1 Functions of Banks Savings(deposits) Investment(loans) Banks channel savingsinvestment savings into investment.

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Presentation transcript:

1 Functions of Banks Savings(deposits) Investment(loans) Banks channel savingsinvestment savings into investment

2 Affecting Money Supply Savings (deposits) Investment (loans) Money supply = Cp (currency in public circulation) + Deposits save cash into bank account: Cp drops but deposit rises make loans to investors: reserves drop but Cp rises

3 Deposit / Credit Creation Adam Cp = $1000 deposit = $1000 Bank reserve = $1000 Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $1000Reserve $1000 Required reserve = $250 Excess reserve = $750

4 Ms = Cp + Dep = $1750 loan = $750 Bank RR = $250 ER = $750 Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $1000Reserve $250 Loan $750 Bobby Cp = $750

5 Ms = 0 + $1750 = $1750 deposit = $750 Bank reserve + $750 Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $1750Reserve $1000 Loan $750 Bobby Cp = $750 Required reserve = $437.5 Excess reserve = $562.5

6 Ms = $ $1750 = $ loan = $562.5 Bank RR = $437.5 ER = $562.5 Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $1750Reserve $437.5 Loan $ Cindy Cp = $562.5

7 Process of deposit creation 1.Initial deposit is saved into a bank under fractional reserve system. 2.The bank lends out all excess reserve. 3.The public does not have cash leakage, i.e., all cash will be re-deposited. 4.Banks lend out all excess reserve again and the above process goes on and on. 5.Multiple deposit creation will happen.

8 Ms = 0 + $4000 = $4000 deposit = $ Bank reserve + $ Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $4000Reserve $1000 Loan $3000 Zeith Cp = $ Required reserve = $1000 Excess reserve = $0

9 Ms = 0 + $4000 = $4000 loan = $0 Bank RR = $1000 ER = $0 Balance Sheet of the Banking System (required reserve ratio = 25%) Deposit $4000Reserve $1000 Loan $3000 The public Cp = $0 Further deposit / credit creation is impossible when excess reserve = 0, or required reserve = actual reserve.

10 Formula of deposit creation Maximum amount of deposit 1 = Initial deposit  Required Reserve Ratio Banking multiplier

11 Process of deposit contraction 1.Initial withdrawal of deposit from a bank under fractional reserve system. 2.The bank lacks of actual reserve and then calls back loans. 3.Since the public does not hold any cash on hand, they have to withdraw deposit. 4.Banks lacks of actual reserve again and the above process goes on and on. 5.Multiple deposit contraction will happen.