Money and Banking Flashcards
Chapter 18
what is the role of money?
money acts as the connection link in the exchange process.
what were disadvantages of the bartering system?
double coincidence of needs and wants, uncertainly of exchange rates, goods are not of uniform quality, problem of divisibility, specialisation and division of labour in the economy are discouraged
what are the characteristics of money?
recognisable, acceptable, portable durable, scarce, homogenous and fungible, can be subdivided into small units
what is the golden standard ?
a currency where notes are fully backed and redeemable in an equivalent amount of gold
define money!
anything that is generally accepted by people in exchange for goods and services or repayment of dept
what are the functions of money?
a medium of exchange,
a measure of value/ unit of account,
a standard for deferred payments,
a store of value/wealth
is money unique as a store of value?
no.
land, houses, jewelry, gold, boats, works of art,… can provide a better store of value
what forms can money have?
cash (notes and coins), cheques, electronic payments/ plastic money, automated teller machine (ATM) cards, debit cards, credit cards,
describe the evolution of our payment system!
barter - precious metals (gold and silver) - paper currency (fiat money) - cheques - electronic means of payment - electronic money (debit and credit cards) - internet banking
what/who is the ECB
european central bank
formed in Frankfurt, germany in 1998,
it works with the central national banks of each EU member states to formulate the European system of central banks (ESCB),
responsible for conducting monetary policy in the eurozone
what are the key functions of the ECB?
maintain price stability,
formulate and implement EU monetary policy,
hold and manage the official reserve of the euro area countries,
financial stability and supervision,
sole right to issue euro currency
what is monetary policy?
those actions by the ECB that influence money supply, interest rates and the availability of credit.
how can the ECB implement monetary policy within the eurozone countries?
- Monitoring the growth of money supplies ( relative to the value)
- engaging in open market operations,
- interest rates.
- use of standing facilities
- minimum reserve requirements
trough what ways has the ECB an immense impact on the Irish economy?
monetary policy ,
emergency liquidity assistance (ELA)
what is the role of the central bank in Ireland?
prints/issues legal tender, government bank, regulator of financial sector, official external reserves, maintains price stability, Financial stabiliy, provides costumer information, consumer protection, the banker's bank, lender of last resort
what are commercial banks?
instructions that provide deposit and lending services to personal consumers and businesses
what banking needs do commercial banks handle?
current and saving accounts, personal and business deposits, credit cards, mortgages and personal loans, advice to businesses, processing payments and transactions, night safe facilities, foreign exchange, act as trustees and executors of wills
name examples of commercial banks in Ireland!
AIB (Allied Irish Bank)
Banks of Ireland
Ulster Bank
what are merchant (Wholesale) Banks?
they deal with the commercial banking needs of international finance, long term company loans and stock underwriting.
what are industrial banks?
they specialize in providing installment credit to personal borrowers and companies in the form of fixed-term loans and hire purchase facilities.
what is a credit union?
a group of people who save together and lend to each other.
every union is owned by its members.
it exists only to serve its members and not to profit from their needs.
what is a post office?
a national Organisation that provides a wide rage of services which encompass postal, communicational, retail and financial services.
people can buy savings products offered by an post, as it acts as an agent of the national treasury management agency (NTMA)
how can one measure the supply of money?
currency in circulation
current account balances
deposit account balances
all other loan instruments uo to 2 years
what is the primary liquidity ratio/ liquidity coverage ratio?
the amount of money with respect to short-term deposits that the central bank requires commercial banks to keep in cash form.
e.g it the ratio is 10% , the bank will need to keep 10 euro for every 100 euro deposited.
what is the capital adequacy ratio?
the percentage of a bank’s capital to its risk-weighted assets. Tier 1 capital is comprised of profits (i.e. retained earnings) and certain types of shares. effectively, this is the amount of back-up a bank has apartnfrom cash as security
e.g. common shares
define profitability for a bank!
refers to the need for a bank to make as much profit as possible from its assets to satisfy its shareholders. the more profitable the asset is, the less liquid it is.
define liquidity for a bank!
refers to a banks need to have liquid assets in order to meet the demand for cash by its costumers. the more liquid the asset is , the less profitable it is.
what are an banks twin objective and how does a bank reconcile these?
profitability and liquidity
banks must satisfy their customers needs for cash i.e. they must have enough liquidity
but cash doesn’t earn interest and banks also wish to be profitable
they tend to compromise in having sufficient liquidity and yet earning profits.
what are the restrictions that limit the power of commercial banks to create infinite credit?
