Macroeconomics Unit IV: Banks

CREATING A BANK

Transaction #4

• depositing reserves in a Federal Reserve Bank

Reserve Ratio 

• (commercial banks required reserve) / (commercial banks checkable deposits - liabilities)

Required Reserves 

• (checkable deposits x reserve ratio) 

Excess Reserves

• (actual reserves - required reserves) 

How Banks Work

Assets

• reserves:
• required reserves (RR): % required by Fed to keep money on hand to meet demand 
• excess reserves (ER): % reserves over and above the amount needed to satisfy the minimum reserve ratio set by the Fed
• loans to firms, consumers, and other banks (earn interest)
• loans to the government = Treasury security
• bank property: if the bank fails, could liquidate the property

Liabilities and Equity

• demand deposits: money put into bank
• timed deposits (CD's) 
• loans from: Federal Reserve and banks
• shareholder's equity: (to set up a bank must invest own money in to to have a stake in the banks success or failure)

Key Principles

• a single bank can create money (through loans) by the amount of excess reserves
• the banking system as a whole can create money by a multiple (deposit or money multiplier) of the initial ER.

Key Information: Initial Deposits

• Cash is existing money, that increases bank reserves, and is not a change in money supply
• Fed purchase of a bond from the public is new money, that increases bank reserves, and is a change in money supply
• Bank purchase of a bond from the public is new money, that increases bank reserves, and is a change in money supply

Factors That Weaken Effectiveness of Deposit Multiplier

1. if a bank fails to loan out all of their ER
2. if bank customers take their loans in cash, rather than in new checking account deposits, it creates a cash or currency drain.