Banking 9: More on reserve ratios (bad sound)

let's talk a little bit more about reserve ratio requirements and then if I have time I want to introduce another almost related and often confused topic and that is leverage so let's do reserve reserve ratio requirement and let's say in whatever jurisdiction or world that I live in that requirement is 10% so that means that for every dollar of checking account liabilities or notes liabilities that I have outstanding that I have to keep at least 10% of that in actual whatever the reserve currency is in our world we've been dealing so far it's been gold in the current world it's not gold it's actually dollar bills anyway we'll stay in the gold world and later on we'll get ourselves off of the gold standard and see how that works but let's just do the example from scratch again and just see how big I can get my balance sheet and see exactly how this stops me from getting too big so I have my bank like I always did let's say my building is worth a hundred gold pieces and then I capitalize it with another 200 gold pieces 200 gold pieces this is the building and this is my equity that I start off with so I start off with 300 equity 300 gold pieces of equity I should always do the equity in a different color sometimes it gets confused with the liabilities because they're both on the right hand side so this is my equity and then I might take some deposits let's just I don't want to make this too large of a of a diagram so let's just a say I take another 100 gold pieces and deposits 100 gold pieces of actual deposits and then I have checking accounts for these people who deposited them let me do that I'll do that in purple so these are these are checking accounts or notes deposit accounts for people these are my liabilities so my question is if these are all the deposits I have or these are this is all of the reserves I have how much can I lend out or how much can I expand my balance sheet well the reserve ratio requirement says that my reserves over my total checking and checking accounts that I have on my liabilities and kind of the the the notes that I issue that my reserves can be no more or have to be at least 10% of that so right now I only have a hundred whoops I press the wrong button right now we only have a hundred gold pieces of on-demand checking accounts and I'm not going to worry too much about the notes outstanding right now they're really the same thing at least from a balance sheet point of view and I have 300 gold pieces I actually have more reserves that I have on demand accounts because I've actually pre capitalized it with some of my initial equity so how much lending can I do well this requirement says that I can only expand these on-demand accounts so that this is at least 10% of it this 300 gold pieces is at least 10% of it right this is all these are my actual reserves so let's let's think of it this way 10% has to equal my reserves I have 300 gold pieces of reserves 100 from actual deposits 200 that I actually put in ahead of time to start up my bank that was my own gold over the total amount of auto say demand deposits I won't worry it's demand deposits plus bank notes but we'll keep it simple right now I think you get the idea deposits so we can do a little bit of math let's see multiply so we get 10% of the demand deposits have to equal 300 or divide both sides by 0.1 and then you say well I could have up to 3000 gold pieces of demand deposits so how much could I expand my balance sheet well I could keep making loans until I have 3000 gold pieces of Amman deposit so I could make let me start making loans out so someone has a project where up to say 900 gold pieces they need to build a factory of sometime I say sure here you go 900 gold pieces I'll draw a little bit less high than it should be if it would be proportional to that so 900 loan and I don't hand that person gold I just give them a checking account so it's a 900 checking account of course they're going to use this maybe to write checks to the to their laborers or their contractors whoever whoever needs to build the factory and so let's see how much do I have outstanding right now in terms of demand deposits I have nine hundred plus 100 I have a thousand so I have two thousand left so let's say someone has a really big project they want to build a bridge over the local River or whatever and they'll charge a toll and I think that's a pretty good idea because people are very likely to use that bridge so I'll give out a loan to that person so I'll give out a two thousand gold pieces own to that person two thousand loan and then instead of giving him actual gold I'll just create a checking account for Mick I could have actually issued banknotes same idea so two thousand checking account and then I'm done right because what are my total demand deposits two thousand plus 900 plus one hundred I have 300 in total demand deposits and actually all of my liabilities at this point our demand deposits I could have borrowed money in some other way but I won't worry about that right now so the ratio of my reserves 300 to my demand deposits which is this part right here which is essentially all of my liabilities right now is 10% and what this allows because of this requirement wanted it kept me from upkeep making loans out I've essentially maxed out what I can do in under this type of reserve ratio requirement and what it says is it allows 10% essentially to make sure that I'm liquid enough it makes sure that when these people who I've said at any good point in time you can come and ask for your money then if people actually do want their money in terms of gold remember they can transact with this money they can write checks or if these were if these were bank notes they can exchange those bank notes but if if someone whoever has access to this checking account at some point in time actually wants their gold I need to keep at least 10% aside assuming that no more than 10% needed at one time so that's what these reserve requirements are it keeps me liquid liquid means when someone actually asks for their gold I have the gold to give it to them now a separate question is am i solvent solvent means am I good for the money and solvent is just an issue of all your assets larger than your liability so right now in this world my assets are what I have seized 3,000 plus my initial equity this was a hundred down here so my assets are 3,300 so I'm also solvent as long as my assets which are in this entire left-hand side of the balance sheet as long as my assets are bigger than my liabilities I'm solvent which means that even if in a world let's say in a world where for whatever reason people wanted gold again they come to me and let's say they wanted 400 gold pieces I would not be liquid in that situation because I don't I do not have 400 gold pieces to immediately give them so I would have a liquidity problem maybe I would have to borrow gold from someone else but I would be solvent assuming that these loans these two loans are still good and if someone gave me enough time even these loans would be paid back or maybe I could sell these assets which these loans are to somebody else and get 900 gold pieces for them in which case I could pay these people with the goal that they need so I know anyway I just want to show you that difference between liquidity and solvency and actually I realize that I almost used up all my time so in the next in the next video I'm going to show you about leverage and leverage and leverage requirements are have a lot more to do with solvency than liquidity and just to give you a little bit of a preview it essentially says how much of a cushion do you need to have before you're insolvent before your liabilities are greater than your assets so how much loss can you take here before you're kind of out of business anyway I'll see you in the next video it ended up being just on reserve ratios this one the next one I'll do leverage