- BANKING RATIOS ( primary liquidity ratio and capital adequacy ratio)
- EUROPEAN CENTRAL BANK GUIDELINES
- LIMITED OPPORTUNITIES for credit extension via a limited supply of creditworthy customers
- an economic recession would lower confidence, employment and the number of successful businesses. as a result, loans may not be demanded in a recessionary period to the same extent as in a period of growth.
what is the impact of the explosion of plastic money?
i.e. use of credit cards, etc…
+ credit is easier to use when you don’t have to apply for a loan month-on-month, but instead just hand over a card and tap in a PIN. as a result, plastic card use enables banks to create more credit.
+ since credit cards are so popular today, banks need to take into account the lending provided by these plastic cards when calculating their bank rates.
how could the tightening in the availability of credit affect the motor industry ?
DECREASED DEMAND FOR CARS
less consumers can purchase a car. fall in demand for new and for second-hand cars
INCREASED REDUNDANCIES
less demand for cars - number of people employed in the motor industry and the sale of cars could decline
BUSINESS CLOSURES / CONSOLIDATIONS
many small car dealerships may not survive and would be forced to close. inability to get credit results in cash flow problems, inability to pay suppliers and possible closure of the firms
how could the tightening in the availability of credit affect inflation ?
INFLATION WOULD DECREASE
the supply of money / credit will fall, causing a decrease in the amount that individuals have to spend. this fall would lead to a reduction in demand-pull-inflation
DEFLATION
the price of goods and services may fall due to falling demand and cost of production
how could the tightening in the availability of credit affect irelands balance of payments?
IMPORTS INCREASE
less demand for goods and services - automatic fall in demand for imports
EXPORTS DECREASE
businesses would not be able to avail of credit in order to expand their businesses. this fall in investment may lead to an decrease in exports
what is the nominal interest rate?
the interest rate unadjusted for inflation
e.g. interest rate 3%, you deposit 100 euro, you’ll have 103 euro a year later
what is the real rate of interest?
the nominal interest rate minus the rate of inflation?
e.g. interest rate 3% , you deposit 100 euro , inflation rate 2% , now your return is only 1% more worth (not 3% )
how can you loose money whilst saving?
if the inflation rate is bigger then the interest rate, your money might loose value.
what are the effects of an increase on interest rates on the Irish economy?
know 3 !
SAVINGS ENCOURAGED
higher rates of return, it becomes more attractive to save more and spend less
COST OF SERVICING NATIONAL DEPT
higher interest rates, cost of repaying the national debt rises
COST OF PRODUCTION / IMPROVED COMPETITIVENESS
rising cost of capital - increased cost may be passed on, resulting in higher prices (inflation), lower employment and/or reduced margins
INCENTIVE TO INVEST
fewer companies will want to invest - disadvantage
ECONOMIC GROWTH IS DAMPENED
lower investment and less disposable income in the pockets of mortgagees, economic growth is hampered
REVENUE RECEIVED FORM DIRT
higher savings, government may receive more revenue from DIRT.
what are the effects of a reduction on interest rates on the Irish economy?
know 3!
SAVINGS DISCOURAGED
lower rates of return, less attractive to save, more spending
INCREASED DEMAND FOR HOUSES
lower cost of borrowing, increased demand for properties
COST OF SERVICING THE NATIONAL DEPT
cost of repaying the national dept falls
COST OF PRODUCTION/ IMPROVED COMPETITIVENESS
lower cost of capital, reduction in cost may be passed on. or increases the margin of the business. employment may be increaed.
INCENTIVE TO INVEST
higher marginal efficiency of capital - higher profits. investment is encouraged, as it becomes cheaper for businesses to borrow
ECONOMIC GROWTH ENCOURAGED
possibly higher investment, increased future economic growth
REVENUE RECEIVED FROM DIRT
less savings, government may receive less revenue from DIRT (but greater from gains tax on investment profits)
what does NAMA mean?
national asset management agency
what are the consequences of NAMA ?
- banks were prevented from insolvency or very serious problems as Nama paid them for large commercial property loans
- artificial floor was put under the falling property market
- banks received fresh capital so that they could lend to businesses . they could stay open and generate profits for the banks, increasing borrowers sustainability and their own profitability.
- no resources taken away from the government to spend on public services.
what is an interbank market ?
… a market, where banks lent to one another.
e.g. if one Irish bank needs short-term funds, it could borrow from another Irish bank or a foreign bank over night.
