1. Economics for Journalists
Week 10: The Banking System
Jeffrey Timmermans
Monday, 15 April, 13

2. Role of the banking system
✤ To channel individuals’ savings to others who want to borrow money
✤ To serve as a financial intermediary
Monday, 15 April, 13

3. The Banking System
Prime rate
Home/car
Commercial
Bank Loans
Interbank Commercial
rate Bank
Interbank
Commercial market
Bank
Deposits
Commercial Deposit rate Home/car
Bank Loans
Finance
Open- Discount Business Company
Market window loans
Ops Discount rate Commercial
lending rate Money
Central Market Fund
Commercial
Bank Paper
Monday, 15 April, 13

4. Key interest rates
✤ Interbank rates Low
✤ Overnight, 1-wk, 1-mth, 3-mth
✤ Deposit rates
✤ Overnight, 1-wk, 1-mth, 3-mth
✤ Commercial lending rate High
✤ Prime (lending) rate
Monday, 15 April, 13

5. Structure of the Banking System
✤ The central bank sets a target rate for overnight lending by banks
✤ Commercial banks borrow from each other to meet short-term needs
in the interbank market
✤ Commercial banks take deposits from individuals and lend out some of
those deposits
✤ Corporations issue short-term debt in form of commercial paper, which
is purchased by banks & money-market funds
Monday, 15 April, 13

6. The “Shadow Banking System”
✤ Any non-bank financial institution that is subject to less oversight
than traditional lenders like commercial banks
✤ Finance companies
✤ Money-market funds
✤ Hedge funds
Monday, 15 April, 13

7. Interbank rates
✤ H.K.: Hong Kong Interbank Offer Rate (Hibor)
✤ U.K.: London Interbank Offer Rate (Libor)
✤ Fed sets Fed Funds target rate; supply/demand determine Hibor &
Libor
✤ Banks’ other lending rates often based on local interbank rate
Monday, 15 April, 13

8. Commercial Banks
✤ Take deposits ✤ Make loans
✤ Deposits are banks’ liabilities ✤ Loans (& reserves) are
assets
✤ Pay depositors interest
(deposit rate) ✤ Banks keep some reserves,
lend out the rest
✤ Earn interest from
borrowers
Monday, 15 April, 13

9. Required Reserve Ratio
✤ Typically set by the central bank
✤ Indicates the percentage of deposits a bank must keep as reserves
✤ In U.S., reserve ratio is now 10% for deposits above $55.2 million
✤ An increase in the reserve ratio forces banks to curtail lending, a
decrease leads to more lending and an expansion of the money supply
Monday, 15 April, 13

10. Jeff’s Bank (100% reserve ratio)
Assets Liabilities
Reserves $100 Deposits $100
Monday, 15 April, 13

11. Jeff’s Bank (10% reserve ratio)
Assets Liabilities
Reserves $10 Deposits $100
Loans $90
Monday, 15 April, 13

12. How the multiplier works
Original deposit $100
Jeff’s Bank lending $90 (.9 x $100)
Masato’s Bank lending $81 (.9 x $90)
Wylie’s Bank lending $72.90 (.9 x $81)
etc. etc.
Total money supply $1,000
Monday, 15 April, 13

13. The Money Multiplier
1
reserve ratio
Monday, 15 April, 13