Money and Banking Flashcards
definition of money
anything accepted by the majority of people in the exchange for goods and services or in repayment of debt
definition of barter
the direct exchange of goods/services for other goods/services
double coincidence of wants
If i want to exchange one good for another, not only must I find the person with that good I am looking for, but they also must want the good I have
functions of money
- acts as a means of exchange (overcomes double c)
- acts as a measure of value (relative value of a product is shown by the amount of money they are worth)
- acts as a means of deferred payment (enables the operation of an efficient credit system)
- acts as a store of wealth (facilitates saving)
token money
money that has an exchange value rather than an intrinsic value
why is credit important
industry cannot develop without it
most customers couldn’t buy expensive durables with it
characteristics of a good money form
- instantly recognisable as genuine money
- generally acceptable ie people should have confidence in it as a medium of exchange
- portable ie should be able to carry around large amounts safely and inconspicuously
- reasonably durable, not costly to replace
- divisible into units of small value ie enables the purchase of small goods, facilitates giving change
- scarce in relation to demand, this is a characteristic of an economic good
bank deposit
a claim on the bank/a form of money
a person may lodge money into the bank
or a bank a/c is created when a person takes out a loan
money can them be withdrawn
legal tender
any money form which must be accepted in settlements of debt
eg notes/coins
a cheque is NOT legal tender
the money supply
three categories:
M1
M2
M3
m1
narrow money supply
currency outstanding and overnight deposits and current accounts
less than 1 year
m2
intermediate money supply m1 +: post office savings bank deposits up to 2 years
m3
broad money supply
m2 +:
debt securities over 2 years maturity ie bonds
repurchase agreements
liquidity
how readily an asset can be converted to cash
primary liquidity reserve ratio
cash: claims
the ratio of cash, which banks must hold to claims on the bank
commercial banks create money by
giving loans
people deposit cash with them, they give out loans to a multiple of the cash deposited
example of creating credit
- A lodges €100. assuming a reserve ratio of 10%, the bank must keep €10 for any cash claim by A
- the €90 left represents 10% of the maximum that could be loaned to B
- to satisfy the reserve ratio, to give B a €900 loan, they must have €90 ie 10%, and they do
- thus the bank has created a €900 claim on the bank
formula for the increase in money supply
increase in cash x (1 ÷ reserve ratio) - initial increase in cash
limitations of credit creation by banks
- the value of its cash deposits
- can only lend to customers that are capable of repaying the loans
- any changing of PLR and capital adequacy ratio
- credit guidelines set by ECB and CB
- economic recession (less demand for loans)
effect of plastic money on banks ability to create credit
-positive effect-
allows banks to create more credit
people use cards instead of coins, they demand less cash from bank
therefore, banks keep less money on reserve and can reduce the reserve ratio and give out more credit
how can the supply of credit affect the economy
- inflation, more credit is created= more money to lend out
- industry, certain industries are heavily dependent on credit
- imports and exports, businesses can use credit to invest in selling abroad
- banking vulnerability, excessive lending= vulnerable if borrowers cannot repay
effect of reduction in availability of credit
- decrease in industries which require credit ie motor industry (less people buying new cars)
- deflation due to fall in demand for goods
- imports decrease, exports decrease
banks twin objectives
profitability
liquidity
must have a balance between them, as per the diagram
profitability
refers to a banks need to make as much profit as possible from its assets to satisfy shareholders
the more profitable an asset is, the less liquid it is
liquidity (long answer)
refers to banks need to have liquid assets in order to meet the demand for cash by its customers
the more liquid an asset is, the less profitable it is
by focusing on profitability at the expense of liquidity…
banks may give loans to high risk borrowers eg commercial property developers, as they are very profitable but highly illiquid may run the risk of : increasing bad debts falling share prices bank failure
by ignoring liquidity requirements..
banks may not have enough cash to meet the demand of their depositors
could result in a run on the banks ie bank failure
