ecn 102 (8), introduction to money and banking

7/26/2019 ECN 102 (8), Introduction to Money and Banking

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Introduction to

Money and Banking This chapter -- covers some basic

fundamentals on Money and

Banking. In this way, it helps us tobecome more familiar with howMonetary Policy works.

Money -- acilitator of Trade.


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!pecific "oles of Money

as a acilitator of Trade Medium of #$change -- Money is

e$changed for goods and services

!tandard of %alue -- %alue ismeasured in dollars &the 'price

tag()


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!tandard of *eferred Payments --+oans and financial instruments

are denominated in terms ofmoney.

!tore of %alue -- People can usemoney when they wish.


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*efinitions of Money

M urrency held by the public

/ Travelers hecks

/ heckable *eposits

M0 M / !avings *eposits

/ !mall Time *eposits/ Money Market

Mutual unds


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*efinitions ofMoney !upply omponents

urrency 1eld by the Public -- Papermoney and coin held by consumers

and firms.

heckable *eposits -- bank depositswhich customers can write checksupon.


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2ther Bank *eposits

!avings *eposits -- 3o checkableprivileges, but customers can withdrawfunds at any time without penalty.

Time *eposits -- 4 contract specifyingpayment of principal and interest in ane$plicit way over a given interval.

5ithdrawal before maturity results inpenalty.


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Money Market Mutual unds

offered by private institutions &not banks)

pools investor funds

invests in short-term bonds

pays interest based upon overallportfolio

restricted checkability &based uponminimum si6e of check)


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7uirks -- *efining Money

M emphasi6es medium of e$changefunction of money. M0 represents a

broader measure. heckable deposits, not checks, are

included in the money supply

definitions. redit card purchases are not

includedin money supply definitions.


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+i8uidity of inancial 4ssets

+i8uidity-- how easily an asset canbe converted into a medium of

e$change.

"anking &most to least) based upon

li8uidity9 &) urrency, &0) heckable*eposits, &:) !avings *eposits, &;)Time *eposits.


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The "ole of Interest "ates

The Interest "ate-- compensatesfinancial investors for inconvenience dueto holding asset &e.g. loss of li8uidity).

"anking &most to least) based uponinterest rate9 &) Time *eposits, &0)

!avings *eposits, &:) heckable*eposits, &;) urrency.


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Types of Banks

ommercial Banks &full service)

!avings and +oans &consumermortgages)

!avings Banks &consumer

mortgages and consumer loans) redit


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Banks asinancial Intermediaries

inancial Intermediary-- 4ninstitution that borrows fromlenders, then loans toborrowers.


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The "ole of

inancial Intermediaries Takes advantage of institutional

fact of life -- lenders want to 'lend

small(, but borrowers want to'borrow large(.

Pools small savers funds into large

amount, available for privateborrowers &e.g. mortgages,businesses).


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The Bank=s Balance !heet

4ssets +iabilities / #8uity

4ssets -- Market value of items in yourpossession.

+iabilities -- 4mounts owed to otherparties.

#8uity 4ssets - +iabilities


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5orking 5ith 4ssets,+iabilities, and #8uity

3ote9 *efinition of e8uity implies9

4ssets +iabilities / #8uity

&Balance sheets balance>).


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4 Balance !heet #$ample

onsider a house that you buy worth?0@,@@@. Aou take out a mortgage

of ?@@,@@@.

Assets Liabilities + Equity

House $120,000 Mortgage$100,000

Equity $20,000


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The Bank=s Maor+iabilities and #8uity&) *eposits &*) -- hecking,

!avings, and Time *eposits of

bank customers.

&0) Borrowings &B2"") -- unds

borrowed by banks, usually for

very short-term adustments.

&:) #8uity ) Total 4ssets- Total +iabilities


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The Bank=s Maor 4ssets

&) "eserves &") -- vault cash of

banks plus deposits at the

ederal "eserve

-- 3on-interest earning

-- Purpose9 to back up customerwithdrawals from deposits


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undamentalBalance !heet "ule

Any customer withdrawal from any

of their deposits (checkable

deposits or savings and timedeposits) must be met with an

equal decrease in reserves.


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4n #$ample9ustomer 5ithdrawal

ustomer withdraws ?0@@ fromtheir savings deposit at hase.

hase

" - ?0@@ * - ?0@@


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3ew ustomer *eposits andthe 4c8uisition of "eserves

#$ample9 ustomer deposits ?:@@in their checkable deposit &*).

hase

" / ?:@@ * / ?:@@


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2ther 4ssets

&0) 1oldings of Bonds &B) -- source

of revenue from interest.

&:) +oans &+) -- revenue source

preferred to bonds.

-- less li8uid

higher interest rate

-- more personal aspect


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InherentInstabilities in Banking

+oan *efault-- borrower fails to repayloan, bank loses assets and e8uity.

Profits %ersus !afety-- tradeoffbetween having enough reserves tomeet depositors= withdrawal needs

versus making sufficient profits fromloaning the funds.


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Bank "egulation -- *ealing5ith Banking Instabilities

apital "e8uirements-- minimume8uity-asset ratio to absorb loan

defaults. *iscount 5indow-- ederal

"eserve serves as outlet for banksto borrow reserves for emergencywithdrawal needs.


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*eposit Insurance&provided by theederal *eposit Insuranceorporation, or *I) -- guaranteesreimbursement up to ?@@,@@@ perdepositor if their bank fails.

"eserve "e8uirements-- mandating a'minimum safety +evel( of reserves.


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"eserve "e8uirements9 The'Minimum !afety +evel(

ederal "eserve9 issues a reserveratioon customer deposits &r*)

with the provision that, at any time

" C &r*)&*)


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*ecomposition of "eserves

"e8uired "eserves &""), "" &r*)&*)

#$cess "eserves "),#" " - ""

#8uivalent 5ays to #$press"eserve "e8uirement """, or #" @


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Bank +oaning --Balance !heet *escription

onsider the following e$ample.

&r* @.@)

hase

" ?;@@@ * ?D@@@

+ ?E@@@ # ?@@@

B ?:@@@


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omputing "e8uired and#$cess "eserves hase r* @.@

" ?;@@@ * ?D@@@

+ ?E@@@ # ?@@@B ?:@@@

"" &r*)&*) &@.@)&?D@@@) ?D@@

#" " - "" ?;@@@ - ?D@@ ?0D@@


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hase Makes +oan of ?0D@@!tep F -- +oan is

4pproved hase" ?;@@@ * ?GD@@

+ ?D@@ # ?@@@

Bonds ?:@@@

Borrower signs loan contract,

receives check from bank.


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!tep F0 -- +oan is !pent

hase

" ?D@@ * ?D@@@

+ ?D@@ # ?@@@

B ?:@@@

!eller deposits check in her bank.

leet

" / ?0D@@ * / ?0D@@


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Bank +oaning and theMoney !upply

onsider from previous e$ample,leet gets new deposits &?0D@@)

while hase has the same as before. Therefore M0 changes by ?0D@@, the

amount of the loan.

"esult H bank loaning changes themoney supply by the amount of theloan.


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+oaning and theBanking !ystem

!eller deposits check in her bank.

leet

" / ?0D@@ * / ?0D@@

leet now can make a loan.

4s funds from leet=s loan getdeposited in another bank, the processcontinues

ecn 102 (8), introduction to money and banking

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