1 chapter 26 money creation and the banking system 5/25/2015 © ©1999 south-western college...
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Chapter 26Chapter 26Chapter 26Chapter 26Money Creation and Money Creation and the Banking Systemthe Banking System
04/18/23
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Commercial Banking System
Commercial Banking System
• Privately owned, profit seeking
• 2 major functions, accept deposits and make loans
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Who were the first bankers?Who were the first bankers?
Goldsmiths in the Middle Ages
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Why are banks called Why are banks called Depository Institutions?Depository Institutions?Because they accept
deposits from the public
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What is a Fractional Reserve Banking System?
What is a Fractional Reserve Banking System?A banking system that
provides people immediate access to their deposits, but allows banks to hold only a fraction of those deposits in reserve
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How do banks make profit?How do banks make profit?They pay depositors a
lower interest and lend a fraction of the deposits out at a higher interest
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What determines a Bank’s Profit?
What determines a Bank’s Profit?
The spread between interest paid to deposits and interest received from loans
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What is a Bank’s Balance Sheet?
What is a Bank’s Balance Sheet?
The bank’s statement of liabilities (what it owes) and assets (what it owns)
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Assets and Liabilities of a Bank
ASSETS LIABILITIES
•RESERVES•LOANS •BONDS
•BUILDINGS•EQUIPMENT
•DEPOSITS•BORROWING
ASSETS - LIABILITIESEQUALS
NET WORTH
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Find out about cyberspace banking:
Find out about cyberspace banking:
http://www.sfnb.comhttp://www.ots.treas.gov/ebanking.html
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What determines how much a Bank can lend?What determines how
much a Bank can lend?The legal reserve
requirement determines what fraction of a bank’s deposits they can lend
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What is a Legal Reserve Requirement?
What is a Legal Reserve Requirement?
The percentage of demand deposits banks and other financial intermediaries are required to keep in cash reserves
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What areExcess Reserves?
What areExcess Reserves?
Deposits that a bank has above its required reserves
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How do Banks multiply money?How do Banks
multiply money?Because each bank can
legally lend its excess reserves, there is a multiple process that take place as money circulates
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The money multiplier process
The money multiplier process
Assume all excess reserves are loaned out
Use a reserve ratio of 10% ( .10)
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What is the Potential Money Multiplier?
What is the Potential Money Multiplier?
The increase in the money supply that is potentially generated by a change in demand deposits
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What is the money What is the money multiplier with a reserve multiplier with a reserve
requirement of 1/10?requirement of 1/10?
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$100$90$81$74$63
$1,000
original deposit
total money
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...
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What is the Money What is the Money Multiplier formula?Multiplier formula? 1/Required reserve ratio
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If the required reserve ratio is 1/10 and all banks are exactly
meeting their reserve requirement - how do we
calculate the money multiplier?
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One divided by one tenth equals 10
1 1.. 10
=
1 X 10
1=
Multiplier
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Does this multiplication process work in reverse?Does this multiplication process work in reverse?Yes! For every dollar
taken out of circulation, there is a multiple effect on the money supply©©1999 South-Western College Publishing
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Can a Bank fail?Can a Bank fail?If its liabilities are
greater than its assets, a bank can fail
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How do we Safeguard the Banking System?
How do we Safeguard the Banking System?
The Federal Deposit Insurance Corporation (FDIC)
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What is the FDIC?What is the FDIC?A government insurance
agency that provides depositors 100% coverage on their first $100,000 of deposits
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What else does the FDIC do?
What else does the FDIC do?
It audits and examines banks to detect any weaknesses in its operation
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Despite the FDIC, can banks still fail?
Despite the FDIC, can banks still fail?
Yes! There were many bank failures as recently as the 1980’s and 1990’s
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Bank Failures in the 80’s and 90’s
Bank Failures in the 80’s and 90’s
• Effects of inflation from the 70’s and 80’s
• Bad loans, energy industry• Expanded deposit insurance
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http://www.fdic.gov/learning/index.html
http://www.bog.frb.fed.us
http://www.ffiec.gov/nic
http://www.chi.frb.org
http://www.bankweb.com/bankweb.html
http://www.bankrate.com
http://www.bankwatch.com
http://www.bankinfo.com
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• What is a Fractional Reserve Banking System?
• How do banks make profit?• What is a Legal Reserve Requirement?• What are Excess Reserves?• How do Banks multiply money?• What is the money multiplier formula?• What is the FDIC?
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ENDENDENDEND
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