Introduction to Finance

Bank Account 
Amount
Reserve 
Percentage
Reserve Requirement 
Amount
First Bank
$50 million
3%
$1.5 million
0
10%
0
Total
$50 million
$1.5 million
Percent
($1.5 million/$50 million) =
3.0%
Second Bank
$50 million
3%
$1.5 million
50
10%
5.0
Total
$100 million
$6.5 million 
Percent
($6.5 million/$100 million) =
6.5%

---

4.4 Monetary Policy Functions and Instruments
89
Notice that while First Bank was required to hold reserves of only 3 percent against its 
$50 million in transaction account balances, Second Bank had to hold reserves of 6.5 percent 
of its $100 million in transaction accounts. Depository institutions with even larger transaction 
account balances will have to hold proportionately higher reserves. As a result, their percent-
age of reserves to total transactions accounts will be closer to 10 percent.
A change in reserve requirement percentages on large transaction account balances has 
the most impact. For example, if the reserve requirement for transaction balances greater than 
$50 million is increased from 10 percent to 12 percent, Second Bank would have reserve 
requirements of $7.5 million—or 7.5 percent of its $100 million in transaction accounts. The 
required reserves on the second $50 million increase to $6 million, which is the result of 
multiplying $50 million times 12 percent. Adding the $1.5 million on the fi rst $50 million 
in transaction accounts and the $6 million on the second $50 million results in total required 
reserves of $7.5 million, which is 7.5 percent of the total transaction accounts of $100 million. 
Thus, it should be evident that even a small change in reserve requirements is likely to have a 
major impact on the money supply and economic activity.
Discount Rate Policy
The Fed serves as a lender to depository institutions. Banks can go to the Fed’s “discount 
window” and borrow funds to meet reserve requirements, depositor withdrawal demands, and 
even business loan demands. The