Economics Chapter 3 Money and Banking system What

Economics Chapter 3 Money and Banking system

What is money? l People use money to: l l l Money is l l l settle payment pay for goods and services generally accepted means of payment a medium of exchange Definition l Money can be anything that is generally accepted as a means of payment or a medium of exchange.

Barter system l Before using money l l l Exchange of goods directly. E. g. a loaf of bread a jar of wine Limitation l Double coincidence of wants* l l l Both parties want the goods from others No trade if can’t match other’s need From barter to the use of money l l 1 st stage fish vegetable Fish salt / sugar / metal / jewels Fish shells / precious metals Fish coins and notes

Functions of money 1. As a medium of exchange l l A means of payment Avoid the need for double coincidence of wants

Functions of money 2. As a store of value l l Money is a form of asset Store the value of purchasing power use the power to purchase later Avoid perishable goods, high storing cost Types of assets and liquidity Types Liquidity Real estate Extremely low Jewellery Quite low, � cost Share and bonds Quite low, � cost of trading Money High, � cost of keeping it

Functions of money 3. As a unit of account l l For measurement How much…? Price / revenues / income… Value for comparison 4. As a standard of deferred payment l l Outstanding accounts Wages Mortgages Instalments

Properties of money 1. Generally accepted l l 2. Scarce and has a stable value l l l 3. As a medium of exchange Without acceptance by people, no use Hard to obtain, otherwise no one wants Without stable value, purchasing power can’t be stored Limitation: inflation or deflation is inevitable Durable l l If perishable, can’t store the value If easy to wear out, high cost to use

Properties of money 4. Homogeneous and easily recognised l l 5. Divisible l 6. Uniform standard value and authenticity Reduce argument when using Can be divided into smaller value for small-value transaction Portable l Easy to carry out transaction in different location

Barter vs. Using money Barter Using money As a medium of exchange Lack of double coincidence of wants Generally accepted As a store of value Some goods are perishable Durable Indivisible Divisible No common measure of value A unit for measurement Some goods are heavy Portable As a unit of account Easy to carry?

Determination of money (Properties) Cash (coins and banknotes) Generally accepted Scarce and has a stable value Cheque Octopus card Credit Card EPS (system) � � � � � � Durable Homogeneous Divisible Portable Money Are they money?

Determination of money (function) Cash (coins and banknotes) Cheque Octopus card Credit Card EPS (system) As a medium of exchange � As a storage of value � As a unit of account � As a standard of deferred payment � Money The cheque or card itself is not money. The deposits for the service is money.

Money in modern society l Legal tender (Cash) l l l Coins Banknotes Deposit l l l EPS payment Credit card payment Payment by cheque

Money supply l l the total amount of money in a region Formula: Money supply = Cash + Deposits l Cash held by the public l l Deposits (in deposit-taking institutes in HK) l l Money that circulated in the market Licensed banks Restricted licence banks (RB) Deposit-taking companies (DTC) Total money supply = Money supply of HKD + foreign currencies

Money supply l Types of deposits Characteristics Demand deposit Savings deposit Time deposit Negotiable certificate of deposit (NCD) • Cheque account • No interest • High liquidity • Saving account • With interest • Can be withdrawn at any time • • Fixed maturity period Can’t be withdrawn before maturity Higher interest Low liquidity • Fixed maturity period • Higher interest • Tradable at any time Accepted by • Licensed bank • All authorized institutes

Cheque or bearer 持票人

Measuring money supply l Types of deposits Focus M 1 • Medium of exchange (narrow) M 2 • Medium of exchange • Store of value • Savings in licensed banks (broader) M 3 • Medium of exchange • Store of value • Savings in all authorized institutions (the broadest) Include • Cash • Demand deposits • • M 1 Saving deposits in licensed bank Time deposits in licensed bank NCDs by licensed bank (held by public) • M 2 • Deposits in RB and DTC • NCDs by RB and DTC (held by public)

Cash in circulation / Cash held by the public Demand deposits Savings and time deposits in licensed banks Time deposits in restricted licence banks and deposit-taking companies Negotiable certificates of deposit issued by deposittaking companies and held by the publics l l l $ 80 70 120 20 40 M 1 = Cash + Demand deposits = $80 + $70 = $150 M 2 = M 1 + deposits in licensed banks = $150 + 120 = $270 M 3 = M 2 + Deposits & NCDs in RBs & DTCs = $270 + $20 + $40 = $330

Money supply Describe the immediate effect the transaction below have on M 1, M 2 and M 3. (a) John deposits $500 cash into a current account. M 1 remains unchanged. M 1 = Cash + Demand deposits. With cash decreases by $500 but demand deposits increases by $500, M 1 remains unchanged. There is no effect on M 2 and M 3.

