BANKING ACTIVITYYYYYYYYYYYYYYYYYYYYYYYYYY.pptx

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1. BANKING ACTIVITY

2. Chapter Outline Why Money? What is Money? The Banking System Money and Finance Chapter 11 2

3. Why Money : Making Transactions Easier Imagine there was no money : You would need to barter If you want to get a certain good which you don‘t have and want to exchange something else , you need to find someone who wants just the opposite exchange Sometimes , goods are not easily divisible ( imagine you want to get some eggs , but only have a cow ) 3

4. Money and Aggregate Demand Imagine you want to buy a house or make an investment, but do not have the means to do so You go to a bank and ask for a loan If the bank gives you a loan, you will buy the house If the bank does not give you a loan or conditions are too harsh, you will walk away not buying the house Hence, if the government can influence credit conditions, it can influence aggregate demand! 4

5. Some More Basic Thoughts About Money : This, however, is only true if inflation is low to moderate In some cases, inflation becomes so high that money is not generally accepted anymore In these cases, people might resort to barter as money would lose value to quickly barter: exchange of goods, services, or assets directly for other goods, services, or assets, without the use of money. 5

6. Where Do Hyperinflations Come F rom ? Hyperinflation usually happens if the government starts using the printing press to pay for its expenditure (because it does not manage to collect sufficient revenue) If the economy is large and growing and there are not too many newly printed bills, the money usually is just absorbed However, if the governments prints too much money, there will be hyperinflation Germany 1920s Zimbabwe in 2007 6

7. What is the Danger of a Hyperinflation in Europe Today ? No real danger Governments are not allowed to use the printing press to pay for their deficit (EU treaty) Even (recently agreed) purchases of government bonds by the ECB are limited Money in modern, developed economies comes into existence by other means (via the banking system) 7

8. Why is Inflation Disliked E ven if it is Lower ? It redistributes from creditors to debtors It might wipe out savings It makes planning difficult It hurts those with nominally fixed incomes (people on unemployment assistant, pensioners etc. ) It creates “menu” costs 8

9. What A bout F alling P rices – Do T hey B ring P roblems as Well ? Deflation: when the aggregate price level falls Wealth is redistributed from debtors to creditors Debtors tend to be those who spend more – firms are usually debtors This might lead to bankruptcies and problems in the banking sector People might postpone spending There might thus be problems for aggregate demand 9

10. Figure 11.1 The Liquidity Continuum Currency Real Estate Checking Account Share of Stock Precious Metal More Liquid Less Liquid Liquidity Continuum 10 Items more to the left are more liquid or, in other words, more easily used to purchase something of value . The farther to the right on this continuum, the less liquid the item is. Currency is as liquid as it gets, and real estate is usually about the most difficult asset to convert to money (seldom taking less than a few months).

11. Do You U se M oney if You U se a Credit C ard to Make a Purchase ? No! one is taking out a temporary loan from the credit card company only one day a month, when you send a check or electronic transfer to your credit card company from your checking account, you make a “money” transaction 11

12. Bank Deposits and Money Dank deposits fulfill the criteria for money Store of value Widely accepted in payment Unit of account But : deposits have a different degree of liquidity; not all can be used for payment What do we count as money? Pragmatic solution: different monetary aggregates which include bank deposits with different kinds of maturities 12

13. Monetary Aggregates : The Example of the euro area, in B illion € 13 Mid 2009 March 2013 Cash in Circulation 733.6 866.7 + Overnight Deposits 3606.7 4336.0 = M1 4340.3 5202.7 + Deposits with agreed maturity up to 2 years 2134.9 1784.9 + Deposits redeemable at a period of notice up to 3 month 1722.9 2102.2 = M2 8198.2 9089.7 + Repurchase agreements 331.0 122.3 + Money market fund (MMF) shares/units 745.0 457.8 + Debt securities up to 2 years 171.8 140.0 = M3 9445.9 9809.9

14. Table 11.1 A Simplified Balance Sheet of a Commercial Bank Assets Liabilities Reserves €10 million Deposits €100 million Government bonds €20 million     Loans €70 million     14 bank reserves: funds not loaned out by a private bank, but kept as vault cash or as deposit at the central bank In most countries, banks are required to keep some share of their deposits as reserves – this is called required reserves

15. How Commercial Banks Earn Profits G overnment bonds Earn interest by lending money to national governments Relatively safe and liquid Portfolio of loans Funds that are owed to the bank by businesses, households, nonprofits, or nonfederal levels of government Less liquid than government bonds Major asset and major way to make earnings 15

16. Table 11.2 Bank Types   Chief Functions Retail banks Safekeeping of money, checking accounts, loans Savings banks Similar to retail bank but specializing in loans, particularly mortgages and loans to small and medium sized businesses Cooperative banks Same as a retail bank, but cooperatively owned by customers Private banks Caters almost exclusively to high net worth individuals; functions extend beyond traditional banking into variety of financial services Investment banks No traditional banking functions; involved in underwriting and issuing securities, assistance with company mergers and acquisitions, market making, and general advice to corporations Universal banks Covering both investment and retail banking services Central banks Overseeing the monetary stability of the national economy by setting interest rates and providing liquidity to commercial banks 16

17. 17 Central Bank Commercial Bank A Commercial Bank B Borrower Bank makes loan Increase Money Supply M1

18. 18 Central Bank Commercial Bank A Commercial Bank B Borrower Commercial Bank hold certain share of deposits at Central Bank Reserve Requirement reserves do not need to be available at the time when a deposit or a loan is made! Bank makes loan Bank A/B borrows reserves from Bank B/A or Bank A/B borrows from Central Bank against collateral and interest rate

19. 19 Central Bank Commercial Bank A Commercial Bank B Borrower CB provides cash Commercial Bank provides collateral and pays interest ATM Commercial Bank provides Cash NO increase in M1