Banking

1. Banking • What are banks ? • Banks act as financial intermediaries that accept deposits and channel them into investment.

2. Fractional Reserve System • It means banks are required to keep a given fraction of their total deposits as required reserves.

3. Minimum Reserve Ratio • It means the minimum fraction of a bank’s total deposits that is legally required to be in form of cash or specific assets.

4. Why do banks keep a minimum reserve ratio ? • It can meet the usual withdrawal of deposits. • It can prevent the banks from over lending. • It can maintain the confidence of the public to the banks. This will reduce the possibility of bank run.

5. Deposit Creation ( Credit Creation ) • Assume : • Minimum reserve ratio = 25% • Mr P deposits $1 000 cash with bank A. • The working will be done on the blackboard.

6. Maximum Banking Multiplier • Maximum banking multiplier • 1 = minimum reserve ratio

7. Maximum Banking Multiplier • As the minimum reserve ratio increases, the banking multiplier will decrease. • The whole process of deposit creation is called the multiple expansion of deposits.

8. Assumptions for the maximum deposit creation • Banks keep the minimum reserve. They have no excess reserve. • Banks can lend out all money they want to lend. There are enough borrowers to borrow the loan provided by banks. • All people deposit their money into the banks. There is no cash leakage from the banks to the public.

9. Explain why the actual deposit created is smaller than the maximum deposit created. • Banks keep excess reserve. • There is insufficient demand for the loan. There are not enough borrowers to borrow the loan. • There is cash leakage from the banks to the public. People do not deposit all the money back to the banks.

10. What is the excess reserve ? • Assume the minimum reserve ratio = 20% • Total deposit = $10 000 • Reserve = $3 500 • Ans. $1 500

11. What is the excess reserve ? • Excess reserve = actual reserve – minimum required reserve = $3 500 - $10 000 X 20% = $3 500 - $2 000 = $1 500

12. What is the opportunity cost of keeping the excess reserve ? • The opportunity cost is to give up the interest earned by lending out the excess reserve.

13. Brief Description of Deposit Creation in Sequence • Assume : • the minimum reserve ratio is 20% • the initial deposit is $1 000

14. Brief Description of Deposit Creation in Sequence • If one deposits $1 000 in the bank that is an injection of new money. The bank has excess reserve that is $800. • The bank will loan out the excess reserve. • The money loaned out will be re-deposited into the bank.

15. Brief Description of Deposit Creation in Sequence • The bank will have excess reserve and loan out the money. • The process of bank deposit creation goes on. • Ultimately, the maximum total bank deposits created by $1 000 X 1/20% = $5 000. ( CE 1997 Q9c )

16. Deposit Contraction • Assume • A man withdraws $500 from his bank. • The bank does not keep excess reserve. • The minimum reserve ratio = 20%

17. What will be the maximum decrease in deposit in the whole banking system ? • The maximum deposit contracted = $500 X 1/20% = $500 X 5 = $2 500

18. Brief Description of Deposit Contraction in Sequence • Assume : • the minimum reserve ratio is 20% • the initial withdrawal of deposit is $M

19. Brief Description of Deposit Contraction in Sequence • If one withdraws $M from the bank. The bank will lose reserve. The actual reserve will be less than the required reserve. • The bank will call back loans or sell bank assets to the public.

20. Brief Description of Deposit Contraction in Sequence • Further withdrawal of bank deposit to repay the loans or to buy bank assets. • The process of bank deposit contraction goes on. • Ultimately, the maximum total bank deposits contracted by $M X 1/20% = $5M. ( CE 1995 Q10a )

21. How can banks increase the reserve to meet the minimum reserve requirement ? • The banks can call back the loan. • The banks can borrow from other banks. • The banks can sell the investment assets, e.g. shares or bonds to the public.

22. The Value of Money • The nominal value of money • It is the face value printed on the banknote.

23. The Value of Money • The real value of money • It is measured in term of the purchasing power.

24. The Value of Money • During the inflation, • The nominal value of money will remain unchanged. • The real value of money will decrease.

