Money and the Financial System Flashcards
What are the four purposes of money
Medium of exchange
Means of storing wealth
Means of evaluation
Means of establishing value of future claims and payments
What is the role of banks in the economy
Facilitate moving money Risk transformation Maturity transformation Expert advice Transmission of funds Expertise in channelling funds
What are the three levels of money
Narrow money
Intermediate money
Broad money
What is Narrow money M1
currency in circulation with the public and overnight deposit
What is Intermediate money M2
M1 + deposits with agreed maturity up to two years + deposit redeemable up to three month’s notice
What is Broad Money M3
M2+ repos+ money market funds and paper + debt securities with residual maturity up to two years
Define MFI
Monetary financial institution - Deposit taking institutions including central banks, credit institutions, other deposit taking corporation and money market funds
Explain the two types of credit institution
Retail banking -Branch, telephone, postal and internet banking for individual and business at published rate of interest and charges
Wholesale banking - where banks deal in large-scale deposits and loans mainly with companies and other banks and financial institutions. Interest rates and charges may be individual and negotiable
What are a banks assets
Cash including reserve balances
Market loans - especially for retail banks
Bills of exchange
Reverse repos
Advances - short term loans ex: overdraft
Investments
Define assets
Possession or claims held on others
Define market loans
Loans made to other financial institutions
Define bills of exchange
A certificate promised to repay a stated amount on a certain date (usually 3 months from issue). No interest is paid but sold at a discount and redeemed at a face value
Define reverse repo
When assets are purchased under a sale and repurchase agreement, these become an asset of the purchaser
What are liabilities of a bank
Sight deposits Time deposits Sale and repurchase agreements Certificates of deposits Capital
Define liabilities
All legal claims for payment that outsiders have on an institutions
Define sight deposit
Deposits that can be withdrawn on demand without penalty
Define time deposit
Deposits that require notice of withdrawal or where a penalty is charged for withdrawals on demand
Define certificate of deposit
Certificates issued by banks for fixed ter, interest bearing deposits. They can be resold by the owner to another party
Define sale and repurchase agreement
An agreement between two financial institutions whereby one in effect borrows from another by selling its assets agreeing to buy them back at a fixed price and on a fixed date
Define a maturity gap
The difference in the average maturity of loans and deposits - banks should very much consider this - banks get a benefit from the maturity gap and additional maturity.
Define the liquidity ratio
The proportion of a bank’s total assets held in liquid form
Explain profitability key idea from banks perspective
Interest higher on lending than deposit
Explain liquidity from a banks perspective and the key ideas
Ease at which an asset can be converted to cash without loss
The more liquid an asset the less profitable
Cash is least profitable asset you can hold
What is the role of central banks
Issues notes
Operates banking functions
Agent of government policy
Provides liquidity
Define discount and repo market
Banks borrowing from central banks
Define parallel money market
Interbank markets, Inter company Deposit markets, foreign currency market, commercial paper market
Define secondary markets
Where an asset is sold before maturity to another institution or individual. Anywhere an asset is getting sold before maturity to another institution or individual not involved in the primary transaction
Explain securitisation
Where future cash flows (ex: from interest rate of mortgage payments) are turned into marketable securities ex: bonds
What is the securitisation chain
Lender sells assets to SPV
SPV sells secured assets to bond holders
Bond holder gives cash to SPV
SPV gives proceeds form notes to lenders
What does SPV stand for
Special purpose vehicle
Explain the bank deposits multiplier in context of credit creation
Number of times greater the expansion of bank deposits is than the additional liquidity in banks that caused it: i/L (inverse of the liquidity ratio)
Define the money multiplier in context of credit creation
The number of times greater the expansion of money supply is than the expansion of the monetary base that caused it
How do liquidity ratios work in the real world
As you receive more deposit your liquidity ratio will change. Liquidity ratio will not be constant over time
Banks may not operate a simple liquidity ratio - may not be one ratio for everything - different portfolios or commercial loans vs residential roles or credit card advances may have different views on the liquidity ratio
What increases supply of money
Banks reduce liquidity ratio
Non-bank private sector chooses to hold less cash - putting it back into the financial system means there’s more money
A public sector deficit - government spending
Inflow of funds from abroad
Define exogeneous money supply
money supply that does not depend on the demand for money but is set by the authorities - not dependent on interest rates
Define endogenous money supply
Money supply that is determined (at least in part) by the demand for money
Explain the transaction motive for holding money
Require balances of money to conduct transactions(medium of exchange)
Explain the Precautionary motive for holding money
to deal with unforeseen circumstances or uncertainty over timing of receipt/payments ex; if my car breaks I have money available for unexpected events
Explain the speculative motive for holding money
using money as an asset when ex: Anticipating a fall in the value of other assets categories (means storing value)
What determines the demand for money
Money national income
Frequency at which people are paid
Financial institutions
Speculation about future returns on assets
What effect foes money supply increasing have on the key economic indicators
Interest rate goes down so investment increases while saving decreases
Demand for foreign assets increases so exchange rate decreases
This means exports increase and imports decrease
Aggregate demand increases overall and GDP and Prices rise
