banks

ESSAY (200-300 words):
 Explain in detail how banks operate. Include a description of how banks generate profits.
    

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McEachern, W.A (2009). Econ for Macroeconomics. (2010-2011 ed, pp. 216-218). Mason, OH: South-Western Pub.

 

Please no wiki, dictionary.com.  Please cite all work quoted.

accept cash, checks, or debit
cards (some’ such as

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lnternet sites, even prefer credit
cards)’-and credi

t

;;;’;;;;.e more tiran zo percent of
all consumer

ourchases. Credit cards offer an
easy way to get a

i”T”‘it”* ,n”‘tl’a l”t'”t’ if you buy an airiine
ticket

with a credit card, the card issuer
lends you the

il; a p”V for the ticket’ You don’t
need money

until you repay the credit card
issuer’ The credit

card has not eliminated your “t-” ?f.
m:ney’ merely

rolerrpa it Three in io.’i households have generai
uLrq,t v* —

;;;6* credit cards’ About
half of those with credit

cards carry a baiance from month
to month’ and that

gt””pt *”ai”r-t balance is about $3’ooo’
on the other nand’ when you use

your debit

card at a grocery “o'”
o’ drugstore’ you-tap directly

into your checking “t”o””t’
paying wrth electronic

;;;:y-pttt o{ wtr’ Debi’t cards get
their name

because they debit, or teduce’
y:Y .bT:-:i”:::

Visa, theY are not credii carcs'”‘”i”*
n”ople prefer debit

car

nocheckbookisrequiredandpa}rmen-.saremade
;””Iy ;;; 1**uai”t”ry’ traniaitiotts

using debit

cards and other electronic transfers
now exceed pay-

ments by check’ f ite Affvf cards’
debit cards usuaiiy

;;;;;;”;p;tsonai identification number’
or PIN’ to use’

In that regard, deUit cards are
safer than credit cards’

which could be “‘ua
*o'” easi$ by a thief- But debit

cards have some disadv”,,t”gu,.
V.Ihereas.debit cards

draw down your checking actunt
lmmediately’ credit

cards provide a grace peioa between
a?-urchase and

,”q”tria p”y*””t’ Ani some people
prefer to borrow

bevond the grace period-thaf is’
they catry a baiance

*# ;”;,4″;mJntr” atso’ because debit
c ards imme –

;;;”i;;”.” yo”‘bank account’ you-can’t
dispute a

br1l or withhola payment as you
can with a ctedit card

and you can’t stop puy*””i as you t”: -*to
a check’

\iN,u”si..ot=’*to”tto*oo*t”t”::::J””T:i::::
immedr’ate\’ A eiebit c ard’ als

o

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:
i:

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ffi

ff

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.J

rjcalled a check card, com\imes

tfr” fl,ttr.tiot’ts of an AIM card

and a check’ Debit cards
are

issued bY banks, sometimes

loi”trv with visa, MasterCard’
o, otit”t major card issuers’
i,r”r, ttrorrgtt debit cards look

;:’:H;;;;;”-;;;;’percentorhousehordstodaldebit card
eard thal taFs dlr*ctiv
iilt{} the elePi:silcr’s
hank ac{:{::ui1t i’l fund
l.:*rf hases. aico ialiei!
n eti;cii card, a’-il o{l*rt
jr:r;b!*. as *:: itr’Ifr4 c’ar

[#2 F€*w: Banks W”*rT

E

Banks attract deposits from

savers to- lend to

;;;.;”, earning a proft.on the
difference

betweentheinterestpaiddepositorsandthe
;;;;; .rrtrg”d borrowers’ savers need

a safe

place for their money’ and borrowers
need credit;

banks try to earn ”
pion’by sewing both gyoups’

To

il#;”;U;,i- to”na”nce’ banks usual$ present
an

imaee of trust “”a “””t””ce
with impressive offices’

ilfi’*;,:;;’iur” i'”- the lobbv’ and.names
that

impress. Banks are more apt
to be c.alled Fideli$Ttust’

