ALOMAR_212_61 1- Basic Banking  Banks make profits by selling liabilities (of particular combination of liquidity, risk, size, and return) and using the proceeds to buy assets (different combination of liquidity, risk, size, and return). This is called “asset transformation”: saving deposit transformed as mortgage loan.

ALOMAR_212_62 -Operations of a bank: -The T-account: A simplified balance sheet of a bank.

ALOMAR_212_63 Example (1):  X goes to bank (1), opens a checking account with 100KD. This is a liability on the bank:  The bank puts the 100KD into the vault so the bank assets increase by the 100KD

ALOMAR_212_64 AL Vault Cash +100 Checkable D +100

ALOMAR_212_65 Since the vault cash is also a part of the bank ’ s reserves: AL Reserves +100 Checkable D +100 Note: the increase in the bank’s reserves = the increase in checkable deposits

ALOMAR_212_66  If instead, (X) opens her checking account using a check written on an account at another bank, say bank TWO. Therefore, The final balance sheet for the two banks:

ALOMAR_212_67 Bank (1) AL Reserves +100 Checkable D +100

ALOMAR_212_68 Bank (2) AL Reserves -100 Checkable D -100 Note: when a bank receives additional deposits, it gains an equal amount of reserves, when it loses deposits, it loses an equal amount of reserves.

ALOMAR_212_69 Example (2) - Deposit = 100KD - Required reserve ratio = 10% AL RR +10 Checkable D +100 ER +90

ALOMAR_212_610  The bank is not making profits from the reserves it hold (because reserves pay no income). Therefore, the bank must put the reserves into productive usages (i.e. Loans(  Bank 1 make loan =90KD (the excess reserve(

ALOMAR_212_611 AL RR +10 Checkable D +100 Loan +90 Since loans pay interest, the bank can make profits now