25. Central Bank • It is a government owned bank. • It is not profit making. • In Hong Kong, there is no central bank.

26. Functions of Central Bank • It issues the banknotes. • It serves as the lender of the last resort. • It serves as a central clearing house. • It serves as the government’s banker, agent and advisor.

27. Functions of Central Bank • It supervises the private banks. • It formulates and carries out the monetary policies. • It stabilizes the value of the currency.

28. How are Central Bank Functions Carried out in Hong Kong ? • (1) Issue the banknotes • The Hongkong and Shanghai Banking Corporation Limited, the Standard Chartered Bank and the Bank of China are responsible for issuing banknotes in Hong Kong.

29. How are Central Bank Functions Carried out in Hong Kong ? • (2) Lender of the last resort • The Hong Kong Monetary Authority serves as the lender of the last resort in Hong Kong.

30. How are Central Bank Functions Carried out in Hong Kong ? • (3) Central Clearing House • The Hong Kong Interbank Clearance Ltd. is responsible for central clearance in Hong Kong.

31. How are Central Bank Functions Carried out in Hong Kong ? • (4) Supervising the private banks • In Hong Kong, the Hong Kong Monetary Authority is supervising the private banks.

32. How are Central Bank Functions Carried out in Hong Kong ? • (5) Government’s Bank • In Hong Kong, the major banks, such as the Hongkong and Shanghai Banking Corporation Ltd and the Bank of China provide the financial services to the government.

33. Government’s Bank • The treasury ( 庫房 ) pays and collects money for the government. • The Hong Kong Monetary Authority advises the government on money, banking and financial matters.

34. How are Central Bank Functions Carried out in Hong Kong ? • (6) To stabilize the exchange rate of Hong Kong dollars • The Hong Kong Monetary Authority is responsible to stabilize the exchange rate of Hong Kong dollars.

35. Commercial Banks • They are privately owned. • They are profit making. • Their function is to channel the savings into investment.

36. Services of Commercial Banks • Accept deposits • Demand deposits • Saving deposits • Time deposits

37. Deposits • Demand deposit is a better medium of exchange because it can facilitate the exchange with the use of cheques. • Time deposit is a better store of value because it can yield higher interest.

38. Services of Commercial Banks • Grant loans • Overdrafts • Fixed loans

39. Services of Commercial Banks • Financing import / export trade • Letters of credit • Discounting a bill of exchange

40. Services of Commercial Banks • Other services • Credit cards • Gift cheques • Travellers’ cheques • Mortgage • Gold dealing • ATM services • Storage services • Mandatory Provident Fund • Investment services

41. Services of Merchant Bank • Accept the large amount deposits • Financial advisory services • Underwriting new shares • Fund management • Arranging syndicated loans

42. Financial Market • A financial market is where financial assets are bought and sold. • Financial market • Money market • Capital market • Foreign exchange market • Future market

43. Money Market • It deals with the short term financial assets. • E.g. Exchange Fund Bills, inter-bank money

44. Capital Market • It deals with the long-term financial assets. • E.g. bond and shares

45. Functions of Capital Market • The firms can raise capital by issuing shares or debentures. • It provides an opportunity for the public to invest.

46. Functions of Capital Market • It provides the liquidity to financial assets because shares and bonds are freely bought or sold in the capital market. • It can assess the prospect and financial standing of the firms through the price of the shares.

47. Why do people buy shares ? • They can earn dividends if the firm earns profit. • They can enjoy capital gains when the value of their shares is higher than the price they bought.

48. Speculation in stock market • Bull • Bear • Stag

49. Factors contributing to Hong Kong’s development as a financial centre • There is no exchange control. • There is a low tax rate system. • The financial services ( such as banking services ) are well-developed. • The telecommunication facilities are advanced.

50. Factors contributing to Hong Kong’s development as a financial centre • Hong Kong has a favourable geographical position. She is located at the middle of world trade and near China. • Hong Kong has a favourable time zone location. • There is an increasing economic link with China.