First National, or U’S’
gu”ittotp than Benny’s Bank’

Loans ‘R’ Us, or Loadsamoney’
In contrast’ finance

ir*it”t’*aie’nnuntiat intermediaries
that do not get

ii,”i, irrra, r,om depositors’ so they
can choose names

aimed more at borr”;;;;-“”*”s such
as Household

Finance orThe Money Store
Likewise’ mortgage com-

;ilJdo not rely o” d”potitots’
so theypick names

aimed at home buyers’ “”*”‘
such as Lender’s Depot

or Get Home Loans Fast’com’

Eanks AEe Flnaneia*
lntermediaries

:t
n .,i
Lel’

G;*
s&T

By bringing togetherboth sides
of the money mqrket’banks i

serve a’s fnancial ‘n”‘^niio”””
o’ o’ go-bet*ttn’ rtt”y I

gather various u*ot”il’?’o* ‘”u”i’
and- repackage 2

these funds into the “*o””tt
demanded by borrow- E

ers. Some savers need their
money next week’ some i

next vear, some only “i*
t”tit”*ent’ Likewis:’b:t 4

t”*”1#:;;r”an r”t aiiru'”t’tt”ttgths of
time’ Banks’ o

au(,

z
l-
U
(9
6
u
E
l
F
O

.

u

as intermediaries’ offer
desirable durations

to both

;il; ; ; i*, o :*i”*]k ;m;:IHtJr
ihanneling sauinqs

to cr’

B a nk s ar s o I I :’, T^”J:rr1or”;i, ]”rX*: ?ffi :l;;”t;
than do individual :1lr'”.il,’;;”‘better off depositing
Iending theirmonev.H;T;;;g banks do the lend-
their monev i” o?”.::;.if,.,.ii^iu,out. banks develop
ing’rhe:tonoT’-11i”l*iiri,*iir”ess,structurins10ans’
exv ertise in ev aluafing’

oia
“n1o’c’ng

loan contracts’

n i.+rtiou. I r: I I Ir t
g v’e’f ” P iY”e l

s.in
e”e3! e” 1″ ” ” “‘

Bv developing ”
al*”in”d portfolio “1:::*t

rather

than lending rt”to’
“io-l’J”-er””o-1-:oiut’ banks

reduce the risk to
;; i”ait’ia””ut t””l-t^-o bank’

in

“?i”..
t”*’ “‘*’ ffi gti’1″‘””;ffi*:iffi:

to each of its many
o”::”::;::;

” t’ro”. diversifledl: ;”il ; 1; an, it h ardrv ::i: :’:”: lX’,g,?o.”, “,’. .n.

q

?
i
I
I
t

n,1

g g p.i.l g “vjtlr A:vr’n “eIf
ie’ ! l’f”elT slle:l ” ” ” “‘

.

e “”L” “‘
b’ d

L’-‘ i – X

:: jff Xl

y Jt:’;T”‘”t’tl:
are willing to ry]:t;; i,,ol” r”ti”ure information
loan. But borrowers

lji,
il;; and financial plans

about their own creqrL “j,”‘]-i.”i”, for loans, there
than do lenders.rhus,

in *”:”5,1:i# t” what’,s
is asymmeff’: t”l?.Tff’;;: #;;;;o’ a,y-*”u

i.

known by each o*1″.-;;;or*”tio”’ This wouidn’t
information tt t””X;:r;’.;;il be trusted to report

ffi il?T:H: i””ilil;;; io*” u*’o*11′,
n*15′

haveanincentiveto’ipp'””‘i*po’-:11’ti’:f tTl”itli
:ffi;; oit””‘ a”utt outstanding’

a trouol€

history, or pians to “‘”
Jn”

‘”ttJt””a
moleY to fund a

E’i skv venture’ e o”‘o; “‘l
*ni

“‘q-t”-l”l : *t5:H:;
E'”‘:y,”Ti$:i,.’ffi #iiit;m:*;::ff :”
E tion’rhes:.*”:”i;;i”i. ,n”it incomes’ Liars loans
fi to*” “pplit””‘L^o’ui=n,”i-“Ji”””t in trouble ‘n

