Question

a) Explain what happens to the balance sheet of a central bank and to base money when it

(i) lends $100mn to a commercial bank; (3 marks)
(ii) when the commercial bank uses its reserves to repay that loan; (3 marks)
(iii) when the commercial bank pays interest of $1mn on such a loan; (3 marks)
(iv) when the central bank pays a dividend of $50mn to the central government. (3 marks)

b) Explain what happens to the balance sheet of a commercial bank, to the monetary base and to the money supply when the bank makes a commercial loan to a small business. Identify the main limits on the bank’s ability to extend commercial loans to its customers. (13 marks)

Answer 1

a)i) When central bank has to lend $100million to a commercial bank, then it will be shown at the assets side of the central bank.

ii) When central bank uses its rese ves to repay it's loan, it will be shown on the liabilities side of the balance sheet.

iii) When commercial bank pays interest rate to the central bank, it will be shown on the assets side.

iv) When central bank pays a dividend to the central government, then it will be shown on the liabilities side.

b) When a commercial bank makes a commercial loan to a small loan, it will be considered in the assets side.