Commercial Bank potx

Multiple Money Creation by a Series of BanksWhen all banks make loans with funds they have that are above the required reserve ratio, the society’s money supply expands.. Multiple Money

BANKS COMMERCIAL

BANKS

1 Definition

Commercial banks are in the business

of providing banking services to individuals,small businesses and large organizations.While the banking sector has beenconsolidating, it is worth noting that far morepeople are employed in the commercialbanking sector than any other part of thefinancial services industry

Commercial banks are in the business

of providing banking services to individuals,small businesses and large organizations.While the banking sector has beenconsolidating, it is worth noting that far morepeople are employed in the commercialbanking sector than any other part of thefinancial services industry

2 The balance sheet of commercial banks

Total bank assets = Total bankliabilities + bank capital

bank assets are the uses for bankfunds

- They include reserves, securities andloans

- Over the years, securities have

Total bank assets = Total bankliabilities + bank capital

bank assets are the uses for bankfunds

- They include reserves, securities andloans

- Over the years, securities have

• How Bankers Keep Books

– Banks keep balance sheets

• Assets = liabilities + net worth

– Assets include:

• Reserves

• Loans

– Liabilities include:

• Deposits owed to customers.

• How Bankers Keep Books

– Banks keep balance sheets

• Assets = liabilities + net worth

• The Limits to Money Creation by a SingleBank

– Banks can lend money in their vault that is above the minimum required reserve ratio.

– In doing so, they create new money.

• The Limits to Money Creation by a SingleBank

– Banks can lend money in their vault that is above the minimum required reserve ratio.

– In doing so, they create new money.

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Multiple Money Creation by a Series of Banks

When all banks make loans with funds they have that are above the required reserve ratio, the society’s money supply expands.

Multiple Money Creation by a Series of Banks

When all banks make loans with funds they have that are above the required reserve ratio, the society’s money supply expands.

Multiple Money Creation by a Series of Banks

minimum reserve ratio, m Assumes all new money held in the form of deposits

Oversimplified deposit multiplier formula

Multiple Money Creation by a Series of Banks

minimum reserve ratio, m Assumes all new money held in the form of deposits

Oversimplified deposit multiplier formula

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FIGURE 28-3 The Chain of Multiple Deposit Creation

• The Process in Reverse: MultipleContractions of the Money Supply

– Deposits, and with them the money supply, contract when reserves are reduced.

• Banks reduce their loan commitments.

• Calculation of the contraction in the money supply utilizes the same formula as for money expansion.

Contractions of the Money Supply

– Deposits, and with them the money supply, contract when reserves are reduced.

• Banks reduce their loan commitments.

• Calculation of the contraction in the money supply utilizes the same formula as for money expansion.

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• Individuals hold some portion of additions totheir money in the form of cash.

• Banks sometimes hold reserves above therequired minimum

Why the Deposit Creation Formula Is Oversimplified

• Individuals hold some portion of additions totheir money in the form of cash

• Banks sometimes hold reserves above therequired minimum

The Need for Monetary Policy

• Left uncontrolled, banks would:

– Reduce the money supply in a recession

– Increase the money supply during boom periods

• Changes in the money supply wouldexacerbate the business cycle

• One reason for monetary policy, therefore, is

to prevent this behavior on the part of banks

• Left uncontrolled, banks would:

– Reduce the money supply in a recession

– Increase the money supply during boom periods

• Changes in the money supply wouldexacerbate the business cycle

• One reason for monetary policy, therefore, is

to prevent this behavior on the part of banks

Bank liabilities are the sourses of bankfunds:

- They include transaction andnontracsaction deposits as well asborrowings from other banks

- Over the years, transaction depositshave become increasingly less important

as a source of bank funds

Bank liabilities are the sourses of bankfunds:

- They include transaction andnontracsaction deposits as well asborrowings from other banks

- Over the years, transaction depositshave become increasingly less important

as a source of bank funds

Bank capital is the contribution of thebank’s owners, it acts as a cushion against

a fall in the value of the bank’s assets or awithdrawal of its liabilities

Banks make a profit for their owners.Measures of a bank’s profitability includereturn on assets (ROA), return on equity(ROE), net interest income and netinterest margin

Bank capital is the contribution of thebank’s owners, it acts as a cushion against

a fall in the value of the bank’s assets or awithdrawal of its liabilities

Banks make a profit for their owners.Measures of a bank’s profitability includereturn on assets (ROA), return on equity(ROE), net interest income and netinterest margin

Banks’ off-balance-sheet activities havebecome increasingly important in recentyears They include:

- Loan commitments, which are lines ofcredit firms can use whenever necessary

- Letters of credit, which are guaanteesthat a customer will make a promisedpayment

Banks’ off-balance-sheet activities havebecome increasingly important in recentyears They include:

- Loan commitments, which are lines ofcredit firms can use whenever necessary

- Letters of credit, which are guaanteesthat a customer will make a promisedpayment

3 Bank managementBanks face several types of risk in day today business They include:

- Liquidity risk: the risk that customers willdemand cash immediately

+ Liability-side liquidity risk arises fromdeposit withdrawals

+ Asset-side liquidity risk arises from theuse of loan commitments to borrow

Banks face several types of risk in day today business They include:

- Liquidity risk: the risk that customers willdemand cash immediately

+ Liability-side liquidity risk arises fromdeposit withdrawals

+ Asset-side liquidity risk arises from theuse of loan commitments to borrow

Bank can manage liquidity risk byadjusting either their assets or theirliabilities.

Credit risk: the risk that customers willnot repay their loans Banks can managecredit risk by:

- Diversifying their loan portfolios

- Using statistacal models to analyzeborrowers’ creditworthiness

- Monitoring borrowers to ensure thatthey use borrowed funds properly

Bank can manage liquidity risk byadjusting either their assets or theirliabilities

Credit risk: the risk that customers willnot repay their loans Banks can managecredit risk by:

- Diversifying their loan portfolios

- Using statistacal models to analyzeborrowers’ creditworthiness

- Monitoring borrowers to ensure thatthey use borrowed funds properly

Interest-rate risk: the risk that amovement in interest rates will changethevalue of the bank’s asset more than thevalue of its liabilities.

- When a bank lends long and borrowsshort, increases in interest rates will drivedown the bank’s profits

Interest-rate risk: the risk that amovement in interest rates will changethevalue of the bank’s asset more than thevalue of its liabilities

- When a bank lends long and borrowsshort, increases in interest rates will drivedown the bank’s profits

- Banks use variety of tools, such asgap analysis, to assess the sensitivity oftheir balance sheets to a change ininterest rates.

- Banks manage interest-rate risk bymatching the maturity of their assets andliabilities and using derivatives likeinterest-rate swaps

- Banks use variety of tools, such asgap analysis, to assess the sensitivity oftheir balance sheets to a change ininterest rates

- Banks manage interest-rate risk bymatching the maturity of their assets andliabilities and using derivatives likeinterest-rate swaps

Trading risk: the risk that traders whowork for the bank will create losses on thebank’s own account Banks can managethis risk using complex statistical models.

Other risk banks face include foreignexchange risk, sovereign risk and opertionrisk

Trading risk: the risk that traders whowork for the bank will create losses on thebank’s own account Banks can managethis risk using complex statistical models

Other risk banks face include foreignexchange risk, sovereign risk and opertionrisk