Money, Banking, and Financial Institutions PDF

34 Money, Banking, and Financial Institutions McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Functions of Money Medium of exchange Used to buy/sell g...

34 Money, Banking, and Financial Institutions McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.  Functions of Money Medium of exchange Used to buy/sell goods Unit of account Goods valued in dollars Store of value Hold some wealth in money form Money is liquid; needs to be durable LO1 Why money is important? -The barter system -- double coincidence of wants -- lack of standardised unit of measurement; how you express prices of goods? -- lack of means of sub-divisions for most commodities -Current form of money- fiat paper money and electronic money  Money Definition M1 M1 Currency Checkable deposits Institutions offering checkable deposits Commercial banks Savings and loan associations Mutual savings banks Credit unions LO1  Money Definition M2 M2 M1 plus near-monies Savings deposits including money market deposit accounts (MMDA) Small-denominated time deposits Money market mutual funds (MMMF) LO1  Money Definitions January 2010 Source: Federal Reserve System LO1  What “Backs” the Money Supply? Intrinsic vs. face value fiat money- face value>intrinsic value Why is the current form of money valuable? Acceptability Legal tender Relative scarcity LO2  What “Backs” the Money Supply? Depends on the government’s ability to keep its value stable Prices affect purchasing power of money Hyperinflation renders money unacceptable Stabilizing money’s purchasing power Intelligent management of the money supply – monetary policy Appropriate fiscal policy LO2 Federal Reserve - Banking System Historical background Board of Governors 12 Federal Reserve Banks Serve as the central bank Quasi-public banks Banker’s bank LO3 Federal Reserve – Banking System The 12 Federal Reserve Banks LO3  Functions of Central Bank Issue currency Set reserve requirements Lend money to banks (lender of last resort) Checks clearance fiscal agent of the government Supervise banks Control the money supply LO4  Financial Institutions World’s 12 Largest Financial Institutions, 2009 Assets (Trillions of U.S. Dollars) 0 1.5 2.5 3.5 Royal Bank of Scotland (UK) Barclays (UK) Deutsche Bank (Germany) BNP Paribas (France) HSBC Holdings (UK) JPMorgan Chase (US) Credit Agricole (France) Citigroup (US) Mitsubishi UFJ (Japan) UBS (Switzerland) ING Group (Netherlands) Bank of America (US) Source: Forbes Global 2000, www.forbes.com LO4  Major Categories of Financial Institutions Institution Description Examples Commercial Banks State and national banks that provide checking and savings JP Morgan Chase, Bank accounts and make loans of America, Citibank, Wells Fargo Thrifts Savings and loan associations, mutual savings banks, credit Charter One, New York unions that offer checking and savings accounts and make Community Bank loans Insurance Firms that offer policies through which individuals pay Prudential, New York Companies premiums to insure against lose Life, Northwestern Mutual, Hartford Mutual Fund Firms that pool customer deposits to purchase stocks or Fidelity, Vanguard, Companies bonds Putnam, Janus, T Rowe Price Pension Funds Institutions that collect savings from workers throughout their TIAA-CREF, Teamsters’ working years and then invest the funds to pay retirement Union, CalPERs benefits Securities Firms Firms that offer security advice and buy and sell stocks and Merrill Lynch, Smith bonds for clients Barney, Charles Schwab Investment Banks Firms that help corporations and governments raise money Goldman Sachs, Morgan by selling stocks and bonds Stanley, Deutsche Bank, Nomura Securities LO7  Electronic Banking Electronic-based payment systems have pushed aside currency and checks Credit/debit cards Fedwire transfers Electronic money Stored-value cards  Chapter 35 Money Creation McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All  Chapter Objectives “Fractional Reserve” system Actual reserves vs. required reserves How banks create money through granting loans Multiple expansion of loans and money by the banking system The monetary multiplier 32-16  Fractional Reserve Banking The Goldsmiths Stored gold and gave a receipt (initially value of gold = value of receipts) Receipts used as money by public Made loans by issuing receipts (value of gold less than total value of receipts in circulation) Fractional reserve banking was born Banks create money through lending Banks are subject to “panics” 32-17  Fractional Reserve System Balance sheet Assets = Liabilities + Net Worth Both sides balance Necessary transactions Create a bank Accept