money, banking, and financial institutions
DESCRIPTION
17. Money, Banking, and Financial Institutions. 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 Liquid. LO1. Money Definition M 1. M 1 Currency Checkable deposits - PowerPoint PPT PresentationTRANSCRIPT
17
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Money, Banking, and Financial Institutions
17
17-2
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
• Liquid
LO1
17-3
Money Definition M1
• M1
• Currency
• Checkable deposits
• Institutions offering checkable deposits
• Commercial banks
• Savings and loan associations
• Mutual savings banks
• Credit unions
LO1
17-4
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
17-5
Money Definitions
Source: Federal Reserve System
LO1
Savings deposits, including money market deposit accounts
61%
Money market mutual funds
8%Small time deposits
9%
M122%
Currency50%
Checkable deposits
50%
Money supply, M1$1935 billion
Money supply, M2$9001 billion
17-6
What “Backs” the Money Supply?
• Guaranteed by government’s ability to keep value stable
• Money as debt
• Why is money valuable?
• Acceptability
• Legal tender
• Relative scarcity
LO2
17-7
What “Backs” the Money Supply?
• 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
17-8
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
17-9
Federal Reserve — Banking System
Commercial banksThrift institutions
(savings and loan associations,mutual savings banks,
credit unions)
The public(households and
businesses)
12 Federal Reserve Banks
Board of Governors
Federal Open Market Committee
LO3
17-11
Federal Reserve — Banking System
• Federal Open Market Committee
• Aids Board of Governors in setting monetary policy
• Conducts open market operations
• Commercial banks and thrifts
• 6,800 commercial banks
• 8,700 thrifts
LO3
17-12
Federal Reserve Functions
• Issue currency
• Set reserve requirements
• Lend money to banks
• Collect checks
• Act as a fiscal agent for U.S. government
• Supervise banks
• Control the money supply
LO4
17-13
Federal Reserve Independence
• Established by Congress as an independent agency
• Protects the Fed from political pressures
• Enables the Fed to take actions to increase interest rates in order to stem inflation as needed
LO4
17-14
Global Snapshot
World’s 12 Largest Financial Institutions, 2011
Source: Forbes Global 2000, www.forbes.com
LO4
Assets (billions of U.S. dollars)
BNP Paribas (France) 2,681
Deutsche Bank (Germany) 2,557
HSBC Holdings (U.K.) 2,468
Barclays (U.K.) 2,328
Royal Bank of Scotland (U.K.) 2,266
Bank of America (U.S.) 2,265
Mitsubishi UFJ (Japan) 2,177
Crédit Agricole (France) 2,131
JP Morgan Chase (U.S.) 2,118
Citigroup (U.S.) 1,914
ICBC (China) 1,724
Mizuho Financial (Japan) 1,667
17-15
The Financial Crisis of 2007 and 2008
• Mortgage default crisis
• Many causes
• Government programs that encouraged home ownership
• Declining real estate values
• Bad incentives provided by mortgage-backed bonds
LO5
17-16
The Financial Crisis of 2007 and 2008
• Securitization— the process of slicing up and bundling groups of loans into new securities
• As loans defaulted, the system collapsed
• “Underwater” homeowners abandoned homes and mortgages
LO5
17-17
The Financial Crisis of 2007 and 2008
• Failures and near-failures of financial firms
• Countrywide: second largest lender
• Washington Mutual: largest lender
• Wachovia
• Other firms came close
LO5
17-18
The Financial Crisis of 2007 and 2008
• Troubled Asset Relief Program (TARP)
• Allocated $700 billion to make emergency loans
• Saved several institutions from failure
LO6
17-19
Postcrisis U.S. Financial Services
• Major categories of financial institutions
• Commercial banks
• Thrifts
• Insurance companies
• Mutual Fund companies
• Pension funds
• Securities firms
• Investment banks
LO7
17-20
Institution Description Examples
Commercial banks State and national banks that provide checking and savings accounts and make loans
JPMorgan Chase, Bank of America, Citibank, Wells Fargo
Thrifts Savings and loan associations, mutual savings banks, credit unions that offer checking and savings accounts and make loans
Charter One, New York Community Bank
Insurance companies
Firms that offer policies through which individuals pay premiums to insure against loss
Prudential, New York Life, Northwestern Mutual, Hartford
Mutual Fund companies
Firms that pool customer deposits to purchase stocks or bonds
Fidelity, Vanguard, Putnam, Janus, T. Rowe Price
Pension funds Institutions that collect savings from workers throughout their working years and then invest the funds to pay retirement benefits
TIAA-CREF, Teamsters’ Union, CalPERs
Securities firms Firms that offer security advice and buy and sell stocks and bonds for clients
Merrill Lynch, Smith Barney, Charles Schwab
