TOPIC 9 BANKING

Commercial Banks Are privately owned profit seeking institutions whose main activities are to accept deposits and make loans Eg : BCB , Maybank, Affin Bank.

Functions of Commercial Banks Accept deposits Make payments for customers Receive payments for customers Grant loans and advances Make standing order payments Credit transfers Provide safe custody for valuable Transact foreign business

= actual reserves – required reserves The Creation of Money Banks usually make loans up to the point where they can no longer do so because of the reserve requirement restriction (or up to the point where their excess reserves are zero). excess reserves = actual reserves – required reserves

The Creation of Money When someone deposits $100 in a bank, and the bank deposits the $100 with the central bank, the bank has $100 in total reserves. Balance Sheets of a Bank in a Single-Bank Economy In Panel 2, there is an initial deposit of $100. In Panel 3, the bank has made loans of $400. Panel 1 Panel 2 Panel 3 ASSETS LIABILITIES Reserves 0 0 Deposits Reserves 100 100 Deposits 500 Deposits Loans 400

The Creation of Money If the required reserve ratio is 20%, the bank has excess reserves of $80. With $80 of excess reserves, the bank can have up to $400 of additional deposits. The $100 in reserves plus $400 in loans equal $500 in deposits. Balance Sheets of a Bank in a Single-Bank Economy In Panel 2, there is an initial deposit of $100. In Panel 3, the bank has made loans of $400. Panel 1 Panel 2 Panel 3 ASSETS LIABILITIES Reserves 0 0 Deposits Reserves 100 100 Deposits 500 Deposits Loans 400

The Creation of Money The Creation of Money When There Are Many Banks Panel 1 Panel 2 Panel 3 ASSETS LIABILITIES Reserves 100 100 Deposits Reserves 100 Loans 80 180 Deposits Reserves 20 Loans 80 Reserves 80 80 Deposits Reserves 80 Loans 64 144 Deposits Reserves 16 Loans 64 Reserves 64 64 Deposits 115.20 Deposits Reserves 12.80 .00 500 Total . . . .20 51 Bank 4 64 Bank 3 80 Bank 2 100 Bank 1 Deposits Summary:

The Money Multiplier The money multiplier is the multiple by which deposits can increase for every dollar increase in reserves. In the example above, the required reserve ratio is 20%. Each dollar increase in reserves could cause an increase in deposits of $5 when there is no leakage out of the system. An additional $100 of reserves result in additional deposits of $500. .00 500 Total . . . .20 51 Bank 4 64 Bank 3 80 Bank 2 100 Bank 1 Deposits Summary:

The Central Bank A bank that is owned and controlled by the government It is not a profit institution and its main function is to control money supply in the economy

Functions of Central Bank Issues coins and notes Clearing interbank payments. Acts as the lender of last resort Acts as banker to the government Operating government monetary policy Regulating the banking system. Assisting banks in a difficult financial position. Managing exchange rates and the nation’s foreign exchange reserves. Control of mergers between banks. Examination of banks to ensure that they are financially sound. Setting of reserve requirements for all financial institutions.

How the Federal Reserve Controls the Money Supply Three tools are available to the Fed for changing the money supply: changing the required reserve ratio; changing the discount rate; and engaging in open market operations.