How does an increase in the reserve requirements ratio affect bank lending?

When the reserve requirements ratio increases, banks are mandated to hold a greater percentage of their deposits in reserve and not to lend them out. This means that banks have less money available to issue loans, which can lead to a decrease in the overall lending activity. Consequently, fewer loans being made also contributes to a reduction in the money supply in the economy. A tighter reserve requirement limits how much money banks can create through the lending process, effectively contracting the available funds circulating in the economy.

This mechanism is a key tool used by central banks to control inflation and economic growth. When banks hold a higher reserve ratio, they are less able to multiply their deposits through loans, which dampens the potential growth in the money supply. Therefore, the increase in reserve requirements directly correlates with a reduction in the money available for loans and, as a result, reduces the money supply.