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Ahmad Chapter 18
Banking Money & Interest Rates
41
Economics
Undergraduate 1
02/24/2013

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Term
Functions of Money
Definition
A medium of exchange - can use £ to pay for goods and services A means of storing wealth - we can store and save £. A means of evaluation - £ lets us compare the value of different goods and services
Term
Financial intermediaries
Definition
Banks and other financial institutions are financial intermediaries because they are the link between borrowers and lenders.
Term
Is cash or deposits in banks and other financial institutions the main type of money in a country?
Definition
Deposits
Term
If there was a serious 'run on the bank' how can the government or central bank help?
Definition
Give the bank cash first
Then if that doesn't fix the problem, nationalise the bank
(e.g. Northern Rock 2008)
Term
Is the supply of £ a flow concept or stock concept?
Definition
A stock concept - because at any point in time there is a certain amount of£ in circulation
Term
Liquidity Ratio
Definition
How many liquid assets compared to total assets
eg
Natwest Bank has £100m total assets
£10m are liquid (what they keep in the bank)
£90m are illiquid (what they lend out)
Liquidity ratio is 100/10 = 10%
Term
Bank's liabilities
Definition
Customers' deposits (savings) in the bank - it belongs to the customers so the bank OWES them this money
e.g.
1. sight deposits (£ in current accounts),
2. time deposits (high interest savings),
3. certificates of deposit,
4. sale and repurchase agreements (repos),
5. capital and other funds
Term
Assets of a bank are
Definition

£ the bank owns which it lends to customers eg

1. cash and reserve balances in the central bank

2. short term loans (market loans, bills of exchange, reverse repos)

3. long term loans

Term
Definitions of money
Definition
Narrow definition = all £ in circulation (including individuals, firms, banks, public sector)

M4 broad definition = £ in circulation (but not banks and building docs), + private sector retail £ deposits in banks and building docs + private sector wholesale £deposits (including repos) + private sector holdings of £certificates of deposit, commercial paper and other short term paper issued by financial institutions.
Term
Current accounts are included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Both
Term
Share certificates are included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
neither
Term
Cash in banks' tills are included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Neither
Term
Cash in a person's pocked is included in the narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Both
Term
Deposits in savings accounts are included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Both
Term
A debit card is included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Neither
Term
Wholesale deposits in financial institutions are included in narrow definition of money, broad definition of money, both broad and narrow definitions of money or neither
Definition
Just broad
Term
Retail bank
Definition
High street bank e.g. Natwest, lloyds who have individual customers and business customers and who have set rates of interest and charges
Term
Wholesale bank
Definition
Banks that only do business with companies and deal with large deposits and loans and interest rates are negotiable
Term
Examples of monetary financial institutions (MFIs)
Definition
Retail banks
The Bank of England
Building Socieities
Universal Banks
Term
Certificate of Deposit
Definition
When customers, usually a firm, deposit a large sum in the bank for a certain amount of time e.g. 1 year, the bank gives the customer a certificate of deposit. If the firm needs the money urgently they can then sell that certificate to other firms.
Term
Time deposit
Definition
a deposit in the bank whereby you have to give notice to the bank that you want your money or pay a fee to get it immediately (usually high interest savings accounts)
Term
Sight deposit
Definition
A deposit in the bank you can get to immediately without having to pay a fee (£ in your current account)
Term
Sale and repurchase agreement (repos)
Definition
When one financial institution sells an asset to another financial institution because it needs £, but they agree that the first financial institution can buy its asset back at a certain time and date
Term
Capital Adequacy Ratio (CAR)
Definition
ratio of the total capital of the bank (its reserves and shares)/ its risk-weighted assets (how risky are its assets - e.g. loans to companies)

CAR = (Tier 1 capital + Tier 2 capital) / Risk-weighted assets
Term
Tier 1 capital
Definition
bank reserves from retained profits + ordinary share capital so when times are hard the bank doesn't have to pay much
Term
Tier 2 capital
Definition
preference shares and other financial instruments where banks can't change their payments
Term
Basel II Accord decided the capital adequacy ratio (CAR) must be at least ...
Definition
8%, Tier 1 capital ratio was 4% and minimum share capital ratio was 2%
Term
Basel III Accord decided the capital adequacy ratio (CAR) must be at least ...
Definition
8% but Tier 1 capital ratio was increased to 6% and minimum ordinary share capital ratio increased to 4.5 by 2015
Term
Liquidity
Definition
how easily you can convert something into cash without getting a penalty (fee)

Most liquid to least liquid
Cash, operational balanced with Bank of England, Money lent to financial institutions, Bills of exchange, Government bonds, personal loans
Term
Bills of exchange
Definition
Loans to companies (commercial bills) or the govt (Treasury bills). The company or govt promise to pay the lender a specific sum on a certain (maturity) date - usually 3 months later. Bills DONT pay interest, so sold below value
Term
Government bond or 'gilt edged security'
Definition
A loan to the govt. The govt sells bonds which then pay a fixed interest sum each year until maturity when the govt pays the money back. These bonds can be bought and sold on the Stock Exchange.
Term
The liquidity ratio of a bank
Definition
the ratio of liquid assets to total liabilities. Liquid assets e.g. cash, don't earn the bank money but the bank needs to keep some liquid assets to cover day-to-day transactions.

Assets/liquid assets = liquidity ratio
Too high - not enough profit
Too low - might not be able to cover day-to-day customer needs
Term
Securitisation chain
Definition
Lender/Originator -(sells asset to) - Special Purchase Vehicle (SPV)-(who gets the money by issuing bonds to)- noteholders/investors. So cash is paid by note holders to SPV who then gives it to originator/lender.

Bonds are known as collateralised debt obligations (CDOs)
Term
Secondary Marketing
Definition
Holders of assets sell them to someone else before the maturity date.
Term
Moral hazard
Definition
The temptation to take more risks when you know someone else will cover the risks if you get into trouble
Term
Maturity transformation
Definition
the transformation of deposits into longer term loans
Term
co-ordination failure
Definition
when a group of firms e.g. banks acting independently could have achieved a more desirable outcome if they had coordinated their decision making
Term
The central bank
Definition
acts as the government's agent and oversees the whole monetary system
Term
The Asset Purchase Facility (APF)
Definition
this was introduced in 2009 when the Bank of England began to purchase assets in exchange for money in order to boost nominal spending growth.
Term
Arbitrage
Definition
Buying in low priced markets and selling in high priced markets. This reduces the differences in prices.
Term
Rediscounting
Definition
When the Bank of England purchases bills from the banks and discount houses
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