2oo7-

[ ::: ;
“-*;”1″‘:l’:llJ

### tr ;1 ** m: i:’T::’J
U rates caused some

Dorr{rwli”^.Ir*”*””ttise in evaluat-
I B”.”rr,” of their experience

and expertrst

=

ii- ffi ;io”: ll’;i,li”li ::l’TT:’ ;ffi:l’l’ TJ#;
6 metric informatro:

to repay a 1.o1n’ tt-l::’Jt;ia””t notlepresent the
bank. certai”tv'”::.i,;;i;;”;”‘*”t’s entire nest
ners on al dis a ster tt Yoltt -‘i ^:-‘ r-^r-, r ri r”, n borrower’
U;#i;; directiY

to that defaulting
o’

,-rr..”tt of the bank'”*”itnpt’u the founders plan to invest

$soo,ooo in the banr’
and theY tl]l::t

.J;;ffi ;ir aPPlicatio””,: i ::::::l

Star€Emg a ffiarak

we courd 6 .nsider
rhe;T:l;T”:t;:t”Yf;t ffil:I

:””?*’:;li:;i”‘:.\:il1″J:Hlru*mf.X
:?15,f ::H: liil’?:; ;;;”‘ ti'”

op”‘”‘in g, princiPle
s

aoplv to other deposrt”yi”ttit”ti:;t “:i:’t]
Suppose

::fi: ilJ*,,””11# T;”j*ilf;:;: #il: ;:
establish 1

t”*l:t:ii”
n?ni i” “p”rate,

thev must
obtain a chqrter’.:il;;t;;;”thority i”-.1″ case of a
apply to ln”

t:it.”,:i:.’t”o*puol1″r of the currencv
state bank o1to

t^:;;i;;;*:rhe
charterins asencv

in rhe case:f i::,Hfi^ j”e”, the qu.aiity of man-

::'”‘ilTi,fJ’ilJjlT;m”7u””t’inthe.region’the
P’ooo'”l”#1’t”*”g’

and the likelY

t

e
g

E
E

t
$

3

7,;:EJt’il’:1,” “d;’ilff :T, :i,:l’,T::i;
.,’13.*’1′.””11′”Jlli””iiti:ii:::t,:t:’Jl?of stock-ce”tl:'”‘;r;;;,

“it*&
in the bank’

exch an ge St oo’
o1l,1ll “;”;;;r;, equiry, or the net

These shares are call€

*”t*. “i*e
bank’ Part of

H”””il;*,”* ‘”Y $so’ooa Hl;3f”lg;
t.

-“t”a
to Uuy shares rn , *;tu*=i*n in which

r!r1P

;-::l’:’n:*h*m::;
*31*r;: :;.t*:.Bank. So Home BanK IS rtu* l,.r* rnon tlre other sirie


*”mb”t of the l”.d”lut

‘ret
worth

Rur”*” System’ With tne o”*tt *in”u lirlhrlities;

;;;il;’ g45o,oo9, lh.: iij:.::”-oorryners’
J;;’;;;uire and furnish

+qi:iiY

the bank building’

CHAPTER t 5 ‘i’iiriliil16 rrrLi
tho i’lllrri;y SLrpply

217

fj

.;
l’

i.

iltmtffif lil

ir:xi.irf rii- :.-l

Home Bank’s Balance Sheet

Assets

Building and furniture $450’000

Stock in district Fed

50,000

$500,000 $500,000

To focus our discussion, we examine the bank’s
l:alanee sheet, presented in Exhibit e. As the name
implies, a balance sheet shows a balance between the

two sides of the bank’s accounts. The left side lists
the bank’s assets. An asset is any physical property

or financial claim owned by the bank. At this early
stage, assets include the building and equipment
owned by Home Bank plus its stock in the district

f eqeral Keserve 6arlia. nle rrlirr stut rl>rb r{re,}arrd-}
liabilities and net worth. A iiability is an amount the
bank owes. So far the bank owes nothing, so the right
side includes oniy the net worth of $5oo,ooo. The two
sides of the ledger must always be equai, or
inba,lance, which is why it’s called abalance
sheet. So assets must equai liabilities plus
net worth:

