This question is a typical question from a US introductory economics course or from a course on money and banking. And the answer is, ceteris paribus, that the money supply would decrease.
According to Richard Bove, the requirement that commercial banks in the US hold increased capital has the same effect.
[T]he main reason bank lending has declined may be that the banks’ capital requirements have increased, and this encourages them not to lend. They certainly don’t have a shortage of capital. The F.D.I.C.’s data shows that the common equity in the banking system — the amount of money invested — as a percentage of all bank assets is now at the same level as it was in 1937. If one calculates what is called the banks’ “capital ratio,” which is done by adding the banks’ reserves and common equity and then dividing by the assets, it appears that the banking system has more capital than at any time since 1934.Another culprit that Scott Sumner and others (including me) have been writing about since the fall of 2008 is the decision of the Fed to pay interest on reserves held at the Fed by the commercial banks. This policy change, by itself, has induced commercial banks to hold more of their assets in the form of deposits with the Fed instead of making loans (i.e. instead of creating more money).
Yet banks are sitting on the money rather than getting it out into the economy. Why? Because ever since the collapse, politicians and policymakers have been insisting that risky lending by the banks was the prime culprit, and have demanded that banks build up a cushion of capital to protect the system.
So what has happened, in a nutshell, is that the US Fed has tried to increase liquidity with its quantitative easing (and the buying up of many, many assets) yet at the same time it (along with Congress!) is soaking up most of that increased liquidity with various policies that require or encourage commercial banks to hold more reserves. The net effect has been not much monetary easing. Quoting Bove once again,
In fact, by many measures — like MZM, which tracks the liquid money supply in the economy, and M2, which includes deposit and retail money market funds in addition to cash — the money supply is actually shrinking on a year-over-year basis. While in 2005 the Fed stopped publishing its assessment of the broadest money measurement — called M3 — by some estimates that figure is shrinking at the fastest rate since the Great Depression.
Increased capital requirements might not be a bad idea, in light of the recent financial crisis. And I have always wondered why commercial banks were required to hold deposits at the Fed at zero interest, so from that perspective, I agree with paying interest on those reserves. But at a time when the economy needs to increase the amount of liquidity in the system, implementing policies that reduce liquidity seems counter-productive. As Scott Sumner wrote,
In fact the Fed has done almost nothing to stimulate the economy.
