Suppose a bank discovers its reserves will temporarily fall slightly short of those legally required. How might it remedy this situation through the Federal funds market? Now assume the bank finds that its reserves will be substantially and permanently deficient. What remedy is available to this bank? Be sure to answer the question fully and mention all remedies.

a) borrow overnight through Fed Funds

b) Suspend lending

Explanation:

a) Banks must maintain a certain percentage of their deposits in the central bank by law. This is the reserve requirement. When a bank discovers that its reserves will temporarily fall slightly short of those legally required, it can remedy this situation by borrowing from other Banks at the Federal Fund Rate.

The Federal Fund Rate is the amount that Banks charge other Banks for lending them money from their surplus reserve requirement. Sometimes Banks will have more than they are supposed to deposit and they can then loan these surpluses out.

b) Now if the bank finds that its reserves will be substantially and permanently deficient it's best option is to suspend it's core business of lending money. Lending money is the main reason money leaves Banks so if it is suspended, it will give the bank time to "breathe" so to speak as they will be able to rebuild their reserves when previous borrowers pay back the money they had borrowed till the Reserves are sufficiently restocked.

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