CIMA BA1 Syllabus D. The Financial Context Of Business - The Credit Multiplier - Notes ^{8 / 9}

Helps you calculate the increase in deposits:

Illustration 1

• If a bank decides to keep a cash reserve ratio of 20%, the credit multiplier = 1 / 0.2 = 5. 

  If the bank receives additional deposits of $1,000, the increase in bank deposits will be $1,000 x 5 = $5,000.

• If a bank decides to keep a cash reserve ratio of 30%, the credit multiplier = 1 / 0.30 = 3.333. 

  If the bank receives additional deposits of $1,000, the increase in bank deposits will be $1,000 x 3.33 = $3,333.

Illustration 2

If all the commercial banks have cash reserve ratio of 40%, how much cash would have to flow into the banks initially for the money supply to increase by $100 million in total?

Solution

• Initial cash deposited x credit multiplier = increase in deposits

  The credit multiplier here is 1 / 0.4 = 2.5

  Call the extra cash C.

• Then:

  C x 2.5 = 100

  So C = 100 / 2.5 = 40

  If an extra $40 million is deposited, the total money supply will rise by $100 million.

  This includes the initial $40 million deposited. 

  So there is a further increase of $60 million after the initial deposit.