Week 1 - The Financial System and Introduction of Bank's Balance Sheet

What is the primary role of financial intermediaries?

To facilitate the transfer of funds from savers to borrowers in the economy.

What is indirect finance?

The process of facilitating funds from savers to borrowers through intermediaries like banks and mutual funds.

What are the main types of financial intermediaries?

Banks, mutual funds, insurance companies, credit unions, and pension funds.

What is the traditional view of commercial banks?

They raise funds mainly by issuing deposits and use these funds to make loans and buy securities.

What are the main functions of financial intermediaries?

Risk transformation, economies of scale, information analysis, and maturity transformation.

How do financial intermediaries enhance efficiency in the financial system?

By connecting those with excess funds to those in need of funds.

What is the importance of regulatory oversight in financial intermediaries?

To ensure financial stability, protect consumers, and maintain market integrity.

What are the pros and cons of financial intermediaries?

Pros include efficiency and risk management; cons include risks of conflicts of interest and systemic risk.

What is the function of financial markets?

To provide platforms for buying and selling financial instruments like stocks and bonds.

What is the key difference between financial intermediaries and financial markets?

Intermediaries facilitate indirect transactions, while markets facilitate direct transactions between buyers and sellers.

What is a bank balance sheet?

A statement showing a bank's financial position, including its assets and liabilities on a specific day.

What are the primary sources and uses of funds for banks?

Sources: deposits; Uses: loans and securities.

What is the significance of liquidity management in commercial banks?

It ensures that banks can meet their short-term obligations while funding long-term investments.

What is risk transformation in the context of financial intermediation?

The process of diversifying risk by pooling funds from multiple investors.

What does maturity transformation refer to in banking?

The practice of borrowing short-term and lending long-term.

What role do mutual funds play as financial intermediaries?

They pool funds from multiple investors to invest in diversified portfolios.

How do financial intermediaries help in capital allocation?

By directing funds to productive projects, contributing to economic growth.

What is the importance of liquidity provision by financial intermediaries?

It ensures that funds are available for withdrawal while supporting long-term investments.

What is the role of the Federal Reserve in monetary policy?

To implement monetary policy instruments that influence the economy.

What is the significance of the capital asset pricing model (CAPM)?

It helps in understanding the relationship between risk and expected return in financial markets.

What is the primary purpose of financial markets?

To enable the transfer of ownership of financial assets between buyers and sellers.

What is the role of transparency in financial markets?

To provide price transparency as asset prices are determined through supply and demand.

What are the key activities of investment banks?

Assisting in capital raising, mergers, and acquisitions.

What is the significance of the fractional reserve banking system?

It allows banks to hold a fraction of deposits as reserves while lending out the rest.

What is the main goal of the financial system?

To efficiently allocate resources and manage risks in the economy.

What is the definition of an asset in banking?

An asset is something of value that an individual or a firm owns, particularly a financial claim.

What is a liability in banking?

A liability is something that an individual or a firm owes, particularly a financial claim on an individual or a firm.

What is bank capital?

Bank capital is the difference between the value of a bank's assets and the value of its liabilities, also known as shareholders' equity.

What does it mean for a bank to be solvent?

A bank is solvent if it has enough assets to pay off all its liabilities, with something still left for shareholders.

What are the conditions for a bank to be considered solvent?

Total Assets must be greater than Total Liabilities, and Shareholders' Equity must be greater than 0.

What does it mean for a bank to be insolvent?

Insolvency means a bank cannot repay its depositors because its liabilities exceed its assets.

What are the conditions for a bank to be considered insolvent?

Total Assets must be less than Total Liabilities, and Shareholders' Equity must be less than 0.

What is the role of the Federal Reserve in relation to commercial banks?

The Federal Reserve acts as a central bank, providing services like holding reserves for commercial banks and regulating monetary policy.

What are required reserves?

Required reserves are the minimum amount of funds that a bank must hold in reserve against deposits, as mandated by the central bank.

What are excess reserves?

Excess reserves are the amount of reserves that banks hold beyond the required reserves.