Reserve
,Aeegurnts

Where do we go
from here? As
mentioned in the
previous chapter,
banks are required
by the Fed to set
aside, or to hold in
reserve, a percent-
age of their checkable
deposits. The dollar
amount that must be
hetd in reserve is called
req uired reserves-check-
able deposits multiplied by the required reserye
ratio. The reguired reserve ratjc dictates the mini-
mum proportion of deposits the bank must hold in
reserve. The current reserve requirement is ro per-
cent on checkable deposits (other types of deposits
have no reserye requirement). A11 depository insti-

tutions are subject to the Fed’s reserve
requirements. Reserves are held either
as cash in the bank’s vault, which earns
the bank no interest, or as deposits at
the Fed, which earn some interest. Home
Bank must lherefore hold $roo,ooo as
reserves, or ro percent times $r,ooo,ooo.

Suppose Home Bank deposits $roo,ooo
in a reserve account with its district
Federal Reserve Bank. Home Bank’s
resewes now consist of $ioo,ooo in
required resewes on deposit with the Fed

Liahilities and Net Worth

Net worth $500,000

Total

Total

au

l-u(t
O

o
o
Fo
=L
J
J

E
E

z
oo
obalance sheet

* fin**cia{ stetei’:let]t at
a given pcint in tiffie that
ghilw$ asseig {}n sne
side aad liabillties and
nei \,vorth $n the $ther
side; l–aeauss assets
must equal tiabllities
i:lus net w$rth, ihe t!’ro
sid*s of the slatemcnt
nrusi b* in bala;:cs

asset
a*ything of value that is
owned

liability
any*hi*g that is awed
io ogtrer pe*!:le tr
in:titutieils

requireC reseffes
th* dollar arfi$tifit
c? reserves a bank is
obligated i:y regulatian
ttr hsld as cash in the
bank’s var;lt or s* at-
c$ufit at the red

required reserve
ratl0
th* rati$ ol reserves tfi
dep,Jsit$ ihat henks are
cbiigateci tiy reg*laticn
ta halci

excess reseilles
i:ranL reserves exceecling
requir*ti reserl’gs

ASSets :
Liabilities +
Net worth

The bank is now
ready for busi-
ness. Opening day
is the bank’s lucky day, because
the first customer carries in a
briefcase full of $roo notes and
deposits $r,ooo,ooo into a new
checking account. In accePting
this, the bank promises to repay

the depositor that amount. The
deposit therefore is an amount
the bank owes-it’s a liabil-
ity of the bank. As a result of
this deposit, the bank’s assets
increase by $r,ooo,ooo in cash
and its liabilities increase by
$r,ooo,ooo in checkable depos-
its. exhibit 3 shows the effects
of this transaction on Home
Bank’s balance sheet. The right
side now shows two claims on
the bank’s assets: claims bY the
owners, called net worth, and
claims by nonowners, called
liabilities, which at this Point
consist of checkable deposits.

Assets =Uabilities +
Net worth

and $9oo,ooo in escess reserves held as cash in the
vault. Home Bank earns no interest on cash in the
vault. Excess reserves, however, can be used to make
loans or to purchase interest-bearing assets, such
as government bonds. By 1aw, the bank’s interest-
bearing assets are limited primariiy to loans and to
government securities (if a bank is owned by a hold-
ing company, the holding company has broader lati-
tude in the kinds of assets it can hold).

i:lxirihil :
Home Bank’s Balance Sheet After $1,000,000
Deposit into Checking Account

Assets

Cash

Building and furniture

Stock in district Fed

Total
50,000

$l4Wqq Total qLqqgrqg

Liabilities and Net Worth

$1,000,000 Checkabledeposits $1,000,000

450,000 Net worth 500,000

21A PART’ 3 l’tsi;al aitd ivionelairl P.rlii;’/

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