Date post: | 14-Jul-2015 |
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Economy & Finance |
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Key Termsmoneymedium of exchangeunit of accountstore of valueliquiditycommodity moneyfiat moneycurrencydemand depositscentral bankmoney supplymonetary policy
reservesfractional-reserve bankingreserve ratiomoney multiplierbank capitalleverageleverage ratiocapital requirementopen-market operationsdiscount ratereserve requirements
Six Functions• Issues national currency, the Saudi Riyal.
• Acts as a banker to the government.
• Supervises commercial banks.
• Manages Kingdom’s foreign exchange reserves.
• Conducts monetary policy for promoting price and exchange rate stability.
• Promotes the growth and ensures the soundness of the financial system.
Fractional-Reserve Bank
Bank only holds a fraction of the deposits
as reserves
Loans out the remainder
Bank DepositReserve
10%Loan
Remainder
1000 100 900
900 90 810
810 81 729
• • • •
• • • •
• • • •
Total 10,000
How does 1000 become 10,000?
Reserve Ratio
Fraction Reciprocal MoneyMultiplier
100% 1 1÷1 1
50% 0.5 1 ÷ 0.50 2
25% 0.25 1 ÷ 0.25 4
10% 0.1 1 ÷ 0.10 10
5% 0.05 1 ÷ 0.05 20
1% 0.01 1 ÷ 0.01 100
Money multiplier is the reciprocal of the reserve ratio
Leverage1. I have 10
2. I borrow 90 from you
3. I buy something for 100
4. I resell the item for 150
5. I pay back your 90
6. I keep the 60
7. I earned 50 profit on my 10
Bank Balance Sheet
AssetsLiabilities and Owner Equity
Reserves 200 Deposits 800
Loans 700 Debt 150
Securities 100 Capital 50
Total 1000 Total 1000
Totals must balance or be equal
What is the leverage ratio?
AssetsLiabilities and Owner Equity
Reserves 200 Deposits 950
Loans 800 Capital 50
Total 1000 Total 1000
Assets ÷ Capital1000 ÷ 50 = 20
Leverage is Risky!If leverage ratio is 20,
5% increase in asset value = 100% return to owners
5% decrease in asset value = 100% loss to owners
Open-Market Operations
Purchase and sale of government bonds
Buy bonds increases supply
Sell bonds decreases supply
Discount RateThe rate the central bank charges to make loans to
member banks
Called the Official Repo Rate or ORR rate in Saudi Arabia
SAMA Official Repo Rate
Dropped from5.5% October 2008
to 2.0% by January 20093 month period of
global financial crisisRate increased
as economyheated up
Reserve Ratio
Increase reserve ratio will reduce money multiplier
Decrease reserve ratio will increase money multiplier
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1 2 4 6 8 10 12 14 16 18 20
ReserveRatio
Money Multiplier
The Power of the Reserve Ratio to Multiply Money
Reserve RatioNot changed very often
What is the current reserve ratio in Saudi Arabia? 7%
What is the Money Multiplier?
1÷7% = 14.28
Bank Deposit Insurance
Protects against bank runs
Moral Hazard to take more risk because government
will pick up losses
The Meaning of MoneyThree Functions of Money
Medium of ExchangeUnit of AccountStore of Value
Two Kinds of MoneyCommodityFiat
Money in the EconomyCurrencyDemand Deposits
Central BanksSAMA
Banks and the Money Supply100-Percent Reserve BankingFractional-Reserve BankingReserve RatioMoney MultiplierLeverageCapital Requirement
Tools of Monetary ControlOpen-Market OperationsDiscount Rate - ORRReserve RatioBank Runs and Deposit Insurance