ESSAY (200-300 words):
Explain in detail how banks operate. Include a description of how banks generate profits.
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
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 using debit
cards and other electronic transfers ments by check’ f ite Affvf cards’ ;;;;;;”;p;tsonai identification number’ In that regard, deUit cards are which could be “‘ua cards have some disadv”,,t”gu,. draw down your checking actunt cards provide a grace peioa between ,”q”tria p”y*””t’ Ani some people bevond the grace period-thaf is’ *# ;”;,4″;mJntr” atso’ because debit ;;;”i;;”.” yo”‘bank account’ you-can’t br1l or withhola payment as you and you can’t stop puy*””i as you t”: -*to \iN,u”si..ot=’*to”tto*oo*t”t”::::J””T:i:::: o
i t t ffi
ff
$ j ! i i* ‘l;”!
3
.; :l rjcalled a check card, com\imes
tfr” fl,ttr.tiot’ts of an AIM card
and a check’ Debit cards issued bY banks, sometimes
loi”trv with visa, MasterCard’ ;:’:H;;;;;”-;;;;’percentorhousehordstodaldebit card [#2 F€*w: Banks W”*rT E
Banks attract deposits from
savers to- lend to
;;;.;”, earning a proft.on the betweentheinterestpaiddepositorsandthe a safe
place for their money’ and borrowers banks try to earn ” To
il#;”;U;,i- to”na”nce’ banks usual$ present imaee of trust “”a “””t””ce ilfi’*;,:;;’iur” i'”- the lobbv’ and.names impress. Banks are more apt First National, or U’S’ Loans ‘R’ Us, or Loadsamoney’ ir*it”t’*aie’nnuntiat intermediaries ii,”i, irrra, r,om depositors’ so they aimed more at borr”;;;;-“”*”s such Finance orThe Money Store ;ilJdo not rely o” d”potitots’ aimed at home buyers’ “”*”‘ or Get Home Loans Fast’com’
Eanks AEe Flnaneia* :t G;* By bringing togetherboth sides serve a’s fnancial ‘n”‘^niio””” gather various u*ot”il’?’o* ‘”u”i’ these funds into the “*o””tt ers. Some savers need their next vear, some only “i* t”*”1#:;;r”an r”t aiiru'”t’tt”ttgths of au(,
z .
u as intermediaries’ offer to both
;il; ; ; i*, o :*i”*]k ;m;:IHtJr to cr’
B a nk s ar s o I I :’, T^”J:rr1or”;i, ]”rX*: ?ffi :l;;”t; oia loan contracts’
n i.+rtiou. I r: I I Ir t s.in Bv developing ” rather
than lending rt”to’ reduce the risk to in
“?i”.. to each of its many ” t’ro”. diversifledl: ;”il ; 1; an, it h ardrv ::i: :’:”: lX’,g,?o.”, “,’. .n.
q
? n,1
g g p.i.l g “vjtlr A:vr’n “eIf . e “”L” “‘ L’-‘ i – X y Jt:’;T”‘”t’tl: lji, about their own creqrL “j,”‘]-i.”i”, for loans, there in *”:”5,1:i# t” what’,s i.
known by each o*1″.-;;;or*”tio”’ This wouidn’t ffi il?T:H: i””ilil;;; io*” u*’o*11′, haveanincentiveto’ipp'””‘i*po’-:11’ti’:f tTl”itli a trouol€
history, or pians to “‘” ‘”ttJt””a E’i skv venture’ e o”‘o; “‘l “‘q-t”-l”l : *t5:H:; 2oo7-
[ ::: ; ### tr ;1 ** m: i:’T::’J Dorr{rwli”^.Ir*”*””ttise in evaluat- and expertrst
=
ii- ffi ;io”: ll’;i,li”li ::l’TT:’ ;ffi:l’l’ TJ#; to repay a 1.o1n’ tt-l::’Jt;ia””t notlepresent the to that defaulting ,-rr..”tt of the bank'”*”itnpt’u the founders plan to invest
$soo,ooo in the banr’ .J;;ffi ;ir aPPlicatio””,: i ::::::l
Star€Emg a ffiarak
we courd 6 .nsider :””?*’:;li:;i”‘:.\:il1″J:Hlru*mf.X op”‘”‘in g, princiPle aoplv to other deposrt”yi”ttit”ti:;t “:i:’t] ::fi: ilJ*,,””11# T;”j*ilf;:;: #il: ;: t”*l:t:ii” thev must t:it.”,:i:.’t”o*puol1″r of the currencv t^:;;i;;;*:rhe in rhe case:f i::,Hfi^ j”e”, the qu.aiity of man-
::'”‘ilTi,fJ’ilJjlT;m”7u””t’inthe.region’the and the likelY
t e E t 3 7,;:EJt’il’:1,” “d;’ilff :T, :i,:l’,T::i; “it*& exch an ge St oo’ These shares are call€
*”t*. “i*e H”””il;*,”* ‘”Y $so’ooa Hl;3f”lg; -“t”a r!r1P
;-::l’:’n:*h*m::; ” ‘ret Rur”*” System’ With tne o”*tt *in”u lirlhrlities;
;;;il;’ g45o,oo9, lh.: iij:.::”-oorryners’ +qi:iiY
the bank building’
CHAPTER t 5 ‘i’iiriliil16 rrrLi 217
fj
.; 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 two sides of the bank’s accounts. The left side lists or financial claim owned by the bank. At this early f eqeral Keserve 6arlia. nle rrlirr stut rl>rb r{re,}arrd-} Reserve Where do we go tutions are subject to the Fed’s reserve Suppose Home Bank deposits $roo,ooo Liahilities and Net Worth
Net worth $500,000
Total Total
au
l-u(t o E z * fin**cia{ stetei’:let]t at asset liability requireC reseffes required reserve excess reseilles ASSets : The bank is now the depositor that amount. The Assets =Uabilities + and $9oo,ooo in escess reserves held as cash in the i:lxirihil : Assets Cash
Building and furniture
Stock in district Fed
Total $l4Wqq Total qLqqgrqg
Liabilities and Net Worth
$1,000,000 Checkabledeposits $1,000,000
450,000 Net worth 500,000
21A PART’ 3 l’tsi;al aitd ivionelairl P.rlii;’/
;””Iy ;;; 1**uai”t”ry’ traniaitiotts
now exceed pay-
debit cards usuaiiy
or PIN’ to use’
safer than credit cards’
*o'” easi$ by a thief- But debit
V.Ihereas.debit cards
lmmediately’ credit
a?-urchase and
prefer to borrow
they catry a baiance
c ards imme –
dispute a
can with a ctedit card
a check’
immedr’ate\’ A eiebit c ard’ als
I
:
i:
?