Money supply Describe the immediate effect the transaction below have on M 1, M 2 and M 3. b) Mary transfer $1, 000 from a current account to a saving account. M 1 decreases by $1, 000 because demand deposits are part of M 1. M 2 remains unchanged because both demand deposits and savings deposits are components of M 2. There is no effect on M 3.

Banking System l What is a Bank? l l A bank is a financial intermediary which provides special types services relating to finance. A bank is a company which carries on “banking business” with a valid banking license. (Banking Ordinance)

Banking System l 2 types of bank l l Central banks Commercial banks

Central banks l A central bank l a non-profit making government body monitoring the monetary system l controlling the money supply l Accepting deposit from and providing loans to commercial banks (bankers’ bank) l

Central banks l USA: l The Federal Reserve System (The Fed) 美國聯邦儲備局 l China l People’s Bank of China (PBC) 中國人民銀行 l l UK l Bank of England 英倫銀行 HK l Hong Kong Monetary Authority (HKMA) 香港金融管理局 l HSBC 香港上海匯豐銀行

Functions of a central bank 1. Issuing banknotes and coins l ensuring circulation & stability of value l in HK: § § HSBC Standard Chartered Bank of China HKMA Acting as the government’s banker 2. l l offering bank services to the gov’t in HK: HKMA + HSBC

Functions of a central bank Providing discount windows (貼現窗) services 3. l l borrow loans to commercial banks named as: “discount window” interest rate: “discount rate” (貼現率) in HK: HKMA Lender of the last resort (最後貸款人) 4. l l l to help banks or financial institutions survive a bank run. avoid widespread bank failure & collapse of banking system in HK: HKMA

Functions of a central bank Monitoring commercial banks 5. l l l formulate banking regulations monitor irregular banking business in HK: HKMA Formulating monetary policies 6. l l l money supply and interest rate increase interest rate to reducing C and I (not in HK) in HK: Financial Secretary and HKMA

Functions of a central bank Acting as a clearing house (結算所) 7. l l l cheque clearing for commercial banks settle cheque payment in HK: Hong Kong Interbank Clearing Limited (HKICL) 香港銀行同業結算有限公司(結算公司) A’s bank A 4. HKICL sends the cheque to A’s bank 5. A’s bank agree the payment 1. Mr. A writes a cheque to Mr. B HKICL B 2. Mr. B saves the cheque to his account B’s bank 6. B’s bank receive the payment 3. B’s bank sends the cheque to the clearing house

Who has the role of a central bank in HK? Functions Institution(s) in HK 1. Issuing banknotes and coins • Coins and $10 notes: HKMA • Banknotes: HSBC, SCB & BOC 2. Gov’t banker • HKMA + HSBC 3. Discount window services • HKMA 4. Lender of the last resort • HKMA 5. Monitoring commercial banks • HKMA 6. Implementing monetary policies • Financial Secretary + HKMA 7. Clearing house • HKICL

Commercial banks l 3 Tier system l Licensed bank (LBs) 持牌銀行 l Restricted licence banks (RBs) 有限制牌照銀行 l Deposit-taking companies (DTCs) 接受存款公司

Deposit-taking institutes in HK (The 3 -tier banking system) Accept… Licensed banks (持牌銀行) • current and savings accounts, • deposits of any size and maturity • pay or collect cheques drawn by or paid in by customers. Restricted licence • Merchant banking banks • deposits of any maturity of (有限制牌照銀行) HK$500, 000 and above. Deposit-taking companies (接受存款公司) Exampls • Hong Kong Bank • Bank of China • AIG Finance (Hong Kong) Limited • specialised activities, including • Promise Co. , Ltd. consumer finance and securities • Prime. Credit business. Limited • deposits of HK$100, 000 or above with • Octopus Cards an original term of maturity of at least Limited three months.

Functions of a commercial bank l l l l Receive deposits of various types including demand, savings and time deposits Make loans of various types including bank overdraft, mortgage, tax loans and trade finance Issue letters of credit (LC) (信用證) and bills of exchange (BOE) (匯票) Accept and pay bank drafts Rent safety deposit boxes Currency exchange Gift cheque

Deposit-taking institutes in HK (The 3 -tier banking system) Deposit Minimum paid-up capital Type Amount Maturity LB $300 million Any Any RB $100 million Time deposits NCDs $500, 000 or above Any DTC $25 million Time deposits NCDs $100, 000 or above 3 months or above

