Question

“The statutory requirement of the Reserve Ratio (RR) acts as a limit to the amount of credit that banks can create.”

Justify the given statement with the valid explanation.

Answer 1

• The reserve ratio is the percentage of deposits that every commercial bank must keep as reserves, and the rest of the deposits can be used to give loans. The reserve ratio is fixed by the central bank to avoid ‘over lending’ by commercial banks.
• This is legally binding to all commercial banks. Hence, the statutory requirement of the reserve ratio acts as a limit to the amount of credit that banks can create.