Central Banks

Question 1

What are the functions of a central bank?
*Note that these functions are not carried out by all banks

(8)

Answer 1

Main goal: Manage inflation in the country

1) Issuance of currency
2) Implementation of monetary policy
3) Controlling of money supply
4) Act as a lender of last resort
5) Setting of official interest rate (in sg, it is set by the market, not MAS)
6) Managing of foreign exchange rate and gold reserves
7) Managing foreign exchange rate
8) Regulation and supervision of the banking industry

Question 2

What is the Trilemma of a central bank?

3

Answer 2

The central bank has to balance:

1) Open economy
2) Monetary policy
3) Exchange rate policy

Question 3

What are the main monetary policy instruments made available to central banks?

(3)

Answer 3

1) Bank reserve requirement
- The minimum reserves each bank must hold to satisfy withdrawal demands

2) Interest Rate Policy
- Change in money supply to target i/r

3) Open market operation
- Buying and selling government securities or other instruments
- Serve the purpose of controlling money supply
e. g. To increase liquidity, central bank sells more in the REPO market, banks buy and more money will be injected

Question 4

How to regulate the financial industry?

5

Answer 4

1) Permissible Financial activities
- Commercial banking activities: e.g. full banks, qualifying full banks, finance companies, etc
- Investment banking activities: e.g. Glass Steagall Act, Gramm-Leach-Biley Act

2) Interest rate ceiling on deposit/loan
3) Geographic restrictions on branches
4) Capital requirement of commercial banks

5) Deposit insurance:
- US$250,000 per depositor > regulated by Federal Deposit Insurance Corporation (FDIC), US
- S$75,000 per depositor per bank (not by account!) > regulated by Singapore Deposit Insurance Corporation (FDIC)

Question 5

How does the deposit insurance work?

Answer 5

Even if a bank goes bankrupt, this particular amount will still be around due to deposit insurance.

Question 6

What is the Glass Steagall Act?

Answer 6

It separated investment and commercial banking activities in response to the commercial bank involvement in stock market investment.

This mixing of commercial and investment banking was considered to be too risky and speculative and widely considered to be a culprit that led to the Great Depression.

Question 7

What is the Gramm-Leach-Biley Act?

Answer 7

Allows banks to offer financial services previously forbidden by the Glass-Steagall Act.

Under the GLBA, each manager or service-person is only allowed to sell or manage one type of financial product/instrument.

All banks must share their information-sharing practices with the customer.