Lecture 1 - Banks and Financial Intermediation Flashcards
What is Fractional Reserve Banking?
Banks only keep a fraction of the money people have deposited with them “on reserve” in case people come looking for their money. They lend it out to other people.
Liabilities are:
sources of the bank’s funds (where it got them from)
Assets are:
use of funds (what they did with them)
Net interest
The bank’s interest earned minus its interest paid
Net Interest Margin
average interest rate earned on assets minus average interest rate paid on liabilities
Convenience yield
low interest rate on overnight deposits
A bank’s income statements lists its:
revenues and expenses
Fractional-reserve banking advantages:
Saves Depositors Money
Financial Intermediation
Financial Intermediation:
Banks are an intermediary between those that have money and those that need to borrow money.
Why do we need financial intermediaries?
Polling Savings
Risk Diversification
Information Processing
Maturity Transformation
Disadvantage of fractional-reserve banking:
potential for instability - may be a run on the bank
Run on the bank
lots of depositors look to get their money back.
Maturity Mismatch
the average maturity of a bank’s assets is longer than the average maturity of its liabilities
Things Financial Intermediaries help you do:
Buying a house
Starting a Business
Insurance - insurance companies are financial intermediaries that takes the money from those looking to be insured and use the funds to pay out to those that need the money due to bad luck.
Maturity Transformation
Banks or other financial institutions borrow funds with short-term maturities and subsequently lend those funds with long-term maturities. This can lead to maturity mismatch.
