Which of the following statements is correct?
A) When borrowers repay bank loans, the money supply is increased.
B) When borrowers take out bank loans, the money supply is decreased.
C) A single bank can legally lend an amount equal to its total reserves.
D) A bank can grant loans to customers only if it has excess reserves.

Question

Quizplus · Accepted Answer

When a bank grants loans, it does so based on its excess reserves—the funds it holds beyond the required reserve ratio set by the central bank. This process is part of how banks create money within the economy. Options A and B are incorrect because when borrowers take out loans, the money supply increases (not decreases), and when they repay loans, the money supply decreases (not increases) as the loan repayment reduces the amount of money in circulation. Option C is incorrect because a bank cannot lend an amount equal to its total reserves; it must keep a portion of deposits as reserves as mandated by the central bank's reserve requirement.

Which of the Following Statements Is Correct