# Banking

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```					Banking

   What are banks ?

   Banks act as financial intermediaries
that accept deposits and channel
them into investment.
Fractional Reserve System

   It means banks are required to keep a
given fraction of their total deposits as
required reserves.
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.
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.
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.
Maximum Banking Multiplier

   Maximum banking multiplier

              1
=
minimum reserve ratio
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.
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.
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.
What is the excess reserve ?

   Assume the minimum reserve ratio = 20%
   Total deposit = \$10 000
   Reserve = \$3 500

   Ans. \$1 500
What is the excess reserve ?

   Excess reserve
= actual reserve – minimum required
reserve
= \$3 500 - \$10 000 X 20%
= \$3 500 - \$2 000
= \$1 500
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.
Brief Description of Deposit
Creation in Sequence

   Assume :
   the minimum reserve ratio is 20%
   the initial deposit is \$1 000
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.
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 )
Deposit Contraction

   Assume
   A man withdraws \$500 from his bank.
   The bank does not keep excess reserve.
   The minimum reserve ratio = 20%
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
Brief Description of Deposit
Contraction in Sequence

   Assume :
   the minimum reserve ratio is 20%
   the initial withdrawal of deposit is \$M
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.
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 )
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.
The Value of Money

   The nominal value of money

   It is the face value printed on the banknote.
The Value of Money

   The real value of money

   It is measured in term of the purchasing power.
The Value of Money

   During the inflation,

   The nominal value of money will
remain unchanged.

   The real value of money will
decrease.
Central Bank

   It is a government owned bank.
   It is not profit making.
   In Hong Kong, there is no central bank.
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,
Functions of Central Bank

 It supervises the private banks.
 It formulates and carries out the
monetary policies.
 It stabilizes the value of the currency.
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.
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.
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.
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.
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.
Government’s Bank

   The treasury ( 庫房 ) pays and collects
money for the government.

   The Hong Kong Monetary Authority
banking and financial matters.
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.
Commercial Banks

   They are privately owned.
   They are profit making.
   Their function is to channel the savings
into investment.
Services of Commercial Banks

   Accept deposits
–   Demand deposits
–   Saving deposits
–   Time deposits
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.
Services of Commercial Banks

   Grant loans
–   Overdrafts
–   Fixed loans
Services of Commercial Banks

   Financing import / export trade
–   Letters of credit
–   Discounting a bill of exchange
Services of Commercial Banks
   Other services
–   Credit cards
–   Travellers’ cheques
–   Mortgage
–   Gold dealing
–   ATM services
–   Storage services
–   Mandatory Provident Fund
–   Investment services
Services of Merchant Bank

   Accept the large amount deposits
   Underwriting new shares
   Fund management
   Arranging syndicated loans
Financial Market

   A financial market is where financial assets are
bought and sold.

   Financial market
–   Money market
–   Capital market
–   Foreign exchange market
–   Future market
Money Market

   It deals with the short term financial
assets.

   E.g. Exchange Fund Bills, inter-bank money
Capital Market

   It deals with the long-term financial
assets.

   E.g. bond and shares
Functions of Capital Market

   The firms can raise capital by issuing
shares or debentures.

   It provides an opportunity for the
public to invest.
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.
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.
Speculation in stock market

   Bull
   Bear
   Stag
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
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
   Hong Kong has a favourable time zone
location.
   There is an increasing economic link with
China.
Contributions of a financial centre
to Hong Kong economy

   Financial services produce jobs. Job
opportunities are provided.
   Financial markets provide more capital and
investment opportunities. This will speed
up the economic growth.
   This can attract more foreign investors to
Hong Kong.

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