Given an initial deposit of K600 million and an LGS ratio of 20%.

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3 parts
b

K160 million\text{K160 million}

c

5\text{5}

d

K200 million\text{K200 million}

Step-by-step solution

7 steps

Here's the credit creation analysis:

Part a· 1 step

Draw the initial balance sheet

  1. Calculate initial liquid assets and loans.

    Given an initial deposit of K600 million and an LGS ratio of 20%.
    Initial Liquid Assets = 20%×K600 million=0.20×K600 million=K120 million20\% \times \text{K600 million} = 0.20 \times \text{K600 million} = \text{K120 million}
    Initial Loans = K600 million−K120 million=K480 million\text{K600 million} - \text{K120 million} = \text{K480 million}

    The initial balance sheet is:

    AssetsLiabilitiesLiquid AssetsK120 millionDepositsK600 millionLoansK480 millionTotal AssetsK600 millionTotal LiabilitiesK600 million\begin{array}{|l|l|} \hline \textbf{Assets} & \textbf{Liabilities} \\ \hline \text{Liquid Assets} & \text{K120 million} & \text{Deposits} & \text{K600 million} \\ \text{Loans} & \text{K480 million} & & \\ \hline \textbf{Total Assets} & \textbf{K600 million} & \textbf{Total Liabilities} & \textbf{K600 million} \\ \hline \end{array}

Part b

K160 million\text{K160 million}

Calculate the Additional Credit Created (ACC)

  1. Calculate the Bank Credit Multiplier.

    Bank Credit Multiplier=1LGS ratio=10.20=5\text{Bank Credit Multiplier} = \frac{1}{\text{LGS ratio}} = \frac{1}{0.20} = 5

  2. Calculate the initial excess reserves from the new deposit.

    New Deposit = K40 million
    Required Reserves = 20%×K40 million=0.20×K40 million=K8 million20\% \times \text{K40 million} = 0.20 \times \text{K40 million} = \text{K8 million}
    Initial Excess Reserves = New Deposit−Required Reserves=K40 million−K8 million=K32 million\text{New Deposit} - \text{Required Reserves} = \text{K40 million} - \text{K8 million} = \text{K32 million}

  3. Calculate the Additional Credit Created (ACC).

    The ACC represents the total new loans created by the banking system.

    ACC=Initial Excess Reserves×Bank Credit Multiplier=K32 million×5=K160 million\text{ACC} = \text{Initial Excess Reserves} \times \text{Bank Credit Multiplier} = \text{K32 million} \times 5 = \boxed{\text{K160 million}}

Part c

5\text{5}

Calculate the Bank Credit Multiplier

  1. Calculate the Bank Credit Multiplier.

    Bank Credit Multiplier=1LGS ratio=10.20=5\text{Bank Credit Multiplier} = \frac{1}{\text{LGS ratio}} = \frac{1}{0.20} = \boxed{\text{5}}

Part d

K200 million\text{K200 million}

Calculate the Multiplier Effect

  1. Calculate the Multiplier Effect.

    The Multiplier Effect is the total increase in deposits in the banking system due to the new deposit.

    Multiplier Effect=New Deposit×Bank Credit Multiplier=K40 million×5=K200 million\text{Multiplier Effect} = \text{New Deposit} \times \text{Bank Credit Multiplier} = \text{K40 million} \times 5 = \boxed{\text{K200 million}}

Part e· 1 step

Draw the final balance sheet showing the multiplier effect

  1. Calculate the final total deposits, liquid assets, and loans.

    Final Total Deposits = Initial Deposits + Multiplier Effect = K600 million + K200 million = K800 million
    Final Liquid Assets = 20%×K800 million=0.20×K800 million=K160 million20\% \times \text{K800 million} = 0.20 \times \text{K800 million} = \text{K160 million}
    Final Loans = K800 million−K160 million=K640 million\text{K800 million} - \text{K160 million} = \text{K640 million}

    The final balance sheet is:

    AssetsLiabilitiesLiquid AssetsK160 millionDepositsK800 millionLoansK640 millionTotal AssetsK800 millionTotal LiabilitiesK800 million\begin{array}{|l|l|} \hline \textbf{Assets} & \textbf{Liabilities} \\ \hline \text{Liquid Assets} & \text{K160 million} & \text{Deposits} & \text{K800 million} \\ \text{Loans} & \text{K640 million} & & \\ \hline \textbf{Total Assets} & \textbf{K800 million} & \textbf{Total Liabilities} & \textbf{K800 million} \\ \hline \end{array}
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