Illiquidity different from insolvency
How Illiquidity different from insolvency? Show each scenario using two separate balance sheets for a commercial bank.
What is fractional reserve banking? Draw a balance sheet of a bank that engages in fractional reserve banking.
Create an example involving 4 separate banks and 4 separate people that depicts the money creation process inherent in fractional reserve banking through balance sheets. Assume that the initial injection of cash worth $500 is made by the first person in the first bank and that each bank maintains a 10% reserve ratio.
Draw a balance sheet for New Bank, which started its first day of operations with $6 million in capital. A total of $100 million in checkable deposits is received. The bank makes a $25 million commercial loan and lends another $25 million in mortgage loans. Required reserves are 8%.
The bank you own has the following balance sheet: Reserves: 50 million, Deposits: $500 million, Bank Borrowings: $25 million, Securities: $125 million, Loans: $400 million. Draw a balance sheet for this bank and calculate this bank’s capital or equity. What is the reserve ratio that this bank keeps?
Explain the argument that asymmetric information between depositors and bank managers justifies the need for an institution such as the FDIC.
What are open market operations? Explain how an open market purchase works. Now show the impact of an open market purchase of $500 million worth of bonds by the Fed on the balance sheets of the banking system. Assume a reserve ratio of 10%.
Now show the impact on the money supply of an open market sale by the Fed on the banking system worth $200 million, assume a reserve ratio of 8%.
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