Use commercial bank and Federal Reserve Bank balance sheets...

Key Concepts

Commercial Bank Reserves

Commercial bank reserves are the funds that banks either hold in their vaults or maintain on deposit at the central bank. These reserves are a critical component of the banking system because they determine a bank’s ability to meet withdrawal requests and influence the money multiplier effect, thereby affecting the overall money supply in the economy.

Central Bank Balance Sheet

The central bank’s balance sheet is a record of its assets, such as securities and loans to banks, and liabilities, including reserves held by commercial banks. Analyzing the balance sheet provides insight into how various operations, like asset purchases or lending, transform the liquidity available to the banking system.

Open Market Operations

Open market operations involve the buying or selling of securities by the central bank in the open market. When the central bank purchases securities, it credits commercial banks’ reserve accounts, increasing their available funds. Conversely, selling securities withdraws reserves from the banking system. This tool is a primary means for influencing liquidity and controlling short-term interest rates.

Discount Window Lending

Discount window lending is the process by which commercial banks borrow funds directly from the central bank, typically at a pre-set discount rate. This borrowing temporarily boosts a bank’s reserves, providing liquidity during periods of stress, and serves as a safety valve to ensure banks maintain sufficient levels of reserves.

Reserve Requirement Ratio

The reserve requirement ratio is the regulatory mandate that determines the minimum fraction of customer deposits banks must retain as reserves rather than lend out. Changes to this ratio can alter the amount of excess reserves in the banking system, affecting banks’ capacity to extend credit and influence the money creation process.

Term Auction Facility

The term auction facility is a mechanism through which banks can borrow funds from the central bank by bidding in an auction for a fixed term, rather than relying solely on traditional discount window operations. This tool provides an alternative source of liquidity, particularly during times of market stress, and can similarly increase banks’ reserves once borrowing occurs.

Transcript

00:03 For problem four, we are asked to use commercial bank and federal reserve bank balance sheets to demonstrate the impact of each of the following transactions on commercial bank reserves.

00:17 So a, the federal reserve bank purchases securities from banks.

00:25 So the federal reserve bank controls money supply by influencing the reserves of commercial banks through open market operations.

00:34 However, open market operations are just one of the tools that central banks use to control the reserves of commercial banks.

00:43 The other tools are the required reserve ratio, open market operations, the discount rates, and the term auction facility or the auctions of the reserves.

01:00 Okay, so securities such as government bonds are held as assets by commercial banks.

01:05 And by the central bank or the federal reserve purchasing these reserves it will increase the liquidity of commercial banks and hence increase their reserves central bank will see the securities bought as assets because they bought the buns or the securities and now they own them and the commercial banks will exchange these securities for money or which is also seen as reserves okay and for b, it says commercial banks borrow from the faroe reserve at the discount rates.

01:48 So the commercial banks can also increase their reserves by borrowing from the central bank.

01:53 All right? so they borrow at the discount rates.

01:58 And if the discount rates increases, it will obviously decrease the reserves of commercial banks because it will increase the cost of borrowing.

02:06 And if the discount rates decreases, it will increase the results of commercial banks.

02:09 Commercial banks because that will decrease the cost of borrowing.

02:13 Okay? and the money borrowed from the central bank or the federal reserve will be seen as liabilities in the balance sheets of commercial banks.

02:26 And by borrowing from the central bank, it will increase liquidity or reserves.

02:32 The central banks will see the money borrowed as an asset on their balance sheets because the commercial bank banks have to pay back that money.

02:41 Okay and c says the fed reduces the reserve ratio all right so by the fed reducing the reserve ratio list reserves or require reserves will be kept by commercial banks at central banks all right and require reserves held by the commercial banks at the central bank or the federal reserve are seen as liabilities by the central banks because this money is not theirs but it belongs to the commercial banks all right and by the reserve and by the required reserve ratio decreasing less reserves will be held by commercial banks at the central banks all right and so the liabilities of central banks will decrease all right and the commercial banks will hold more money or reserve or reserves which are assets that they can loan out to buy securities or do other things.

03:48 So the required reserves held by the central banks are seen as liabilities...

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