deposits Lend excess reserves 32-18  Creating a Bank Transaction #1 Vault cash: cash held by the bank Creating a Bank Balance Sheet 1: Wahoo Bank Assets Liabilities and Net Worth Cash $250,000 Stock Shares $250,000 32-19  Creating a Bank Transaction #2 Acquiring property and equipment Acquiring Property and Equipment Balance Sheet 2: Wahoo Bank Assets Liabilities and Net Worth Cash $10,000 Stock Shares $250,000 Property 240,000 32-20  Creating a Bank Transaction #3 Commercial bank functions Accepting deposits Making loans Accepting Deposits Balance Sheet 3: Wahoo Bank Assets Liabilities and Net Worth Cash $110,000 Checkable Deposits $100,000 Property 240,000 Stock Shares 250,000 32-21  Creating a Bank Transaction #4 Depositing reserves in a Federal Reserve bank Required reserves Reserve ratio Commercial bank’s Reserve Required reserves ratio = Commercial bank’s Checkable-deposit liabilities 32-22  Creating a Bank Transaction #4 Assume the bank deposits all cash on reserve at the Fed Depositing Reserves at the Fed Balance Sheet 4: Wahoo Bank Assets Liabilities and Net Worth Cash $0 Checkable Reserves 110,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 32-23  Reserve Requirements Excess reserves Actual reserves - required reserves Required reserves Checkable deposits x reserve ratio Example: Checkable deposits $100,000 Reserve ratio 20% 32-24  Creating a Bank Transaction #5 Clearing a check $50,000 check reduces reserves and checkable deposits Clearing a Check Balance Sheet 5: Wahoo Bank Assets Liabilities and Net Worth Checkable Reserves $60,000 Deposits $50,000 Property 240,000 Stock Shares 250,000 32-25  Money Creating Transactions Transaction #6a Granting a loan $50,000 loan deposited to checking When a Loan is approved Balance Sheet 6a: Wahoo Bank Assets Liabilities and Net Worth Reserves $60,000 Checkable Loans 50,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 32-26  Money Creating Transactions Transaction #6b Using the loan $50,000 loan cashed After a Check is Drawn on the Loan Balance Sheet 6b: Wahoo Bank Assets Liabilities and Net Worth Reserves $10,000 Checkable Loans 50,000 Deposits $50,000 Property 240,000 Stock Shares 250,000 A single bank can only lend an amount equal to their preloan excess reserves 32-27  Money Creating Transactions Transaction #7 Bank buys government securities from dealer (public) Deposits payment into checking Buying Government Securities Balance Sheet 7: Wahoo Bank Assets Liabilities and Net Worth Reserves $60,000 Checkable Securities 50,000 Deposits $100,000 Property 240,000 Stock Shares 250,000 New money is created 32-28  Commercial Banks Conflicting goals Earn profit Make loans to earn interest Buy securities to earn interest Maintain liquidity Alternative? Overnight bank loans Federal funds rate Malaysia- Official Policy Rate and KLIBOR 32-29  The Banking System Multiple-deposit expansion Assumptions: 20% required reserves All banks “loaned up” Banks lend all of excess reserves A $100 bill is found and deposited Multiple deposits can be created 32-30  The Banking System (1) (3) (4) Acquired (2) Excess Amount Bank Can Reserves Required Reserves Lend; New Money Bank and Deposits Reserves (1)-(2) Created = (3) Bank A $100 $20 $80 $80 Bank B $80 $16 $64 $64 Bank C $64 $12.80 $51.20 $51.20 Bank D $51.20 $10.24 $40.96 $40.96 The process will continue… 32-31  The Banking System (2) (1) Required (3) (4) Acquired Reserves Excess Amount Bank Can Reserves (Reserve Reserves Lend; New Money Bank and Deposits Ratio =.2) (1)-(2) Created = (3) Bank A $100.00 $20.00 $80.00 $80.00 Bank B 80.00 16.00 64.00 64.00 Bank C 64.00 12.80 51.20 51.20 Bank D 51.20 10.24 40.96 40.96 Bank E 40.96 8.19 32.77 32.77 Bank F 32.77 6.55 26.21 26.21 Bank G 26.21 5.24 20.97 20.97 Bank H 20.97 4.20 16.78 16.78 Bank I 16.78 3.36 13.42 13.42 Bank J 13.42 2.68 10.74 10.74 Bank K 10.74 2.15 8.59 8.59 Bank L 8.59 1.72 6.87 6.87 Bank M 6.87 1.37 5.50 5.50 Bank N 5.50 1.10 4.40 4.40 Other Banks 21.99 4.40 17.59 17.59 $400.00 32-32  The Monetary Multiplier Monetary 1 1 multiplier = = required reserve ratio R Graphic New Reserves $100 Example $80 $20 Excess Required Reserves Reserves $100 $400 Initial Bank System Lending Deposit Money Created 32-33  The Monetary Multiplier Maximum amount of new money created by single dollar of excess reserves Higher R, lower m Reversibility Making loans creates money Loan repayment destroys money 32-34  Bank Panics of 1930-1933 Before deposit insurance Bank failure led to mass withdrawals Forced loan reduction 25-33% decline in money supply 1933 national bank holiday to evaluate all banks Contributed to the Great Depression Regulation protects the system today 32-35