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7. Equilibrium in the Banking System
Questions:
11. How does the banking system return to equilibrium when it has excess reserves or a reserve deficiency?
T-Accounts:
12. Assume that there are two banks with a given binding required reserve ratio. They each have a given amount of excess reserves. Given information about their borrowers and depositors, Show: a. Taccounts representing the net change in the balance sheets of the seven different parties. b. the change in each bank's reserves. c. the total change in both banks' reserves. d. each bank's excess reserves. e. the total of both bank's excess reserves.
13. Assume that there are two banks with a given binding required reserve ratio. They each have a reserve deficiency. Given information about their borrowers and depositors, show: a. T accounts representing the net change in the balance sheets of the five parties effected by the banks' response. b. The change in each bank's reserves. c. The total change in both banks' reserves. d. Each bank's reserve deficiency. e. The total of both banks' reserve deficiency.
The Banking System
Usually some banks have excess reserves and other banks have reserve deficiencies. The banking system has excess reserves if the total of the excess reserves in some banks is greater than the total of the reserve deficiencies in other banks. The banking system has a reserve deficiency if the total of the reserve deficiencies in some banks is greater than the total of the excess reserves in other banks. The banking system returns to equilibrium as changes in interest rates and the supplies of credit and money cause the amount of reserves banks are required to hold to adjust to the amount of reserves the banks actually hold.
Excess Reserves in the Banking System
Excess reserves in the banking system implies that the typical bank has excess reserves. Each bank with excess reserves intends to cause the amount of reserves it holds to decrease to the amount it is required to hold by purchasing T-bills, buying negotiable C.D.s, and selling Federal Funds.
Each bank intends to for its actual reserves to adjust to its required reserves. But what is the unintended consequence?
The immediate consequence of purchases of investments, repurchase certificates of deposit, and attempts to sell Federal Funds is a decrease in the yields on these money market instruments. The big New York banks react to this lower cost of funds and decrease their prime interest rates. Other banks follow their lead. Because of the lower interest rates, borrowers are willing to increase borrowing, so banks increase their lending. That implies an increase in the supply of credit.
Borrowers spend the funds they borrow and the sellers deposit the checks they receive in payment. Because the banks' credit the sellers' checkable deposits, the supply of money increases.
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Given the required reserve ratio, the increase in checkable deposits causes an increase in amount of reserves the banks are required to hold. Contrary to the banks' intentions, the banking system returns to equilibrium because the total amount of reserves banks are required to hold increases to match the amount of reserves actually in the banking system.
The unintended consequence of the banks' efforts to rid themselves of excess reserves is for their required reserves to rise to their actual reserves.
Reserve Deficiency in the Banking System
Each bank with a reserve deficiency intends to cause the amount of reserves it holds to increase to the required amount by selling T-bills, issuing negotiable C.Ds, and buying Federal Funds.
Each bank intends for its actual reserves to adjust to its required reserves. But what is the unintended consequence?
The net sales of investments and C.D.s and purchases of Federal Funds cause the yields on these money market instruments to increase. The New York banks react to the higher cost of funds by increasing their prime interest rates. The other banks follow their lead. Because of the higher interest rates, borrowers are less willing to borrow. Since banks make fewer new loans, credit contracts as the borrowers repay their old loans. That implies that the supply of credit decreases.
The banks debit the borrowers' checkable deposits as they repay loans. The supply of money decreases.
Given the required reserve ratio, the decrease in the amount of checkable deposits causes a decrease in the amount of reserves banks are required to hold. Contrary to the banks' intentions, the contraction of the supplies of credit and money continues until the banking system returns to equilibrium because the total amount of reserves banks are required to hold decreases to the amount of reserves actually in the banking system.
The unintended consequence of the banks' efforts to obtain more reserves is for their required reserves to fall to their actual reserves.
For the SINGLE bank, its actual reserves adjust to its required reserves. For the banking SYSTEM, the required reserves adjust to the actual reserves.
Example T-Accounts
1. Wachovia (W) and Southern National (SN) each have a reserve deficiency
of $900,000. There is a 10% binding reserve requirement. Hall repays a
loan to W using a check drawn on his account at W. Black repays a loan
to SN using a check drawn on his account at SN.
a. Use five Taccounts to show the change in the balance sheets of the
five parties influenced by the transaction, b. Determine the change in
each bank's reserves, c. Determine the change in all banks' reserves, d.
Determine each bank's reserve deficiency, e. Determine all banks' reserve
deficiency.
Hall Black Wachovia SN Fed
a l a l a l a l a l
______
Mon. Loans Money Loans Ch.Dep. Ch.Dep.
Ch.Dep. -900k Ch.Dep. -900k -900k H -900k B
-900k -900k ______
-900k -900k -900k -900k Loans Loans
-900k -900k ______
b.FU 0, no change ______0 0
FCB 0, no change -900k -900k -900k -900k
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c. 0, no change
d. W 810k
SN 810k
e. 1620k
2. W and SN each have a reserve deficiency of $900,000. There is a 10%
binding reserve requirement. Hall repays a loan to W using a check drawn
on his account at W. Black repays a loan to SN using a check drawn on
his account at W.
a. Use five Taccounts to show the net change in the balance sheets of
the five parties influenced by the transaction, b. Determine the change
in each bank's reserves, c. Determine the change in all banks' reserves,
d. Determine each bank's reserve deficiency, e. Determine all banks'
reserve deficiency.
