Economics

Chapter 3

Money and Banking system

What is money?

People use money to: settle payment pay for goods and services

Money is generally accepted means of payment a medium of exchange

Definition Money can be anything that is generally accepted

as a means of payment or a medium of exchange.

Barter system Before using money

Exchange of goods directly. E.g. a loaf of bread a jar of wine

Limitation Double coincidence of wants*

Both parties want the goods from others No trade if can’t match other’s need

From barter to the use of money 1st 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 A means of payment Avoid the need for double coincidence of wants

Functions of money

2. As a store of value 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 For measurement How much…? Price / revenues / income… Value for comparison

4. As a standard of deferred payment Outstanding accounts Wages Mortgages Instalments

Properties of money

1. Generally accepted As a medium of exchange Without acceptance by people, no use

2. Scarce and has a stable value Hard to obtain, otherwise no one wants Without stable value, purchasing power can’t be

stored Limitation: inflation or deflation is inevitable

3. Durable If perishable, can’t store the value If easy to wear out, high cost to use

Properties of money

4. Homogeneous and easily recognised Uniform standard value and authenticity Reduce argument when using

5. Divisible Can be divided into smaller value for small-value

transaction

6. Portable 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

As a unit of account

Indivisible Divisible

No common measure of value

A unit for measurement

Easy to carry? Some goods are heavy Portable

Determination of money (Properties)

Cash(coins and banknotes)

Cheque Octopus card

Credit Card

EPS(system)

Generally accepted

Scarce and has a stable value

Durable

Homogeneous

Divisible

Portable

Are they money?

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

The cheque or card itself is not money.The deposits for the service is money.

Money

Money in modern society

Legal tender (Cash) Coins Banknotes

Deposit EPS payment Credit card payment Payment by cheque

Money supply

the total amount of money in a region Formula:

Money supply = Cash + Deposits Cash held by the public

Money that circulated in the market Deposits (in deposit-taking institutes in HK)

Licensed banks Restricted licence banks (RB) Deposit-taking companies (DTC)

Total money supply = Money supply of HKD + foreign currencies

Money supply

Types of deposits

Characteristics Accepted by

Demand deposit• Cheque account• No interest• High liquidity

• Licensed bank

Savings deposit• Saving account• With interest• Can be withdrawn at any time

Time deposit

• Fixed maturity period• Can’t be withdrawn before maturity• Higher interest• Low liquidity • All authorized

institutesNegotiable

certificate of deposit (NCD)

• Fixed maturity period• Higher interest• Tradable at any time

Cheque

or bearer 持票人

Measuring money supply

Types of deposits

Focus Include

M1• Medium of exchange

(narrow)• Cash• Demand deposits

M2

• Medium of exchange• Store of value• Savings in licensed banks

(broader)

• M1• Saving deposits in licensed bank• Time deposits in licensed bank• NCDs by licensed bank (held by

public)

M3

• Medium of exchange• Store of value• Savings in all authorized

institutions(the broadest)

• M2• Deposits in RB and DTC• NCDs by RB and DTC (held by

public)

  $Cash in circulation / Cash held by the public 80Demand deposits 70Savings and time deposits in licensed banks 120Time deposits in restricted licence banks and deposit-taking companies

20

Negotiable certificates of deposit issued by deposit-taking companies and held by the publics

40

M1 = Cash + Demand deposits= $80 + $70 = $150

M2 = M1 + deposits in licensed banks= $150 + 120 = $270

M3 = M2 + Deposits & NCDs in RBs & DTCs= $270 + $20 + $40 = $330

Money supply

Describe the immediate effect the transaction below have on M1, M2 and M3.(a) John deposits $500 cash into a current account.

M1 remains unchanged.M1 = Cash + Demand deposits.With cash decreases by $500 but demand deposits increases by $500, M1 remains unchanged.There is no effect on M2 and M3.

Money supply

Describe the immediate effect the transaction below have on M1, M2 and M3.b) Mary transfer $1,000 from a current account to a

saving account.M1 decreases by $1,000 because demand deposits are part of M1.M2 remains unchanged because both demand deposits and savings deposits are components of M2.There is no effect on M3.

Banking SystemWhat is a Bank?

