Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What does an increase in reserve requirements lead to?

1. Lower interest rates

2. More available credit

3. Tighter credit conditions

4. Increased consumer spending

The correct answer is: Tighter credit conditions

An increase in reserve requirements refers to the amount of funds that a bank must hold in reserve against customer deposits. When reserve requirements rise, banks are required to keep a larger portion of their deposits as reserves, which means they have less money available to loan out. This results in tighter credit conditions. As banks have to hold more of their assets in reserve, they cannot issue as many loans or extend as much credit to consumers and businesses. This restriction can lead to reduced liquidity in the economy, making it harder for individuals and companies to borrow money for various transactions, including buying homes, financing education, or investing in business operations. In contrast, lower interest rates and more available credit would typically occur if reserve requirements were decreased. Increased consumer spending is typically associated with a scenario where credit is more accessible, such as when reserve requirements are low, allowing banks to lend more. Therefore, the correct answer highlights the direct consequence of higher reserve requirements leading to more stringent lending practices and an overall tightening of credit conditions in the financial system.