Meeting _19 - US Banking System (Example)

Meeting _19 - US Banking System (Example) - Bank...

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Unformatted text preview: Bank Organization and Money Creation 1. Obtain a charter through the Comptroller of the Currency or State Treasurer's Office Raise financial capital for Moo Bank Buy Equipment Accept Deposits 1. 1. 1. Bank Organization and Money Creation (Cont) 1. Establish a reserve account at the Fed Can send all, none, or some of cash to Fed Bank Organization and Money Creation (Cont) 1. Check Clearing Customer writes check from his Moo Bank account to a second party Second party deposits check into their Comp Bank account Comp Bank sends check to the Fed Fed credits Comp Bank account and debits Moo Bank account Fed forwards check to Moo Bank Moo Bank reduces checkable deposits by amount of check Bank Organization and Money Creation (Cont) 1. Bank purchases government securities Purchased from other bank, Fed, business, or individuals 1. Making and spending loan Reserve Requirement Ratio Repeat process in #6 Example Steps 2 - 8 Moo Bank Balance Sheet (Step 2 - Raise Financial Capital) Assets Cash $200,000 Liabilities Owner's Equity $200,000 Total Assets $200,000 Total Liabs $200,000 Moo Bank Balance Sheet (Step 3 Buy Equipment) Assets Cash $0 Liabilities Owner's Equity $200,000 Equipment Total Assets $200,000 $200,000 Total Liabs $200,000 Moo Bank Balance Sheet (Step 4 Accept Deposits) Assets Cash $120,000 Liabilities Checkable Deposits $120,000 Equipment Total Assets $200,000 $320,000 Owner's Equity Total Liabs $200,000 $320,000 Moo Bank Balance Sheet (Step 5 Establish Fed Reserve Account) Assets Cash Reserves at Fed $0 $120,000 Liabilities Checkable Deposits $120,000 Equipment Total Assets $200,000 $320,000 Owner's Equity Total Liabs $200,000 $320,000 Moo Bank Balance Sheet (Step 6 Clearing Check for $20,000) Assets Cash Reserves at Fed $0 $100,000 Liabilities Checkable Deposits $100,000 Equipment Total Assets $200,000 $300,000 Owner's Equity Total Liabs $200,000 $300,000 Mike writes check to CZJ Corp for $20,000 CZJ Corp deposits check in its account at Comp Bank CZJ checkable deposit account at Comp Bank is credited Comp Bank sends electronic copy of the check to the Federal Reserve Regional Bank. Fed adds $20,000 to Comp Bank account and subtracts $20,000 from Moo Bank account Fed sends copy of the original check to Moo Bank Moo Bank reduces checkable deposits by $20,000 (takes it out of Mike's account) Moo Bank Balance Sheet (Step 7 Purchase Government Securities) Assets Cash Reserves at Fed Government Securities Equipment Total Assets $0 $40,000 $60,000 Liabilities Checkable Deposits $100,000 $200,000 $300,000 Owner's Equity Total Liabs $200,000 $300,000 Moo Bank Balance Sheet (Step 8 Make and Spend Loan) Assets Cash Reserves at Fed $0 $100,000 Liabilities Checkable Deposits $100,000 Equipment Total Assets $200,000 $300,000 Owner's Equity Total Liabs $200,000 $300,000 Make and Spend Loan Assume (in our example) reserve requirement ratio is 25% Required Reserves are therefore $25,000 ($100,000 * .25) ($100,000 - $25,000) Leaves $75,000 in Excess Reserves Loan out all of excess (Do not have to loan out all) Assume all $75,000 is spent Follow Step 6 procedures for processing Moo Bank Balance Sheet (Step 8 Make loan) Assets Cash Reserves at Fed Loans $0 $100,000 $75,000 Liabilities Checkable Deposits $175,000 Equipment Total Assets $200,000 $375,000 Owner's Equity Total Liabs $200,000 $375,000 Moo Bank Balance Sheet (Step 8 Spend loan) Assets Cash Reserves at Fed Loans $0 $25,000 $75,000 Liabilities Checkable Deposits $100,000 Equipment Total Assets $200,000 $300,000 Owner's Equity Total Liabs $200,000 $300,000 HOW BANKS CREATE MONEY Use required Reserve ratio Set by Fed (FOMC) Excess Reserves Deposit Excess loaned Extra deposits made Money created There is $75,000 in NEW money in the banking system How much money is created by each bank in the system? How much money is created in the system? What are the limitations to money creation? Money Creation in the Banking System Assume the $75,000 loan was given to Mike Mike spends money at Kinky's Whip Emporium (his wife is an avid horse rider) Kinky deposits in his account at Spurs and Chains National Bank (SCNB) SCNB now has additional reserves to loan out (remember 25% reserve requirement ratio) 75% of the $75,000 ($56,250) Money is loaned out and process is repeated throughout the system DEPOSIT MULTIPLIER Reserve Requirement = 25% BANK DEPOSITS POTENTIAL NEW LOANS Moo Bank SCNB 3rd 4th 5th 6th 7th All Others Total $75,000 $56,250 $42,188 $31,641 $23,730 $17,798 $13,348 $75,000 $56,250 $42,188 $31,641 $23,730 $17,798 $13,348 $40,045 $300,000 Equation for Entire System Total money created = (Deposit Multiplier) * Initial excess DM = 1_________ Required Reserve Ratio 1 25% = 1 .25 = 4 DM = Total money created = (1/RRR) * Initial excess For our example Total money created = (1/.25) * $75,000 = $300,000 ...
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This note was uploaded on 04/14/2008 for the course ECON 101 taught by Professor Thompson during the Spring '06 term at Mines.

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