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 System2 types of bank

Central banks Commercial banks

Central banksA central bank

a non-profit making government bodymonitoring the monetary systemcontrolling the money supplyAccepting deposit from and providing

loans to commercial banks(bankers’ bank)

Central banks USA:

The Federal Reserve System (The Fed)美國聯邦儲備局

ChinaPeople’s Bank of China (PBC)中國人民銀行

UKBank of England 英倫銀行

HKHong Kong Monetary Authority (HKMA)香港金融管理局

HSBC 香港上海匯豐銀行

Functions of a central bank1. Issuing banknotes and coins

ensuring circulation & stability of value in HK:

HSBC Standard Chartered Bank Bank of China HKMA

2. Acting as the government’s banker offering bank services to the gov’t in HK: HKMA + HSBC

Functions of a central bank3. Providing discount windows (貼現窗 ) services

borrow loans to commercial banks named as: “discount window” interest rate: “discount rate” (貼現率 ) in HK: HKMA

4. Lender of the last resort (最後貸款人 ) 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

5. Monitoring commercial banks formulate banking regulations monitor irregular banking business in HK: HKMA

6. Formulating monetary policies 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 bank7. Acting as a clearing house (結算所 )

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

HKICL

B

B’s bank

A’s bank

1. Mr. A writes a cheque to Mr. B

2. Mr. B saves the cheque to his account

3. B’s bank sends the cheque to the clearing house

4. HKICL sends the cheque to A’s bank

5. A’s bank agree the payment

6. B’s bank receive the payment

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

3 Tier system Licensed bank (LBs) 持牌銀行

Restricted licence banks (RBs) 有限制牌照銀行

Deposit-taking companies (DTCs) 接受存款公司

Deposit-taking institutes in HK(The 3-tier banking system)

Accept… Exampls

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.

• Hong Kong Bank• Bank of China

Restricted licence banks

(有限制牌照銀行 )

• Merchant banking• deposits of any maturity of

HK$500,000 and above.

• AIG Finance (Hong Kong) Limited

Deposit-taking companies

(接受存款公司 )

• specialised activities, including consumer finance and securities business.

• deposits of HK$100,000 or above with an original term of maturity of at least three months.

• Promise Co., Ltd.

• PrimeCredit Limited

• Octopus Cards Limited

Functions of a commercial bank

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 Any

RB $100 millionTime deposits

NCDs$500,000 or

aboveAny

DTC $25 millionTime deposits

NCDs$100,000 or

above3 months or

above

HK as an international financial centre

1. China market Economic reform in China

allow export from & import to China HK provides:

a. Re-exports

b. Commercial services Insurances Loans Foreign exchange Infrastructure development connected to Mainland, such as

highway, railway…

HK as an international financial centre

c. Professionals: 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

Law and order to protect business Financial and banking system

Ease the running of business Communication system

Ease the communication with oversea businessmen

HK as an international financial centre

3. Government policies 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 Continuous trading: New York + London + HK

City New York London Hong Kong

Security market

Closed Running Closed

Running Closed Closed

Closed Closed Running

Benefits to HK economy

1. Wealth creation GDP:

Banking (8%) Insurance (1.3%) Others, e.g. financial consultation, legal related (3.4%)

2. Employment Banking (2.2%) Insurance (1.3%) Others (1.7%)

Benefits to HK economy

3. Providing investment opportunities Security market, for capital raising Further enhance investment

Negative effect to HK economy1. Fluctuates with external factors

International financial crisis (e.g. Lehman’s mini-bond) Rely on capital from China (e.g. hot money from

China)

2. Lack of autonomy Easily affected by the change of interest rate

in USA and worldwide

3. Speculations against linked exchange rate 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. Its face value is the same as its intrinsic value.

B. It can be exchanged for precious metals.

C. It is legal tender issued by the government.

D. 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 M1.

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. M2 and M3 remain unchanged.

B. M1 increases while M2 decreases.

C. M1 remains unchanged while M2 increases.

D. M1 decreases while M2 remains unchanged.

MC Questions

Suppose all shops in Hong Kong accept payment by Octopus. The ratio of

A M2 to M3 increases.

B. M1 to M2 remains unchanged.

C. M1 to M2 increases.

D. M1 to M3 decreases.

MC Questions

‘Savings deposits’ and ‘deposits in restricted licence banks’ are both included in _______ in Hong Kong.

(1) M1

(2) M2

(3) M3

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)

M2 (in $billion) is

A. 112

B. 152

C. 158

D. 168

  $ billionCash in circulation 20Cash held by authorized institutions 6Demand deposits 12Savings and time deposits in licensed banks 80Negotiable certificates of deposit issued by licensed banks and held by the public 40

Time deposits in restricted licence banks and deposit-taking companies 10