Post on 27-Dec-2015
transcript
Jeffrey Timmermans
Global Economic JournalismClass 8: The Banking System
Measuring the money supply
✤ M1: Currency + Demand Deposits + Traveler’s Checks + Other Checkable Deposits
✤ M2: M1 + Savings Deposits + Retail Money Market Mutual Funds
U.S. Money Supply
CurrencyCurrencyM1M1
Savings Savings DepositsDeposits
Time DepositsTime Deposits
billions of U.S. dollars
Source: U.S. Federal Reserve
Money Mkt FundsMoney Mkt Funds
Structure of the Banking System
✤ Commercial banks borrow from each other to meet short-term (overnight) needs in the interbank market
✤ The overnight interbank rate is typically influenced by changes in the money supply made by central banks (open-market operations)
✤ Commercial banks take deposits from individuals and lend out some of those deposits
✤ The role of the banking system is channel savings to those who need funds/capital (financial intermediation
The Banking System
Central Bank
Commercial Bank
Commercial Bank
Commercial Bank
Commercial Bank
Discount window
Interbank market
Deposits
Home/car Loans
Business loans
Interbank rate
Base/discount rate
Prime rate
Deposit rate
Commercial lending rate+$ –$
Key interest rates
✤ Interbank rates
✤ Overnight, 1-wk, 1-mth, 3-mth
✤ Deposit rates
✤ interest rate banks pay for funds
✤ Prime (lending) rate
✤ interest rate banks charge for (some) loans
LOW
HIGH
Interbank rates
✤ U.S.: Fed Funds target rate
✤ H.K.: Hong Kong Interbank Offer Rate (Hibor)
✤ U.K.: London Interbank Offer Rate (Libor)
✤ Fed sets Fed Funds target rate; supply/demand determine Hibor & Libor
✤ Banks’ lending rates often based on local interbank rate
Commercial Banks
✤ Take deposits
✤ Deposits are banks’ liabilities
✤ Pay depositors interest (deposit rate)
✤ Make loans
✤ Loans (& reserves) are assets
✤ Banks keep some reserves, lend out the rest
✤ Earn interest from borrowers
Reserve Ratio
✤ Typically set by the central bank
✤ Indicates the percentage of deposits a bank must keep as reserves
✤ In U.S., reserve ratio is now 10% for deposits above $55.2 million
✤ In China, the reserve ratio is now 21% for large banks
✤ An increase in the reserve ratio forces banks to curtail lending, a decrease leads to more lending and an expansion of the money supply
Jeff’s Bank (100% reserve ratio)
AssetsAssets LiabilitiesLiabilities
Reserves $100 Deposits $100
Jeff’s Bank (10% reserve ratio)
AssetsAssets LiabilitiesLiabilities
Reserves $10 Deposits $100
Loans $90
The Money Multiplier
1
reserve ratio
How the multiplier works
Original deposit $100 $100
Jeff’s Bank lending$90 (.9 x
$100)$190
Masato’s Bank lending
$81 (.9 x $90) $271
Diane’s Bank lending
$72.90 (.9 x $81)
$343.90
etc. etc. etc.Total money supply $1,000
$90$90
$81$81
Definition of Capital (Basel III)
✤ Common equity (core) Tier 1 capital: equity
✤ Tier 1 capital: equity + disclosed reserves
✤ in other words: share capital + retained earnings (shareholders’ funds)
✤ Tier 2 capital: undisclosed reserves + revaluation reserves + general provisions/loan-loss reserves + hybrid instruments (equity look-alikes)
Source: Bank for International Settlements
Basel III capital requirements
✤ Minimum capital requirement: 8.0%
✤ Of which:
✤ at least 4.5% is core Tier 1
✤ at least 6% is Tier 1
✤ PLUS conservation buffer: 2.5% (entirely core Tier 1)
✤ PLUS counter-cyclical buffer: 0-2.5%(entirely core Tier 1)
Source: Bank for International Settlements