What is the formula for calculating excess reserves?

Excess Reserves = Total Reserves - Required Reserves.

What was the reserve requirement ratio in the U.S. before 2020?

Banks were required to hold a minimum fraction of checkable deposits as reserves, which was gradually sidelined and set to 0% in March 2020.

What is the purpose of reserve requirements?

To ensure liquidity for meeting withdrawals and payments and to promote stability in the banking system.

How did the reserve requirement change after March 2020?

The reserve requirement ratio was reduced to 0%, meaning U.S. banks are no longer legally required to hold reserves.

What is the traditional view of the reserve requirement ratio?

The central bank determines the reserve requirement ratio based on economic conditions, inflation targets, and banking system stability.

How do commercial banks calculate required reserves?

By considering the amount of checkable deposits and the reserve requirement ratio.

What happens to excess reserves in modern banking practice?

Excess reserves mainly serve as liquidity buffers rather than being lent out.

What is the significance of negative shareholders' equity?

Negative shareholders' equity is a sign of insolvency and indicates that a bank cannot meet its long-term financial obligations.

What is the relationship between the Federal Reserve's balance sheet and commercial banks' balance sheets?

The reserves of commercial banks appear as liabilities on the Fed's balance sheet and as assets on commercial banks' balance sheets.

What is the formula to calculate required reserves?

Reserve Requirement = Amount of Checkable Deposits × Reserve Requirement Ratio.

What are the required reserves for $8,000,000 in checkable deposits with a 10% reserve requirement?

$800,000.

What does it indicate if a bank's reserves are greater than the required reserves?

The bank is compliant with the reserve requirement.

What are the main sources of bank assets?

Funds received from depositors, borrowings from other institutions, initial shareholder investments, and retained profits.

What constitutes a bank's reserves?

Vault cash and deposits held at the Federal Reserve Bank or central bank.

What are marketable securities?

Liquid assets that banks trade in financial markets, including U.S. Treasury securities and corporate bonds.

What is the largest category of bank assets?

Loans.

What are the two main categories of loans banks provide?

Non-mortgage loans (commercial and consumer loans) and mortgage loans (residential and commercial).

What is collateral in the context of bank loans?

An asset provided as a guarantee for a loan, allowing the lender to recover losses if the borrower defaults.

What are demand deposits?

Checkable deposits on which banks do not pay interest.

What are NOW accounts?

Negotiable order of withdrawal accounts that are checking accounts paying interest.

What are fixed-term deposits?

Deposits that include savings accounts and certificates of deposit (CDs).

Why are borrowings considered a liability for banks?

They represent obligations that the bank must fulfill in the future.

What is the purpose of bank capital?

To act as a cushion against a drop in the value of its assets, preventing insolvency.

What were reserve requirements in banking?

Regulations obliging depository institutions to hold a fraction of their checkable deposits as reserves.

When were reserve requirements eliminated in the U.S.?

In March 2020.

What are cash items in the process of collection?

Claims banks have on other banks for uncollected funds.

What are the risks associated with loans compared to marketable securities?

Loans are illiquid, have greater default risk, and incur higher information costs.

What types of loans fall under non-mortgage loans?

Commercial and industrial loans to businesses and consumer loans to households.

What is the significance of collateral after a loan default?

It enters the bank's assets as the lender takes over the collateral.

What is the role of the Federal Reserve in relation to bank reserves?

It holds deposits that banks maintain as reserves.

What are the implications of a bank having excess reserves?

It can lend more money, potentially increasing its profitability.

What is the primary function of a bank's balance sheet?

To provide a snapshot of the bank's assets, liabilities, and equity.

What is the relationship between checkable deposits and bank liabilities?

Checkable deposits are liabilities for banks and assets for households and firms.

What is the impact of interest-bearing accounts on customer deposits?

They incentivize customers to keep their money in the bank to earn interest.

What is the significance of the changing mix of bank loans from 1973 to 2012?

It reflects shifts in banking practices and economic conditions over time.

What is the importance of financial data sources for banks?

They provide essential information for decision-making and risk management.