Banks Flashcards
Know the definitions and processes of banks
what is Base money
money used to kick start a financial system. central banks e.g BoE buy government bonds and loans from the government which are an asset on their balance sheet not a liability. This money is then lend to commercial banks
what is fractional reserve banking?
when banks make a loan to a borrower the borrower spends the money which is paid into another bank and the borrower must also pay interest. This increases the wealth in the financial system
What is a financial intermediary?
A entity which transfers funds between surplus agents and deficit agents allowing efficient capital allocation in a growing economy
surplus fund?
expenditure is less than income - a depositor or lender
a deficit fund?
expenditure exceeds income - a borrower
what is maturity transformation and how does it help a bank make money?
is when surplus agents and deficit agents have different time horizons leading to surplus agents wanting more liquid short term access and deficit agents want to borrow over long periods. Must convert liabilities (payables) into assets (receivables) efficiently to avoid a run. Changing liquid liabilities into illiquid assets allows optimisation
what is risk transformation and how does a bank use this to allocate capital?
surplus agents want safe and deficit agents want to take risk. Agency paradigm means a bank must diversify and use interest rates to meet the needs of its surplus agents and maximise the available capital to deficit agents
what s the liquidity provision?
liquid assets ratio as a portion of all assets. Shows how exposed the fiance al institute is or how vulnerable they are to an economic shock
How do banks reduce the costs of borrowing and lending money?
Banks have great specialist knowledge of their clients allowing them evaluate the riskiness of the investment. Investment contracts are standardised to ensure objectivity rather than sunjectivity. They diversify away risk - systematic and have large economies of scale due to large pools of capital so they have a high book value and are therefore more resilient to shocks themselves
What us credit creation theory?
Banks pool together all surplus agents accounts into one large pool of capital and create an asset. The asset is not touched in fact the bank will credit the account with artificial money - without transferring away any surplus agents funds so they don’t lose liquidity. The interest gained adds to the banks asset Base, creating me equity on the balance sheet.
