Banks hold only a small fraction of their total deposits as cash reserves, yet they are normally able to meet…

Question

Banks hold only a small fraction of their total deposits as cash reserves, yet they are normally able to meet all withdrawal demands. Why is this the case, and what risk does it create?

Accepted Answer

## Model Answer Banks keep only about 5% of their deposits as cash reserves. On any given day, only **some** depositors withdraw money, not all at once. Since withdrawals and new deposits happen continuously, the small cash reserve is sufficient to meet daily demands. **Risk created:** If all depositors were to demand their money simultaneously, the bank would not be able to pay everyone, as the major portion of deposits has been given out as loans. This could lead to a collapse of the bank. *Source: Money and Credit, Loan Activities of Banks* --- ## Explanation - The key phrase from the textbook is: *"only some of its many depositors come to withdraw cash on any given day"* — use this logic directly. - The risk is hinted at by the textbook's own question: *"What would happen if all depositors came at once?"* — always address this for full marks. - For 3 marks: ~1 mark for the mechanism, ~1 mark for why it works, ~1 mark for the risk.

Social Science (087) — AI-generated practice question