<3.1 MONEY & BANKING> 

• At the core of ECONOMICS, are the three ECONOMIC ACTIVITIES OF PRODUCTION (Making stuff), CONSUMPTION (Using this stuff) and of course the EXCHANGE (Buying and selling stuff). Money is simply THE BEST WAY to FACILITATE THESE TRANSACTIONS, when compared to BARTER, thus increasing frequency and convenience, which in turn can be linked to overall output and GDP.

• In the past cigarettes have been used as money in prison. Using this context explain how cigarettes fulfilled the four functions mentioned above for the prisoners that used them:

• "In a prison environment cigarettes were often used as money because they met the 4 functions of money in the following way, firstly..."

• Continuing on our cigarette example, can you apply the 6 characteristics of money above and explain whether or not cigarettes would be a good form of money outside of prison.

• "Cigarettes would not be a good form of money outside of prison, firstly they are not generally accepted by everyone, therefore sellers would not accept them as a medium of exchange, secondly..."

• Firstly, banks attract customers by providing a safe place for storing their money and not worry about it being robbed. 

• These deposits are usually in the form of:

  • • • 'CURRENT ACCOUNTS', which PAY NO INTEREST and which you can use to RECEIVE and MAKE PAYMENTS on a DAILY BASIS,

      • 'SAVINGS ACCOUNTS', which PAY SOME INTEREST but allow for LIMITED TRANSACTIONS, and...  

      • 'TIME DEPOSITS' which EARN GOOD INTEREST but YOU CANNOT WITHDRAW your money until a specified time.  REWARDS

• These deposits can then be offered ('LOANED OUT') to those who are SHORT OF FINANCE IN THE PRESENT ("Need money now, but don't have enough") in exchange for a PROMISE to REPAY the debt WITH INTEREST OVER A SET TIME INTO THE FUTURE.

• In other words, banks act as 'FINANCIAL INTERMEDIARIES', between these two willing parties. 

LENDERS DEPOSIT @ bank -> BANK -> Bank LOANS to BORROWER

• Q. "But how do the banks make money?" Commercial banks make most of their profit By charging a higher interest rate to borrowers than the amount of interest they pay to lenders.

LENDER/DEPOSITOR 2% <- BANK <- 5% LENDER/BORROWER

• Loans come in two main forms:

  • • • • • OVERDRAFTS: This refers to a bank account 

          • BANK LOANS

• Go to HERE and find the 'COST OF BORROWING' for a PERSONAL LOAN of ONE MILLION HKD and repaying it over 5 yrs.

• Q. WHY DO WE BOTHER PUTTING OUR MONEY IN THE BANK IF THEIR IS 0% INTEREST? Well ask yourself how do third main function that banks carry out is to enable their customers to receive and make payments. This is referred to as ACTING AS AGENTS FOR PAYMENTS & PROVIDING MONEY TRANSFERS. There is now a range of ways in which people can receive money and make payments out of their accounts. These include credit cards, standing orders, direct debits, debit/credit cards and online banking.

A CENTRAL BANK  is the single most important and influential bank in the country or, in the  case of the European Union, the region. The five most well-known central banks in the world are probably 

• the Federal Reserve Bank of the USA (often called the Fed), 

• the European Central Bank (ECB), 

• the Bank of England, 

• the Reserve Bank of India and 

• the People’s Bank of China. 

Central banks are owned by governments and are responsible to them

• Ever wonder where the government stores its tax money or who they borrow from? That's right the central bank acts as the banker to the government. Tax revenue is paid into the government’s account.

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• Up to 5 marks for why it should: A central bank is a lender of last resort (1) one of its functions is to lend to commercial banks when they cannot borrow elsewhere (1) example of another function (1). If a central bank does not lend, the commercial banks may collapse (1) holders of bank accounts will lose money (1) they may get into difficulties (1) there may be a ‘run’ on other banks (1) with people withdrawing their money (1) putting other banks at risk (1). Fewer banks would reduce the funds for firms to borrow (1) investment would be reduced (1) economic growth would decline (1) makes it more difficult for commercial banks to carry out their function (1) example of another function (1)

• Ever wonder where the governmnet stores its tax money or who they borrow from?, that's right the central bank acts as the banker to the government. Tax revenue is paid into the government’s account.

• Operates as a banker to the commercial banks. Holding accounts at the central bank enables commercial banks to settle debts between each other and to draw out cash, if their own customers are taking more cash from their branches than usual.

• Acts as a lender of last resort. This means it will lend to banks which are temporarily short of cash. 

• Manages the national debt. The national debt is the total amount the government owes. Over time, government debt tends to build up. The central bank carries out borrowing on behalf of the government by issuing government securities, for example government bonds, pays interest on these and repays them when they fall due.

• Holds the country’s reserves of foreign currency and gold. The central bank keeps foreign currency and gold to influence the exchange rate.

• Issues bank notes. The central bank is responsible for printing notes and destroying notes which are no longer suitable for circulation. It also authorises the minting of coins.

• Implements the government’s monetary policy. The prime aim of this is to keep inflation  low and steady. This involves controlling the money supply and influencing interest rates throughout the economy, by changing the interest rate it charges on its loans. The government may instruct the central bank to increase or decrease the money supply. In some cases, central banks implement interest rate changes decided by their respective governments. In other cases, central banks have been given the responsibility to set interest rates.

• Controls the banking system. Many central banks play a key role in regulating and supervising the banking system.

• Represents the government at meetings with other central banks and international organisations such as the World Bank and the International Monetary Fund.

Independence of central banks

A number of governments have given their central banks the authority to decide the rate of interest. The governments still decide the aims of their central banks and give them a target for inflation. The Bank of England, for example, is instructed to use the rate of interest to achieve an inflation target of 2%. If it thinks that there is a danger that the price level will increase by more than 2%, it is likely raise the rate of interest whereas if it thinks it will fall below 2%, it is likely to lower the rate of interest.

TIP

When answering a question on banking, check very carefully, the type of bank focused on in the question. It is a common mistake to confuse a commercial and a central bank.

There are a number of advantages in allowing the central bank to decide the rate of interest for banking. Unlike a national government, a central bank is unlikely to be tempted to lower the rate of interest to win public support. Most central banks also have extensive knowledge of the banking system and the appropriate rate of interest to set

2-MARKERS

• Define ‘medium of exchange’.

• Identify two functions of money.

• Define a ‘standard for deferred payments’.

• Define ‘Central Bank’. 

• Define commercial bank. 

• Identified two functions of a central bank. 

4-MARKERS

• Explain why cash (notes and coins) is money.

• Explain two ways in which a central bank differs from a commercial bank.

• Explain the different goals that state-owned commercial banks and privately-owned commercial banks may have.

• Explain two reasons why firms may find it difficult to obtain loans from commercial banks.

• Explain two reasons why the poor may find it difficult to get loans from commercial banks.

• Explain two functions of a commercial bank.

6-MARKERS

• Analyse how the growth in the size of commercial banks may benefit their customers.

• Analyse how a central bank might reduce household borrowing.

• Analyse why private sector banks may earn higher profits than public sector banks.

• Analyse how a high rate of inflation affects the functions of money.

8-MARKERS

• Discuss whether a central bank should lend to commercial banks which get into financial difficulties.