banking, money and interest rates 18.1, 18.3 - 18.5

what is money’s main function

a medium of exchange

financial intermediaries

general name for financial institutions who act as an intermediary for depositors and borrowers

maturity transformation

where financial intermediaries loan for longer periods of time to borrowers for bigger financial purchases eg. a house

risk transformation

dispersing the risk of borrowing among larger numbers as they absorb the loss through interest rates

transmission of funds

transmitting payments using credit cards, debit cards, cheques etc…

the different types of bank

retail and wholesale

wholesale banking (deposits and loans)

receiving or depositing large loans from companies or to other financial institutions

wholesale deposits and loans

large scale loans and deposits made by firms and negotiated at interest rates

retail banking

banks operating for individuals and businesses eg. HSBC

functional seperation

the separation of retail and wholesale banking by using a limit: ring-fenced banks (RFB) for firms with over £25 Billion 

building societies

member-owned where profits are reinvested for the benefit of its members

financial deregulation

the removal or reduction of legal rules and regulations surrounding the actions of financial institutions 

monetary financial institutions (MFIs)

used to describe deposit taking institutions eg Bank of England

money markets

the market for short term debt instruments eg. treasury bills

financial instruments

financial products resulting in a financial claim by one party over another

monetary base/ high-powered money

cash (notes and coins) in circulation outside of the central bank.

broad money

the means of measuring a country’s money supply typically includes times and sight deposits, retail and wholesale deposits, bank and building society deposits

bank deposits multiplier

based on the liquidity ratio, the rate at which deposits can rise

1/l

bank’s liquidity ratio 

differ from each bank as they choose their own liquidity ratio

why might a bank want a higher liquidity ratio?

if they are worried about increased risks on default loans

near money

highly liquid assets (other than cash) eg. saving accounts

non-bank private sector

households and non-bank firms

money multiplier

the overall multiplier , delta Ms(total broad money supply)/ delta Mb (monetary base)

total money supply (Ms) equation

total money supply (Ms) = deposits in banks and building societies (deltaD) + cash held by public (deltaC)

monetary base (Mb) equation

monetary base (Mb) = building society reserves (deltaR) + cash held by public (deltaC)

what causes money supply to rise?

central bank action, inflow of funds from abroad, public sector deficit

central bank action

when ms is low, central banks may turn to quantitative easing (QE).

inflows of funds from abroad

when sterling is used to pay for UK exports into UK banks by the exporters, credit can be created on it which increases the domestic money supply. If depositors decide to switch their payments to go through UK banks then this also can create very large fluctuations and cause a push in money supply

public-sector deficit

the difference between public-sector expenditure and public-sector deficit. in order to finance the public-sector deficit they must borrow. What they are allowed to borrow any one year is called the public-sector net cash requirement (PSNCR)

bank deposits multiplier equation

1/L (liquidity)

inverse of the liquidity ratio

broad money multiplier equation

m= (1+c)/(r+c’)