ch 30 the monetary system part 2
TRANSCRIPT
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Chapter 30Part 2
The Monetary System
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Bank Capital
The money the bank’s shareholders have put in
to the bank
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Leverage
OPM
Using other people’s money
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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
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Leverage Ratio
The ratio of assets to bank capital
AssetsBank Capital
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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
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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
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Leverage Ratio of 20
Owners put up 1
Depositors put up 19
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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
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Capital Requirement
Government rule on minimum amount of
bank capital
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Insolvent
Liabilities are more than the assets
You owe more than you own
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Three Tools of Central Banks
Open-Market Operations
Discount Rate
Reserve Ratio
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Open-Market Operations
Purchase and sale of government bonds
Buy bonds increases supply
Sell bonds decreases supply
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Banksnow have
more cash to loan
Central Bank
Public Banks
Increase Money Supply?Buy bonds for cash
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Banksnow have less cash to loan
Central Bank
Public Banks
Decrease Money Supply?Sell bonds for cash
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Discount RateThe rate the central bank charges to make loans to
member banks
Called the Official Repo Rate or ORR rate in Saudi Arabia
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Official Repurchase Rate or Discount Rate
2.0%
Dropped from 2.5% on January 19, 2009
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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
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Reserve Ratio
Increase reserve ratio will reduce money multiplier
Decrease reserve ratio will increase money multiplier
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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
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Reserve RatioNot changed very often
What is the current reserve ratio in Saudi Arabia? 7%
What is the Money Multiplier?
1÷7% = 14.28
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Bank Deposit Insurance
Protects against bank runs
Moral Hazard to take more risk because government
will pick up losses
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Bank RunCustomers all want their money at the same time
Many banks runs at once
Bank Panic
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Quiz 5 Name______________ ID_________
1. What is financial leverage?
2. How do you calculate a bank’s leverage?
3. What are the three tools that SAMA can use to manage the money supply?
4. If SAMA buys bonds, what happens to the money supply?
5. If SAMA lowers the ORR what happens to the money supply?
6. If SAMA lowers the reserve requirement what happens to the money supply?
7. Does deposit insurance make bankers more or less risky?
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Zimbabwe, Nov. 2008 Highest monthly inflation: 79,600,000,000%Prices doubled every: 24.7 hours
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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