The Banking System


Published on

The Banking System, Money Theory & Institution

  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

The Banking System

  3. 3. COMMERCIAL BANK A financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Functions :- Acceptance of Deposits Advancing loans Credit Creation
  4. 4. BALANCE SHEET OF COMMERCIAL BANK Assets Reserves Cash in bank Deposits at the central bank Deposits at the commercial bank Cash on collection Loan Securities Others Liability Deposit Current deposit Savings Deposits Fixed deposit Borrowing Other Capital Account
  5. 5. MANAGEMENT OF COMMERCIAL BANK Banks operate in uncertainty & exposed to the risk Exists a trade-off between risk & return Four principles of management that should be noted :1. Asset management 2. Liability management 3. Capital adequacy management
  6. 6. GENERAL PRINCIPLES OF BANK MANAGEMENT FOUR PRIMARY CONCERNS OF THE BANK IS :Liquidity management. Asset management Liability management Managing capital adequacy
  7. 7. LIQUIDITY MANAGEMENT Deposit outflows must match deposit inflows. To keep enough cash on hand, the bank manager must engage in liquidity management. Financial institutions face liquidity management problems because the volume of cash flowing in rarely matches exactly the volume of cash flowing out.
  8. 8. Financial institutions are sensitive to interest rate movements, which affect the flow of savings they attract from the public and the earnings from the loans and securities they acquire. Liquidity managers usually meet their institutions’ cash needs through two methods :1. Asset management or conversion; ie., the selling of selected assets. 2. Liability management ie, the borrowing of enough liquidity to cover a financial institution’s cash demands as they arise.
  9. 9. Liquidity indicators supply bank managers with signs that a liquidity problem is developing. They include: Ratio of cash to total assets. Ratio of “hot money” assets to “hot money” liabilities. Cost of borrowing for liquidity needs relative to the cost other institutions face. Monitoring the intentions of the bank’s biggest customers.
  10. 10. ASSET MANAGEMENT Four basic methods of asset management: Find borrowers who will pay high interest rates and are unlikely to default. Purchase securities with high returns and low risk. Lower risk by diversifying. Manage the liquidity of its assets so that it can satisfy its reserve requirements without incurring large costs.
  11. 11. LIABILITY MANAGEMENT Raising Funds for a Financial Institution. Factor to be considered :The relative cost of raising funds from each source. The risk (volatility or dependability) of each fund’s source. The length of time (maturity) for which a source of funds will be needed. The size and market access of the financial institution attempting to raise funds. Laws and regulations that limit access to funds.
  12. 12. Relative Cost Factor. The relative cost factor is important because, other things remaining the same, a financial institution would prefer to borrow from the cheapest sources of funds available. Also, if an institution is to maintain consistent profitability, its cost of fund raising must be kept below the returns earned on the sales of its services.
  13. 13. CAPITAL ADEQUACY Functions of bank capital: Help to prevent bank failure Affects returns for equity holders Required by regulatory authorities
  14. 14. Capital and bank failure
  15. 15. Assume that both banks write off $5 of their loan portfolio. Total assets decline by $5, and bank capital, which equals assets minus liabilities, also declines by $5.
  16. 16. Theory of Bank Management The approach that introduced in managing bank to achieve the objective of maximizing profit Commercial loan theory (Real Bills Doctrine) Banks face a dilemma returns – liquidity - if the assets were hold with high liquidity, it cannot bring a lot of income - if given a loan; higher income but liquid assets low
  17. 17. to overcome the dilemma and balance between liquidity, risk and return :- provide short-term bank loans like, loan to finance the production of goods (self-liquidating loans or real bills) - This loan is secured by finished products in the production process in order to secure repayment when the goods are sold to end users - With this loan - the bank can create liquidity and earnings
  18. 18. Weaknesses :- can even help banks keep liquidity, but the return / low results - if all banks practice & there is a crisis in economy liquidity of the banking system cannot be maintained - To solve this problem - the role of the Central Bank should be established & act as a source of final loan
  19. 19. Transition theory (The Theory Shiftability) Bank asset allocation shift is done to balance between profitability, liquidity, risk Liquidity can be created if banks buy long-term assets (high risk, low liquidity) and short-term assets both reserve assets (low risk, high liquidity) To obtain the liquidity, asset must be sale The transition of this asset holdings will be if all banks to sell assets at the same time To ensure the success of adding liquidity of the banking system - the Central Bank acted to buy all short-term assets
  20. 20. The anticipated income theory Introduced to overcome the liquidity level low According to this theory: bank assuming the loan portfolio (long-term) as a source of liquidity - The bank will give the installment loans (, and loan repayment (payments) are continuously considered as providing continuous flow of funds to the bank, and this increases the level of bank liquidity
