In a certain bank, the balance sheet was as follows. In the liabilities column is Deposits worth 200 the total is 200 liabilities. In the Assets column is the Liquid Assets worth 20, and Loans worth 180 giving a total of 200 asset.
Using the information above, answer the following questions:
1. Calculate the LGS ratio.
2. Assume that the bank value of Deposit increased by 20. Draw a new balance sheet capturing the change.
3. What is the new LGS ratio after the change?
4. Calculate the total credit created after the full credit creation process.
5. Draw a final balance sheet.
6. If the bank wants to reduce money supply, how will it manipulate LGS ratio?
1. LGS ratio = Liquid Assets / Deposits = 20 / 200 = 0.1 = 10%
2. New balance sheet:
Liabilities:
Deposits: 220
Total: 220
Assets:
Liquid Assets: 20
Loans: 180
Total: 200
3. New LGS ratio = Liquid Assets / Deposits = 20 / 220 = 0.0909 = 9.09%
4. Total credit created = Loans = 180
5. Final balance sheet:
Liabilities:
Deposits: 220
Total: 220
Assets:
Liquid Assets: 20
Loans: 180
Total: 200
6. To reduce money supply, the bank can manipulate the LGS ratio by increasing the amount of liquid assets relative to deposits. This can be done by increasing the reserves held by the bank or decreasing the amount of loans given out.
In question 2. The balance sheet is not balance. The new deposit is also added to liquid Assets by the same amount. Your answer is wrong.
Apologies for the error. Let's correct it:
2. New balance sheet:
Liabilities:
Deposits: 220
Total: 220
Assets:
Liquid Assets: 40 (20 original + 20 increase)
Loans: 180
Total: 220
Now the balance sheet balances correctly with total liabilities equaling total assets.
Please let me know if you would like me to proceed with the rest of the questions.
Yes proceed
3. New LGS ratio = Liquid Assets / Deposits = 40 / 220 = 0.1818 = 18.18%
4. Total credit created after the full credit creation process remains the same at 180.
5. Final balance sheet:
Liabilities:
Deposits: 220
Total: 220
Assets:
Liquid Assets: 40
Loans: 180
Total: 220
6. To reduce money supply, the bank can manipulate the LGS ratio by decreasing the amount of liquid assets relative to deposits. The bank can achieve this by increasing the amount of loans given out or decreasing the reserve held by the bank.
Answer question 4. Using this method:
Deposit × (advance loan ÷ liquid assets)
Using the formula provided:
Total credit created = Deposits × (Loans / Liquid Assets)
Total credit created = 220 × (180 / 40)
Total credit created = 220 × 4.5
Total credit created = 990
Therefore, the total credit created after the full credit creation process using the alternative method is 990.
Draw the final balance sheet using the multiplier method
When using the multiplier method, the balance sheet can be represented as follows:
Liabilities:
Deposits: 220
Total: 220
Assets:
Liquid Assets: 40
Loans: 180
Total: 220
Total credit created: 990
The balance sheet remains the same but with the addition of the total credit created using the multiplier method.