Hall Black W SN Fed
same as 1 same as 1 a l a l a l
______
b. SN+900k Res. Ch.Dep. Res. Res.Ac.
W -900k Res.Ac -900k H Res.Ac. SN+900k
c. 0, no change -900k -900k B +900k W-900k
d. W 1620k
SN 0 Loans Loans
e. 1620k -900k -900k ______
______0 0
-1800k -1800k O 0
3. W and SN each have a reserve deficiency of $900,000. There is a 10%
binding reserve requirement. Hall repays a loan to Wachovia using a
check drawn on his account at SN. Black repays a loan to SN using a
check drawn on his account at W.
a. Use five Taccounts to show the net change in the balance sheets of
the five parties influenced by the transaction, b. Determine the change
in each bank's reserves, c. Determine the change in all banks' reserves,
d. Determine each bank's reserve deficiency, e. Determine all banks'
reserve deficiency.
Hall Black W SN Fed
same as 1 same as 1 a l a l a l
b. W 0, no change ______
SN 0, no change Res. Ch.Dep. Res. Ch.Dep. Res.Ac.
c. 0, no change Res.Ac. -900kB Res.Ac. -900k H W+900k
d. W 810k +900k -900k -900k
SN 810k -900k +900k SN-900k
e. 1620k Loans Loans +900k
-900k -900k ______
______0 0
-900k -900k -900k -900k
4. W and SN each have excess reserves of $900,000. There is a 10%
binding reserve requirement. W makes a loan to Fama. Fama purchases
goods from Black, who deposits the check into his account at W. SN makes
a loan to Hall. Hall purchases goods from Yeager, who deposits the check
into his account at SN.
a. Use seven Taccounts to show the net change in the balance sheets of
the seven parties influenced by the transactions, b. Determine the change
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in each bank's reserves, c. Determine the change in all banks' reserves,
d. Determine each bank's excess reserves, e. Determine all banks' excess
reserves.
Fama Black Hall Yeager
a l a l a l a l
______
Mon. Loans Mon. Mon. Loans Mon.
Ch.Dep.+900k Ch.Dep. Ch.Dep. +900k Ch.Dep.
+900k +900k +900k +900k
-900k Goods -900k Goods
Goods -900k Goods -900k
+900k ______+900k ______
______0 0 ______0 0
+900k +900k +900k +900k
W SN Fed b. W 0, no change
a l a l a l SN 0, no change
______c. 0, no change
Ch.Dep Ch.Dep. d. W 810k
+900k F +900k H SN 810k
-900k F -900k H e. 1620k
+900k B +900k Y
Loans Loans
+900k +900k ______
______0 0
+900k +900k +900k +900k
5. W and SN each have excess reserves of $900,000. There is a 10%
binding reserve requirement. W makes a loan to Fama. Fama purchases
goods from Black, who deposits the check into his account at SN. SN
makes a loan to Hall. Hall purchases goods from Yeager, who deposits the
check into his account at W.
a. Use seven Taccounts to show the net change in the balance sheets of
the seven parties influenced by the transactions, b. Determine the change
in each bank's reserves.
c. Determine the change in all banks' reserves, d. Determine each bank's
excess reserves, e. Determine all banks' excess reserves.
Fama Black Hall Yeager
same as 4 same as 4 same as 4 same as 4
W SN Fed b.W 0,no change
a l a l a l SN 0,no change
______c. 0, no change
Res. Ch.Dep Res. Ch.Dep. Res.Ac d. W 810k
Res.Ac. +900k F Res.Ac. +900k H W -900k SN 810k
-900k -900k F +900k -900k H +900k e. 1620k
+900k +900k Y -900k +900k B SN +900k
Loans Loans -900k
+900k +900k ______
______0 0
+900k +900k +900k +900k
6. W and SN each have excess reserves of $900,000. There is a 10%
binding reserve requirement. W makes a loan to Fama. Fama purchases
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goods from Black, who deposits the check into his account at W. SN makes
a loan to Hall. Hall purchases goods from Yeager, who deposits the check
into his account at W.
a. Use seven Taccounts to show the net change in the balance sheets of
the seven parties influenced by the transactions, b. Determine the change
in each bank's reserves, c. Determine the change in all banks' reserves,
d. Determine each bank's excess reserves, e. Determine all banks' excess
reserves.
Fama Black Hall Yeager
same as 4 same as 4 same as 4 same as 4
SN W Fed b.SN -900k
a l a l a l W +900k
______c. 0, no change
Res. Ch.Dep Res. Ch.Dep. Res.Ac d. SN 0
Res.Ac. +900k H Res.Ac. +900k F SN -900k W 1620k
-900k -900k H +900k -900k F e. 1620k
+900k B W +900k
Loans Loans +900k Y
+900k +900k ______
______0 0
0 0 +1800k +1800k
Remember: checks clear through the Fed if they need to!