week 4 Flashcards
(31 cards)
What happens when a checking account is opened?
An increase in the bank’s reserves equal to the increase in checkable deposits.
This reflects the basic banking principle where deposits lead to reserves.
How does a bank’s reserves relate to its liabilities?
When a bank receives additional deposits, it gains an equal amount of reserves; when it loses deposits, it loses an equal amount of reserves.
This is fundamental to understanding bank liquidity.
What is one way banks can make a profit?
By using excess reserves to make loans instead of holding them.
the banking is making profit since it holds short-term liabilities such as checkable deposits and uses the proceeds to buy longer-term assets such as loan with higehr interets rates
This allows banks to earn interest on loans.
What is liquidity management?
The acquisition of sufficiently liquid assets to meet the bank’s obligations to depositors.
It ensures the bank can pay depositors during withdrawals.
What happens during a deposit outflow?
The bank loses an equal amount of deposits and reserves.
This affects the bank’s liquidity position.
What occurs to required reserves after a deposit outflow?
They are recalculated based on the new total deposits.
In the example, required reserves became $9 million after a $10 million outflow.
What is a shortfall in bank reserves?
When a bank has less reserves than required by regulation.
This can lead to liquidity issues for the bank.
What are the four basic options for a bank to cover a reserve shortfall?
- Borrowing from other banks
- Borrowing from the Federal Reserve
- Selling securities
- Reducing loans
Each option has its own implications for the bank’s financial health.
What is the cost associated with borrowing reserves from other banks?
The interest rate on these loans, such as the overnight interest rate.
This is a common practice for banks to manage liquidity.
What is the impact of selling securities to meet a reserve shortfall?
It helps cover the deposit outflow but incurs brokerage and transaction costs.
This may affect the bank’s investment strategy.
What happens if a bank has no reserves after a deposit outflow?
It faces a significant problem as reserves are a legal requirement.
The bank must take immediate action to restore required reserves.
True or False: A bank can use all its reserves for lending without any restrictions.
False
Banks must maintain a certain level of reserves to meet regulatory requirements.
What is the cost of selling securities?
The brokerage and other transaction costs.
Selling securities incurs various costs associated with brokerage services.
Why is reducing loans considered the most costly way of acquiring reserves?
Other banks may only agree to purchase loans at a substantial discount.
This makes it a less favorable option for banks needing liquidity.
What are the costs associated with deposit outflows?
The costs include:
* Borrowing from other banks or corporations
* Selling securities
* Borrowing from the central bank
* Calling in or selling off loans
These costs arise when banks face unexpected deposit outflows.
What is the purpose of holding excess reserves?
Excess reserves serve as insurance against the costs associated with deposit outflows.
They protect banks from incurring high costs during liquidity crises.
What may a reserve shortfall indicate for a bank?
It may indicate that the bank is not managing its liquidity effectively.
This can lead to financial instability or increased borrowing costs.
What costs might banks incur for borrowing to cover a reserve shortfall?
Banks may incur costs in the form of interest or penalties.
These costs can further strain a bank’s financial resources.
Fill in the blank: Excess reserves are insurance against the costs associated with _______.
deposit outflows.
This concept emphasizes the importance of liquidity management in banking.
What real-life example illustrates the need for banks to sell assets to cover deposit outflows?
Silicon Valley Bank (SVB) had to sell substantial amounts of their assets.
This case highlights the risks banks face when managing liquidity.
what are federal funds?
interest rates at which US banks or US depository institutions trade federal funds with each other overnight
what happens when a depository institution has large surplus of reserve account?
it lends to other banks in need of larger balances
what is the federal funds target rate?
FOMC - feferal open market committee meets eight times a year to determine the federal funds target rate
