Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Money, Banking, and International Finance

Bank must hold 10% of deposits as reserves, and the bank must find $8 million for required
reserves. Your bank has the following options:

 Bank could sell $8 million of securities to raise funds.

 Bank asks several borrowers to repay $8 million in loans. Moreover, the bank could sell

loans to other banks.

 Bank borrows the funds from the central bank or from another commercial bank.

Your bank borrows the $8 million from the Federal Reserve as a loan. Your bank managed
the liquidity risk well. We show your bank’s balance sheet below:

Your Bank
Assets Liabilities
Required reserves $8 million
Excess reserves 0 million
Loans 80 million
Securities 10 million

Deposits $80 million

Bank Capital 10 million

Fed loan 8 million

How does a bank prevent a bank failure? A bank holds excess reserves and short-term,
highly liquid securities to prevent a bank failure. In the next example, your bank has the
following balance sheet below, and your bank will fail.

Your Bank
Assets Liabilities
Required reserves $10 million
Excess reserves 0 million
Loans 90 million
Securities 10 million

Deposits $100 million

Bank Capital 10 million

Public circulates a rumor the bank president lost millions in the derivatives market and had
disappeared to the Bahamas. Consequently, you and the other depositors are afraid your bank
will fail, so you and the depositors withdraw $20 million from your bank. Your bank sells $10
million in securities and uses $10 million in required reserves to meet depositors’ withdrawals,
shown in the T-account on the next page.