  21. 21. Asset-liability management theory Emphasis on management / coordinating both sides of the balance sheet - assets and liabilities simultaneously to maximize profits Bank combining and matching maturities and at the same time choose the assets to be held and liabilities are to be offered by taking into account interest rate risk involved in make decisions about loans to be made
  22. 22. CENTRAL BANK Is a reserve bank, or monetary authority is a public institution that manages a state's currency, money supply, and interest rates. Examples: European Central Bank (ECB) and the Federal Reserve of the United States, Bank Negara Malaysia The chief executive of a central bank is normally known as the Governor, President or Chairman especially the US Federal Reserve's Board of Governors.
  23. 23. Functions of a central bank may include: Implementing monetary policies. Determining Interest rates Controlling the nation's entire money supply The Government's banker and the bankers' bank ("lender of last resort")
  24. 24. Managing the country's foreign exchange and gold reserves and the Government's stock register Regulating and supervising the banking industry Setting the official interest rate – used to manage both inflation and the country's exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms
  25. 25. MONETARY POLICY- THE USES OF FINANCIAL POLICY Central Bank plays a role in controlling the stability of the economy by applying monetary policy to influence the money supply (Ms) and the rate of interest (r). Divided into two :(i) Policy of Quantitative Finance (Ms influence and r) (ii)Qualitative Monetary Policy (influenced form of loans and investment banks). During inflation, the government will conduct a contractionary monetary policy, while the expansionary monetary policy in use during deflation.
  26. 26. POLICY OF QUANTITATIVE FINANCE Change the bank rate - Bank rate is the interest rate the central bank imposed on commercial banks. Inflation: ↑ bank rate - the cost of borrowing ↑ -I ↓ - ↓ AD - P ↓ Deflation (Unemployment): bank rate ↓ borrowing costs ↓ - I ↑ - ↑ AD – P
  27. 27. Operating in open market a) Inflation : @ BNM sell government bonds the public treasury bills to commercial banks and - money held ↓ - ↓ expenses - P ↓ b) Deflation : otherwise. Change the statutory reserve ratio (RRR) and the ratio of liquid assets a) Inflation : RRR ↑ - ↓ amount of money to loan - Ms. ↓ - ↓ AD - P ↓ b) Deflation : otherwise.
  28. 28. Funding : Funding delay the sale of securities by commercial banks and the general public, this action extends the maturity of government securities. a) Inflation : Reduce the production of short-term government securities and increase the production of long-term securities - Ms. ↓ - ↓ AD -P↓ b) Deflation : otherwise.
  29. 29. QUALITATIVE MONETARY POLICY Selective credit control - efforts to promote @ BNM prevent people making installment credit, mortgages and margin requirements. Inflation : Prevent / reduce (a) The purchase of assets by raising rates installment payment, reducing the amount of loan credit, shorten the repayment period; (b) Restricting the purchase of fixed assets in mortgage; (c) Prevent the purchase of shares for the purpose of speculation.
  30. 30. LIMITATION OF MONETARY POLICY There are several mechanisms that can explain the economic impact of the implementation of monetary policy. Among them include savings and investment, cash flow, money and credit, asset prices and exchange rates.
  31. 31. Savings and Investment :- The interest rate that is too high will increase the cost of borrowing to finance spending, the individuals tend to save or defer expenses. • Rising mortgage rates tend to affect households to postpone buying a house or reduce the quantity of expenses for the purchase of a home. •
  32. 32.  Liquidity flow :- • This section refers to the impact of interest rates in influencing the amount of cash needed to spend. • Most of the household at a time, taking advantage of the financial arrangement that allows them to borrow • Net interest payments on the debt shows an increasing trend in proportion of disposable income. • Financial flows affect the business sector because almost most business borrowers affected by this • Changes in interest rates affect the overall cash flow.
  33. 33. Money and Credit :- • The type of very important mechanism of monetary policy in open market operations to make adjustments in the financial system. • The rate of interest charged by the bank have been adjusted, and an essential part of this mechanism is that monetary policy affects the economy through loans ratio. • A policy that is too tight will reduce the supply of funds to banks and this will force them to reduce their bank loans. • Although the price has not changed much loan, potential borrowers to get a loan in the event the policy is somewhat less strict.
  34. 34. Asset Prices :- • Interest rates are also found to affect the value of assets, which in turn influence individual wealth and spending decisions. • Based on theory, the interest rate is too high is expected to increase the opportunity cost of holding the asset. • In general, the fall in asset prices was found to reduce spending and borrowing capacity of the individual is also reduced.
  35. 35. Exchange Rate :- • Fluctuations in exchange rates affect the economy through changes in the relative price of domestic goods and services and imports. • The import price of the direct relation with the exchange rate, the higher the price of imports, the higher exchange rate.