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When clients deposit funds in a bank it increases the reserves of the bank. The funds deposited are used by the bank in its lending operations to other clients that borrow money from the bank. Banks are usually allowed to lend an amount greater than the total amount deposited with them. Though this helps in increasing money supply in the system, banks can face a crisis if a large number of their depositors try to withdraw their funds at the same time as banks do not have a sufficient amount of cash in their reserves. To avoid this, banks are required to always maintain a certain percentage of deposits made in the form of cash with them at all times. This is the cash reserve ratio or reserve ratio.
If a client deposits $200 in her bank and the reserve ratio of the bank is 6%, the deposit leads to an initial creation of $200 in excess reserves.
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