An increase in cash ratio by the central bank will_______

Step 1: Analyze the question The question asks about the effect of the central bank increasing the cash ratio. This is a monetary policy tool used to control the money supply.

Step 2: Explain the concept The cash ratio (also called the cash reserve requirement) is the percentage of a commercial bank's total deposits that it must keep as cash, either in its vaults or with the central bank (in Nigeria, the CBN). The bank cannot lend out this portion.

Step 3: Work through the effect When the central bank raises the cash ratio:

1. Banks must hold more of their deposits as cash reserves.
2. Banks therefore have less money available to lend.
3. Less lending means less credit creation, so the total money supply falls.
4. With less credit available, loans become harder to get and often more expensive, which discourages borrowing.

Step 4: Check each option

• A. Increase the supply of money. Wrong. This is the opposite of the effect. A decrease in the cash ratio would do this.
• B. Increase banks' lending. Wrong. Banks have less to lend, so lending falls.
• C. Encourage borrowing. Wrong. Tighter credit discourages borrowing.
• D. Reduce the supply of money. Correct. Less lendable funds leads to less credit creation, so the money supply contracts.

Exam tip: Remember that cash ratio and money supply move in opposite directions:

• Cash ratio ↑ → money supply ↓ (a contractionary policy used to fight inflation)
• Cash ratio ↓ → money supply ↑ (an expansionary policy used to fight recession)

The same logic applies to other tools. Raising the Monetary Policy Rate (MPR) or selling government securities also reduces the money supply.