JIC The Liabilities that A Commercial Bank Holds On to Discussion

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Adnan Mohammed Answer Discussion:
Saudi Arabia’s Reserve Ratio
A reserve ratio is the amount of cash deposits or liabilities that a commercial bank holds
on to instead of lending out. When the reserve ratio increases, it is more difficult for banks to issue
loans to businesses (Feng et al., 2022). This is not good news for Saudi Arabia and its economy,
being the country with the highest reserve ratio among the four. Before discussing the impacts of
the 7% reserve ratio on Saudi’s economy, it is essential to understand how a reserve ratio works.
The reserve ratio is calculated as follows;
Reserve Ratio = Reserve Requirements / Deposits
A simplistic example of a reserve ratio would assume that Saudi’s Central Bank has a
defined reserve ratio of 7%. This means that if the bank had a total deposit amounting to 1 billion
Saudi Riyal (SR), it is required to have 70 million SR on reserve, meaning the bank could make a
loan of 930million SR. Suppose the reserve ratio was 5%; the bank would have 50million Riyal
on reserve and 950million SR for loans.
The example given above directly demonstrates how reserve ratios work; when the reserve
ratio is high, there is less money to be loaned out. The exact opposite happens when the reserve
ratio is low (Feng et al., 2022). Therefore, what impact does the 7% reserve ratio have on Saudi’s
economy? When the reserve ratio is low, there is more money supply within the economy; Saudi’s
central bank can issue loans to businesses and customers. However, when the reserve rate is at 7%,
the economy is affected by high inflation and interest rates.
When the reserve ratio is high, as in the case of Saudi Arabia, there is a significant decrease
in the amount of money set aside to be loaned out. Banks, therefore, often take this opportunity to
impose high-interest rates on loans. The high-interest rate discourages taking loans, especially for
consumers. Additionally, businesses might strain financially due to the high-interest charge
imposed on them (Mahmood et al., 2018). On the other hand, low inflation generally indicates that
demand for products and services is less than it should be, thus, slowing economic expansion and
affecting incomes.
Generally, a high reserve ratio has significant impacts on Saudi Arabia’s economy, most of
which are harmful. While the reality of a high reserve ratio is a country running with a low money
supply; this money can provide the Saudi’s central bank with a level of protection against possible
risks like bank failure in case of an economic recession (Feng et al., 2022).
References
Feng, X., Lo, Y. L., & Chan, K. C. (2022). Impact of economic policy uncertainty on cash
holdings: Firm-level evidence from an emerging market. Asia-Pacific Journal of
Accounting & Economics, 29(2), 363-385.
Mahmood, H., & Alkhateeb, T. T. Y. (2018). Asymmetrical effects of real exchange rate on the
money demand in Saudi Arabia: A non-linear ARDL approach. PloS one, 13(11),
e0207598.
Reply to Adnan Mohammed question:
Mohammed Abdullah Answered Discussion:
the implications of the 7% reserve rate on Saudi economy
The reserve requirement is a percentage of the amounts deposited in the bank that the bank must
keep in order to ensure its ability to meet when a large withdrawal of funds occurs suddenly. Since
it is a percentage of deposits, it affects the supply of loanable funds and has an impact on the
interest rate (CHEN, J. 2021).
As in the case mentioned in the question, Saudi Arabia has a 7% reserve ratio, and when we want
to calculate the money multiplier, we will find that 1/7 = 14.28. Whereas in the United Arab
Emirates the money multiplier is 1/1 = 100, it appears to us that there is a very big difference, and
we will clarify this through an applied process:
Suppose a citizen deposits 5000 Saudi riyals, so the money supply will be 5000 * 14.28 = 71,400
riyals.
Whereas if a citizen deposits 5000 dirhams in an Emirati bank, the money supply will be 5000 *
100 = 500,000 dirhams.
We conclude that the higher the reserve requirement will reduce the money multiplier and increase
the reserve ratio. This will cause less investment, which will eventually lead to an economic
downturn.
On the other hand, there are advantages of having a higher reserve ratio, as this reduces inflation
rates. It will also ensure that there is an ability to meet when large withdrawals occur suddenly. It
will also enable the central bank to better control the money supply.
References:
CHEN, J. (2021, August 29). Reserve Requirements.
From: https://www.investopedia.com/terms/r/requiredreserves.asp
Mankiw, N. Gregory. Principles of Macroeconomics, 6th ed. Mason, OH: South-Western
Cengage Learning, 2011.
Reply to Mohammed Abdullah question:

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