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.

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Money Creation 15 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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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

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

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

Last Word: The Bank Panics of 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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