HK as an international financial centre 1. China market l l Economic reform in China allow export from & import to China HK provides: Re-exports Commercial services a. b. § § Insurances Loans Foreign exchange Infrastructure development connected to Mainland, such as highway, railway…

HK as an international financial centre Professionals: c. l l l Financial experts § Security markets Law experts § Contract Science experts § New inventions

HK as an international financial centre 2. HK has well-developed infrastructure Judicial system l l Law and order to protect business Financial and banking system l l Ease the running of business Communication system l l Ease the communication with oversea businessmen

HK as an international financial centre 3. Government policies l l l A free flow of information Local and foreign investors can enter and leave HK freely A free port No foreign exchange control Low tax rates and simple tax structure

HK as an international financial centre 4. Favourite time zone l Continuous trading: New York + London + HK City Security market New York London Hong Kong Closed Running Closed Running

Benefits to HK economy 1. Wealth creation GDP: l l 2. Banking (8%) Insurance (1. 3%) Others, e. g. financial consultation, legal related (3. 4%) Employment l l l Banking (2. 2%) Insurance (1. 3%) Others (1. 7%)

Benefits to HK economy 3. Providing investment opportunities l l Security market, for capital raising Further enhance investment

Negative effect to HK economy 1. Fluctuates with external factors l l 2. Lack of autonomy l 3. International financial crisis (e. g. Lehman’s mini-bond) Rely on capital from China (e. g. hot money from China) Easily affected by the change of interest rate in USA and worldwide Speculations against linked exchange rate l Chance to be damaged by international speculators (to be discussed later)

MC Questions Arrange the following assets from high to low liquidity: (1) Real estate (2) Bonds (3) Cash (4) Demand deposits A. (1), (3), (2), (4) B. (3), (1), (4), (2) C. (3), (4), (2), (1) D. (4), (2), (3), (1)

MC Questions Which of the following properties must an item have to be used as money? A. B. C. D. Its face value is the same as its intrinsic value. It can be exchanged for precious metals. It is legal tender issued by the government. It is generally accepted as a medium of exchange.

MC Questions Compared with paper banknotes, the advantage of polymer banknotes is _______ and the disadvantage is _______. A. being portable … being difficult to be divisible into smaller units B. having higher value … having lower general acceptance C. being more durable and more difficult to reproduce … being more expensive to produce D. being more easily recognised … being less popular

MC Questions Which of the following statements about time deposits and demand deposits is incorrect? A. Demand deposits are a means of payment but time deposits are not. B. Demand deposits have a higher liquidity than time deposits. C. Time deposits offer higher returns than demand deposits. D. Both of them are included in M 1.

MC Questions Miss Wong plans to make a 2 -month time deposit of HK$450, 000. Which of the following institutions can accept her deposit? (1) Licensed banks (2) Restricted licence banks (3) Deposit-taking companies A. (1) only B. (1) and (2) only C. (2) and (3) only D. (1), (2) and (3)

MC Questions Suppose Mr Chan transfers his money from a savings account to a current account. Which of the following is correct? A. M 2 and M 3 remain unchanged. B. M 1 increases while M 2 decreases. C. M 1 remains unchanged while M 2 increases. D. M 1 decreases while M 2 remains unchanged.

MC Questions Suppose all shops in Hong Kong accept payment by Octopus. The ratio of A M 2 to M 3 increases. B. M 1 to M 2 remains unchanged. C. M 1 to M 2 increases. D. M 1 to M 3 decreases.

MC Questions ‘Savings deposits’ and ‘deposits in restricted licence banks’ are both included in _______ in Hong Kong. (1) M 1 (2) M 2 (3) M 3 A. (2) only B. (3) only C. (1) and (2) only D. (2) and (3) only

MC Questions Which of the following deposit-taking institutions in Hong Kong can accept savings deposits? A. Licensed banks B. Restricted licence banks C. Deposit-taking companies D. All of the above

MC Questions The most important economic function of commercial banks is A. issuing banknotes. B. setting the best lending rate. C. acting as a financial intermediary. D. acting as the lender of last resort.

MC Questions Which of the following are the functions of the Hong Kong Monetary Authority? (1) Managing the assets of the Exchange Fund. (2) Setting the best lending rate. (3) Acting as the lender of last resort for banks. A. (1) and (2) only B. (1) and (3) only C. (2) and (3) only D. (1), (2) and (3)

Cash in circulation Cash held by authorized institutions Demand deposits Savings and time deposits in licensed banks Negotiable certificates of deposit issued by licensed banks and held by the public Time deposits in restricted licence banks and deposittaking companies M 2 (in $billion) is A. 112 B. 152 C. 158 D. 168 $ billion 20 6 12 80 40 10