Investment banks Firms that help corporations and governments raise money by selling stocks and bonds
Goldman Sachs, Morgan Stanley, Deutsche Bank, Nomura Securities
Major Categories of Financial Institutions
LO7
17-21
Postcrisis U.S. Financial Services
• Wall Street Reform and Consumer Protection Act
• Passed to help prevent many of the practices that led to the crisis
• Critics say it adds heavy regulatory costs
LO7
17-22
Fractional Reserve System
• The goldsmiths
• Stored gold and gave a receipt
• Receipts used as money by public
• Made loans by issuing receipts
• Characteristics:
• Banks create money through lending
• Banks are subject to “panics”
LO8
17-23
Fractional Reserve System
• Balance sheet
• Assets = Liabilities + Net worth
• Both sides balance
• Necessary transactions
• Create a bank
• Accept deposits
• Lend excess reserves
LO8
17-24
A Single Commercial Bank
Transaction #1Vault cash: cash held by the bank
Assets Liabilities and Net Worth
Creating a BankBalance Sheet 1: Wahoo Bank
Cash $250,000 Stock shares $250,000
LO8
17-25
A Single Commercial Bank
Transaction #2Acquiring property and equipment
Assets Liabilities and Net Worth
Acquiring Property and EquipmentBalance Sheet 2: Wahoo Bank
Cash $ 10,000 Stock shares $250,000Property 240,000
LO8
17-26
A Single Commercial Bank
Transaction #3Commercial bank functions
• Accepting deposits
• Making loans
Assets Liabilities and Net Worth
Accepting DepositsBalance Sheet 3: Wahoo Bank
Cash $110,000 Checkable deposits $100,000Property 240,000Stock shares 250,000
LO8
17-27
A Single Commercial Bank
Transaction #4Depositing reserves in a Federal
Reserve Bank
• Required reserves
• Reserve ratio
Reserveratio =
Commercial bank’srequired reserves
Commercial bank’scheckable-deposit liabilities
LO8
17-28
A Single Commercial Bank
Assets Liabilities and Net Worth
Depositing Reserves at the FedBalance Sheet 4: Wahoo Bank
Cash $ 0 Checkable Deposits $100,000
Property 240,000 Stock Shares 250,000
Reserves 110,000
Transaction #4Assume the bank deposits all cash
on reserve at the Fed
LO8
17-29
A Single Commercial Bank
• Excess reserves
• Actual reserves - Required reserves
• Required reserves
• Checkable deposits × Reserve ratio
• Example:
• Checkable deposits: $100,000
• Reserve ratio: 20 percent
LO8
17-30
A Single Commercial Bank
Transaction #5
Clearing a check
• $50,000 check reduces reserves and checkable deposits
Assets Liabilities and Net Worth
Clearing a CheckBalance Sheet 5: Wahoo Bank
Checkable deposits $ 50,000
Property 240,000 Stock shares 250,000
Reserves $ 60,000
LO8
17-31
Money-Creating Transactions
Transaction #6a
Granting a loan
• $50,000 loan deposited to checking
Assets Liabilities and Net Worth
When a Loan Is NegotiatedBalance Sheet 6a: Wahoo Bank
Checkable deposits $100,000
Property 240,000 Stock shares 250,000
Reserves $ 60,000
Loans 50,000
LO8
17-32
Money-Creating Transactions
Transaction #6b
Using the loan
• $50,000 loan cashed
Assets Liabilities and Net Worth
After a Check Is Drawn on the Loan Balance Sheet 6b: Wahoo Bank
Checkable deposits $ 50,000
Property 240,000 Stock shares 250,000
Reserves $ 10,000
Loans 50,000
A single bank can only lend an amountequal to its preloan excess reserves
LO8
17-33
The Banking System
• Multiple-deposit expansion
• Assumptions:
• 20 percent required reserves
• All banks “loaned up”
• Banks lend all of their excess reserves
• A $100 bill is found and deposited
• Multiple deposits can be created
LO8
17-34
The Banking System
The Banking System’s Lending Potential
LO8
Assets Liabilities and Net Worth
Multiple-Deposit Expansion Process
Checkable deposits $+100 (a1)
Loans +80 (a2) +80 (a2)
Reserves $+100 (a1)
-80 (a3)
-80 (a3)
Balance Sheet: Commercial Bank A
17-35
The Banking System
The Banking System’s Lending Potential
Assets Liabilities and Net Worth
Multiple-Deposit Expansion ProcessBalance Sheet: Commercial Bank B
Checkable Deposits $ +80 (b1)
Loans +64 (b2) +64 (b2)
Reserves $+80 (b1)
-64 (b3)
-64 (b3)
LO8
17-36
Bank ABank BBank CBank DBank EBank FBank GBank HBank IBank JBank KBank LBank MBank NOther Banks
Bank
(1)AcquiredReserves
and Deposits
(2)RequiredReserves(Reserve
Ratio = .2)
(3)Excess
Reserves(1)-(2)
(4)Amount Bank CanLend; New Money
Created = (3)
$100.0080.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.50
21.99
$20.0016.0012.8010.248.196.555.244.203.362.682.151.721.371.104.40
$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40
17.59
$80.0064.0051.2040.9632.7726.2120.9716.7813.4210.748.596.875.504.40
17.59$400.00
The Banking System
LO8
17-38
The Monetary Multiplier
• Maximum amount of new money created by a single dollar of excess reserves
• Higher R, lower m
• Reversibility
• Making loans creates money
• Loan repayment destroys money
LO8