.l
;
i
t
,:
-i
.i;
i’
‘i
*
‘i:i
.-I
.i.1
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are
o, otit”t major card issuers’
i,r”r, ttrorrgtt debit cards look
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
difference
;;;;; .rrtrg”d borrowers’ savers need
need credit;
pion’by sewing both gyoups’
an
with impressive offices’
that
to be c.alled Fideli$Ttust’
gu”ittotp than Benny’s Bank’
In contrast’ finance
that do not get
can choose names
as Household
Likewise’ mortgage com-
so theypick names
such as Lender’s Depot
lntermediaries
n .,i
Lel’
s&T
of the money mqrket’banks i
o’ o’ go-bet*ttn’ rtt”y I
and- repackage 2
demanded by borrow- E
money next week’ some i
t”tit”*ent’ Likewis:’b:t 4
time’ Banks’ o
l-
U
(9
6
u
E
l
F
O
desirable durations
ihanneling sauinqs
than do individual :1lr'”.il,’;;”‘better off depositing
Iending theirmonev.H;T;;;g banks do the lend-
their monev i” o?”.::;.if,.,.ii^iu,out. banks develop
ing’rhe:tonoT’-11i”l*iiri,*iir”ess,structurins10ans’
exv ertise in ev aluafing’
“n1o’c’ng
g v’e’f ” P iY”e l
e”e3! e” 1″ ” ” “‘
al*”in”d portfolio “1:::*t
“io-l’J”-er””o-1-:oiut’ banks
;; i”ait’ia””ut t””l-t^-o bank’
t”*’ “‘*’ ffi gti’1″‘””;ffi*:iffi:
o”::”::;::;
i
I
I
t
ie’ ! l’f”elT slle:l ” ” ” “‘
b’ d
”
:: jff Xl
are willing to ry]:t;; i,,ol” r”ti”ure information
loan. But borrowers
il;; and financial plans
than do lenders.rhus,
is asymmeff’: t”l?.Tff’;;: #;;;;o’ a,y-*”u
information tt t””X;:r;’.;;il be trusted to report
n*15′
:ffi;; oit””‘ a”utt outstanding’
Jn”
moleY to fund a
*ni
E'”‘:y,”Ti$: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
“-*;”1″‘:l’:llJ
U rates caused some
I B”.”rr,” of their experience
6 metric informatro:
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
o’
and theY tl]l::t
rhe;T:l;T”:t;:t”Yf;t ffil:I
:?15,f ::H: liil’?:; ;;;”‘ ti'”
s
Suppose
establish 1
n?ni i” “p”rate,
obtain a chqrter’.:il;;t;;;”thority i”-.1″ case of a
apply to ln”
state bank o1to
charterins asencv
P’ooo'”l”#1’t”*”g’
g
E
$
.,’13.*’1′.””11′”Jlli””iiti:ii:::t,:t:’Jl?of stock-ce”tl:'”‘;r;;;,
in the bank’
o1l,1ll “;”;;;r;, equiry, or the net
bank’ Part of
t.
to Uuy shares rn , *;tu*=i*n in which
*31*r;: :;.t*:.Bank. So Home BanK IS rtu* l,.r* rnon tlre other sirie
*”mb”t of the l”.d”lut
worth
J;;’;;;uire and furnish
tho i’lllrri;y SLrpply
l’
l:alanee sheet, presented in Exhibit e. As the name
implies, a balance sheet shows a balance between the
the bank’s assets. An asset is any physical property
stage, assets include the building and equipment
owned by Home Bank plus its stock in the district
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:
,Aeegurnts
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-
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.
in a reserve account with its district
Federal Reserve Bank. Home Bank’s
resewes now consist of $ioo,ooo in
required resewes on deposit with the Fed
O
o
Fo
=L
J
J
E
oo
obalance sheet
a given pcint in tiffie that
ghilw$ 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
a*ything of value that is
owned
any*hi*g that is awed
io ogtrer pe*!:le tr
in:titutieils
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
ratl0
th* rati$ ol reserves tfi
dep,Jsit$ ihat henks are
cbiigateci tiy reg*laticn
ta halci
i:ranL reserves exceecling
requir*ti reserl’gs
Liabilities +
Net worth
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
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.
Net worth
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).
Home Bank’s Balance Sheet After $1,000,000
Deposit into Checking Account
50,000