Banking and Interest Rates Flashcards
what do commercial banks create
money and credit.
How do banks increase the money supply in the economy
what does the customer then become
by granting loans, bank creates a deposit in the customers account. this is new money.
a debtor of the bank,
what is a loan to a bank
it is an asset
an asset to the bank is anything that is owned by or owned to the bank.
what is a liability for the bank
a customers deposit. anything the bank owes is a liability.
as if customer wants his money the bank has to pay.
what do banks do with each other
where do they do that and what is it called.
they lend each other money,
it is called inter-bank lending. and this occurs on the inter-bank lending market.
how long do loans usually last on the inter-bank lending market?
usually less than one week, and often only overnight.
why do banks need to lend money to each other?
on any day, some banks have excess liquidity others will have a shortage (because they received more or less than they expected in payments for example).
banks with a temporary shortage of liquidity can borrow to meet their customers’ needs. banks with extra liquidity earn interest on what they lend.
the rate charged for inter-lending between banks is called?
the inter-bank lending rate or the overnight rate.
banks have a balance sheet.
what is a balance sheet
what should happen on a balance sheet always
a snapshot in time of its assets and liabilities.
total assets should always equal total liabilities.
why is the banks capital a liability?
because if the bank ceased trading, this money would be returned to shareholders (once all the bank’s outstanding debts had been paid)
on a balance sheet how are assets organised
they go form top to being most liquid to bottom to being least liquid.
what is a banks capital?
it is the total of its share capital which is the money raised when its shares were first issued and its reserves made up from retained profits.
the amount of credit a bank can create depends on
what do banks want to keep?
its levels of capital.
banks want to keep the ratio of loans to capital within a certain limit.
what happens when the banks assets falls.
and why is that.
the banks capital is reduced by the same amount because total assets still equals total liabilities.
when does a bank become insolvent?
when the value of the banks assets becomes less than the value of its liabilities. insolvent banks usually have to close down as the central bank doesn’t usually lend to insolvent banks.
what does a bank try to achieve a balance of?
how do they do that?
the bank tries to achieve a balance of liquidity, security and profitability.
the bank will hold a variety of assets to do this. for example they will have unsecured loans which are more profitable and secured loans which are safer.
How are interest rates determined
they are determined by levels of supply and demand.
what does the loanable funds theory say
it says that interest rates are set by savers and borrowers.
it says the interest rate is determined by the supply of, and demand for, loanable funds.
what are loanable funds
the total amount of money available for borrowing.
at high interest rates the loanable theory says that
the supply of loanable funds will be higher since people save more. and demand will be lower since people borrow less.
when is the market for loanable funds at equilibrium
where the supply and demand curves cross.
the loanable funds theory works best for a
very simple economy.
what does the liquidity preference theory say.
what does it assume
that people balance risk and reward.
It assumes that people can either hold their wealth as liquid money (cash in your pocket) or illiquid bonds (bonds meaning any illiquid interest earning asset whose price can change).
when interest rates are high
bonds are more attractive
the reward of the interest outweighs the risk of a fall in price
