banks

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

lnternet sites, even prefer credit cards)'-and credit

;;;';;;;.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<is :l ':ie::l-o seca;se

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

i I : i:

t ?

t .l ; i

ffi

ff

$ t ,:

j -i

! .i; i'

i 'i * 'i:i

i* .-I

'l;''!

3

.; .i.1

:l .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<i

[#2 F€*w: Banks W"*rTE 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-*"ui. 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

TotalTotal

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;'/