Example: bank notes

A final example: the public (members of the NBPS) pop off to the banks' ATMs and withdraw LCC 100 million in bank notes with their debit cards (= a direct debit to their current accounts) (see Balance Sheets 25-26).

Balance Sheet 27 shows for the position of the MBS, which is the same as for the banks. You will recall that M3 = N&C + BD. The N&C holdings of the NBPS increased by LCC 100 million and their deposits decreased by the same amount. Thus, the money stock did not change, only the composition did. Recall that Item A in the MBS balance sheet = the CB's N&C liability less the N&C held by banks. The former was unchanged and the latter decreased by LCC 100 million.

BALANCE SHEET 25: BANKS (LCC MILLIONS)

Assets

Liabilities

N&C

-100

Deposits of NBPS

-100

Total -100

Total

-100

BALANCE SHEET 26: NBPS (LCC MILLIONS)

Assets

Liabilities

N&C

Deposits at banks

+100 -100

Total

BALANCE SHEET 27: MBS (LCC MILLIONS)

Assets

Liabilities

D. Foreign assets

E. Loans to government

F. Loans to NBPS

A. Notes and coins of NBPS

B. Deposits

1. Government

2. NBPS

C. Foreign loans

+ 100

-100

Total

0

Total

Money destruction

When banks provide new loans (to the government sector or the NBPS), or buy forex, money is created. The overriding source of money creation is bank loans in a balance sheet sense, and the demand for loans that is satisfied by the banks, in a real life sense. Obviously, the money stock can also fall, but this is rare, as seen in Figure 2. In this particular country, and it applies to most countries, not in any month did the growth rate in M3 decrease.

However, it would be amiss if a fall in the money stock was not discussed. Take the example of Mrs A. She took a loan of LCC 50 000 from Bank A in the past. In order to repay the loan, she would accumulate a balance of LCC 50 000 on her bank account over time, and repay the bank on the due date of the loan. Balance Sheets 28-29 show this transaction.

BALANCE SHEET 28: MRS A (NBPS) (LCC)

Assets

Liabilities

Deposit at bank

-50 000

Bank loan

-50 000

Total

-50 000

-50 000

BALANCE SHEET 29: BANK A (LCC)

Assets

Liabilities

Bank loans (NBPS)

-50 000

Deposits of NBPS (M3)

-50 000

Total

-50 000

Total

-50 000

The position of the MBS will be the same as that of Bank A (see Balance Sheet 30).

BALANCE SHEET 30: MBS (LCC)

Assets

Liabilities

D. Foreign assets

E. Loans to government

F. Loans to NBPS

-50 000

A. Notes and coins of NBPS

B. Deposits

1. Government

2. NBPS

C. Foreign loans

-50 000

Total

-50 000

Total

-50 000

Bank deposits and the reserve requirement

As we have seen, by consolidating the balance sheets of the banks and the CB, all the cb2b IBM and the b2cb IBM claims were netted out. This obscures an aspect of the money market and monetary policy: the effect of changes in bank deposits on the banks' required reserves (RR). We introduce it here.

You will recall from the first example above that when Company A sells goods to Company B and Company B acquires a loan facility from Bank A and utilizes it for the purchase, a new bank deposit (new money) is created. What we did not show is the effect on the RR. We now need to add the balance sheet of the CB (see Balance Sheets 31-34) (the amount of the bank loan = LCC 100 million; the RR ratio = 10% of deposits).

BALANCE SHEET 31: COMPANY A (LCC MILLIONS)

Assets

Liabilities

Goods

Deposits at Bank A

-100 +100

BALANCE SHEET 32: COMPANY B (LCC MILLIONS)

Assets

Liabilities

Goods

+100

Loan from Bank A

+ 100

+100

Total

+100

BALANCE SHEET 33: BANK A (LCC MILLIONS)

Assets

Liabilities

Loan to Company A Reserves with CB (TR) (RR +10)

+100

+ 10

Deposits of Company A Loan from CB @ KIR

+ 100 + 10

+110

Total

+110

In this example the required reserves increase by LCC 10 million (increased deposit of LCC 100 million x 0.10). Because Bank A cannot create CB money, the CB will make to loan to the bank (BR). The TR of the banks increases by LCC 10 million (as a result of RR = +LCC 10 million).

BALANCE SHEET 34: CENTRAL BANK (LCC MILLIONS)

Assets

Liabilities

Loans to banks (BR) @ KIR

+ 10

Bank reserves (TR) (RR +10)

+10

Total

+10

As will be seen later, the change in RR is just one of many factors that impact on bank liquidity, and that bank liquidity management is an essential ingredient in monetary policy.

 
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