Macro-final 29 – Flashcards

Commercial banks are private corporations Owned by individual stockholders Banks earn profits by borrowing money from depositors and lending the money to borrowers at higher interest rates than they pay to depositors Banks also earn profits by charging fees for services Checking account fees, ATM fees, estate and trust planning

1. PROVIDE SAFEKEEPING FOR DEPOSITORS' MONEY: 2. MAKE LOANS 3. AS A GROUP, BANKS CREATE MONEY

Banks lend out most of the money that has been deposited. Banks retain some of the deposits in its vault. Some of the deposits might be deposited at the local branch of the Federal Reserve System for safety purposes.

The cash that a bank has in its vault plus any deposits that a bank has at the Federal Reserve Banks earn no interest on reserves sitting in the vault or at the Fed. Thus, holding money as reserves is unprofitable. To generate profits, banks lend most of the money that has been deposited.

Every bank is required (by the Federal Reserve System) to keep a certain percentage of deposits as reserves in its vault or at the local Federal Reserve Branch Bank to satisfy any customer withdrawals of deposits. Depositing reserves at the Fed promotes safety of deposits and limits the potential loss during a bank robbery.

The minimum percentage of deposits that a bank must keep as reserves This percentage is set by the Federal Reserve Board of Governors. For most banks, the required reserve ratio is 10%.

The minimum amount of reserves that a bank must hold Required Reserves = Total Deposits x Required Reserve Ratio

= Actual reserves - Required reserves

The multiple by which the total supply of money can increase for every $1 increase in reserves. A $1 increase in bank reserves leads to a multiple increase in the money supply The amount of the ultimate increase depends on the required reserve ratio The maximum value of the money multiplier is: Money multiplier = 1 / r Where r is the required reserve ratio Final result of increasing the money supply by $1,000 When r = .10 Money expansion STEP 1 $1,000 = $1,000 x 1 = initial increase STEP 2 $900 = $1,000 x .9 STEP 3 $810 = $1,000 x .9 x .9 STEP 4 $729 = $1,000 x .9 x .9 x .9 STEP 5 $656.10 = $1,000 x .9 x .9 x .9 X .9 Total Increase in Money Supply = $10,000 = $1,000 x (1 / .10) The deposit multiplier = 1 / r Where r is the required reserve ratio

The actual money multiplier will be smaller than the theoretical money multiplier There will be leakages from the system LEAKAGE 1: Some of the funds that were loaned out by the bank will not be re-deposited in a bank. That is, the public may hold some of the money as cash. Only the money that has been re-deposited in a bank creates excess reserves. LEAKAGE 2: Some of the money that was re-deposited in the bank will not be loaned out. That is, some banks might keep excess reserves Only the money that has been loaned out increases the money supply

Suppose that many depositors want to withdraw their deposits simultaneously. This represents "a run on a bank". Can be caused by the belief that a bank does not have enough cash reserves in the vault to meet the demand for withdrawals Can be caused by knowledge (or rumors) that the bank has made bad loans If the loans default, the bank will not have enough reserves to pay off the depositors

WHY DO BANKS FAIL? Bank failure occurs when a bank is unable to meet the demands of its creditors. A bank fails when it is unable to pay cash to depositors who wish to withdraw funds. This usually occurs because the bank has made many loans that defaulted.

Instituted in 1933 Financed by insurance fees charged to banks Currently insures deposits up to $250,000 Greatly reduced the number of bank panics

Prohibited interstate banking Fear of large powerful banks

Banks cannot sell stocks and bonds, insurance or real estate Established the FDIC and deposit insurance Established Regulation Q 1. Put a ceiling on interest rates banks could pay on savings accounts 2. Prohibited interest on checking accounts

Allowed interest on checking accounts by banks and S&L's

Abolished Regulation Q interest rate ceilings