Introduction to Banking and Monetary Policy

Introduction to Monetary Policy

• Banks collect savings from individuals and businesses, then lend this pooled money to others.
• Banks operate at their own risk, like any other business.
• Banks profit by charging a higher interest rate to borrowers than they pay to savers.

Fundamental Concepts of Banking

• Banks offer a wide range of financial services.
• Banks gather deposits and provide loans.
  • Depositors put money into the bank; they can later withdraw it with interest.
  • Banks lend money to borrowers who pay it back with interest.

Financial Intermediation through Banks

• Banks act as intermediaries between savers and borrowers.
• Savers deposit money; banks lend it.
• Borrowers borrow money; they repay the loan.
• Banks retain some of their deposits as equity.

A Few Examples of Banks

• Bank of America (BAC) had approximately 6,100 retail banking offices and 18,700 ATMs in 2008. Founded in 1874, it’s headquartered in Charlotte, North Carolina.
• JPMorgan Chase & Co. (JPM) had six major segments: investment banking, retail financial services, card services, commercial banking, treasury and securities services, and asset management. Founded in 1823 and headquartered in New York, NY. In 2008 , it had $962,505,000 in deposits
• Citigroup, Inc. (C) operated 7,730 branches in 2008. Founded in 1812, it’s based in New York, NY. In 2008 , it had $785,801,000 in deposits
• Wells Fargo Bank (WFC) was founded in 1852 and headquartered in San Francisco, CA. In 2008, it had 11,000 branches and 12,160 ATMs. In 2008, it had $438,737,000 in deposits

One-Tier Banking System

• A single institution acts as both a central bank and a commercial bank.
• Economic actors handle all banking transactions through the one institution.
• This system combines the functions of central and commercial banks.

Types of One-Tier Systems

• Monobank: One institution handles all banking services without separating functions or customer types.
• Functional Separation: The institution distinguishes services based on clientele or their needs.

Advantages and Disadvantages of One-Tier Systems

• Advantages:*
• Easier to control.
• Serves the government's economic policy goals.
• Disadvantages:*
• Not flexible.
• Monopoly-like, lack of competition.
• Inefficient pricing.

Two-Tier Banking System

• Divides banking functions between a central bank and commercial banks.

Central and Commercial Banks

• Central Bank:*
• Plays a pivotal role in the banking system.
• Issues currency.
• Acts as the Lender of Last Resort for commercial banks.
• Holds commercial banks' reserves and lends to them.
• Creates cash and credit money.
• Commercial Banks:*
• Accept deposits and provide loans to customers
• Creates only credit money

Role of Central Banks

• Maintain price stability (control inflation).
• Regulate the money supply through credit management.
• Support government economic policies.

Tools of Monetary Policy

• Open Market Operations: Central banks buy or sell securities to influence money supply.
  • Buying securities: Increases money supply.
  • Selling securities: Decreases money supply.
• Reserve Requirement: The percentage of deposits banks must hold in reserve.
  • Low reserve requirement: Increases lending capacity.
  • High reserve requirement: Decreases lending capacity.
• Interest Rate: The rate paid by commercial banks to the central bank. This affects market interest rates and the money supply.