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Chapter 14: How Banks & Thrifts Create Money

Chapter 14: How Banks & Thrifts Create Money. Balance Sheet of a Commercial Bank (or Thrift) is a statement of assets & claims on assets that summarizes the financial position of the bank at a certain time. Liabilities: Claims of nonowners against the firm’s assets

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Chapter 14: How Banks & Thrifts Create Money

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  1. Chapter 14: How Banks & Thrifts Create Money • Balance Sheet of a Commercial Bank (or Thrift) is a statement of assets & claims on assets that summarizes the financial position of the bank at a certain time. • Liabilities: Claims of nonowners against the firm’s assets • Net worth: Claims of owners against the firm’s assets • Assets = Liabilities + Net Worth • Required Reserves: Amount of funds equal to specified % of bank’s own deposit liabilities

  2. Profits & Liquidity • The asset items on a commercial bank’s balance sheet reflect the banker’s pursuit of two conflicting goals: • Profit • Why bank makes loans & buys securities  2 major earning assets of commercial banks • Liquidity • Safety in cash & excess reserves • Compromise between assets that earn higher returns & high liquidity that earn no returns

  3. Federal Funds Market • Banks can reconcile goals of profit & liquidity by lending temporary excess reserves held at Federal Reserve Banks to other banks • Excess reserves are lent on an overnight basis as way of earning additional interest w/o sacrificing long-term liquidity • Federal Funds Market: market for immediately available reserve balances at the Federal Reserve • Federal Funds Rate: Interest rate paid on overnight loans

  4. Last Word: The Bank Panics of 1930 - 1933 • Bank panics in 1930 – 1933 led to contraction of money supply, worsening Depression • Many failed banks were healthy, but suffered as worried depositors panicked & withdrew funds all at once • Reserves & lending power fell • Roosevelt declared “bank holiday” closing banks temporarily while Congress started the Federal Deposit Insurance Corporation (FDIC), ending bank panics on insured accounts

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