Asset liquidity of banks

The liquidity of an asset can be defined as being the ease and certainly with which it can be turned into money. The most liquid asset of all, therefore, must be money itself. THE next most liquid assets are called near-money, or secondary reserves, as contrasted with primary cash reserves. Secondary reserves are money market assets, such as treasury bills, which have no credit risk and have little market risk. that is, these assets will be turned into money within a year by reason of a short-term maturity date. if they need to be sold before maturity, there is little capital loss involved , inasmuch as the market price is not subject to wide fluctuations. All banks need such secondary reserve to protect against either regular or unexpected cash withdrawals. Furthermore, the higher the proportion of term loans (business loans of over one-year maturity) in the loan portfolio of a bank, the more urgent was the necessity, it was thought, for that bank to have an adequate amount of highly liquid assets in the investment portfolio.

Monetization of debt

whenever commercial banks exchange their debt (demand deposits) for a private or governmental debt, they are creating money. It does not matter whether an individual or business firm is securing anew loan from a bank, or whether the bank is buying an outstanding U.S. government security; the result is the same ; debt has been monetized. The bank secure an earning asset, whereas the increase in their liabilities ( demand deposits)means that someone else now has money that he did not have before.
Commercial banks once had the privilege of printing bank notes, which were used as money in hand-to-hand circulation, but the bank note privilege is now restricted to the Treasury and the federal Reserve System. Nevertheless, the great growth in recent years in the use of checks for payment of goods, services, financial assets, and so on has meant that the banking system has kept its importance as the immediate source of most new money. the bank can still create money, but they do it by making changes in their balance sheets rather than by resorting to a printing press. However, before we examine the mechanics of bank deposit creation, let us first consider the major kinds of bank assets and liabilities, inasmuch as we use the balance sheet approach in our explanation of bank deposit creation.

factors effecting the money supply Determined by the central bank

Three of these six factors affecting the money supply are determined by the central bank,i.e., the total bank reserves, the legal reserve ratio behind demand deposit,and the legal reserve ratio behind time deposits. Two other factors, the demand for currency and the desired ratio of time deposits to demand deposits,are under the control of the public, whereas the demand for excess reserves is a function of commercial bank behavior. Only if we regard the public is bank is portfolio policies as being constant,i.e., not effected by interest rate and income demand changes, can we regard the money supply as being exogenously or externally determined by the central bank.

process of money creation

the creation of money seem much less mysterious after the process is examined step by step. It may then be realized that this process of money creation depends upon (1) a fractional legal reserve requirement, so that banks do not have to maintain 100 per cent reserves against their demand deposits,(2) a fractional legal reserve ratio against time deposits, (3) the provision of added reserves by the central bank,i.e., the federal Reserve System,(4) the demand for currency on the part of the public, which may be viewed as a ratio of demand deposits held by the public, (5) the demand for time deposits by the public, which again may be viewed as ratio of demand deposits, and (6) the demand for excess reserve by commercial banks.

the multiple expansion of bank deposits

of all financial intermediaries commercial banks are unique in that they can create demand deposits, which provide the bulk of the money supply in the United States. Furthermore, there is a multiple relationship between the amount of bank deposits a given bank can have in terms of cash reserves. it is this fractional reserve requirement for commercial banks that makes it possible for them to create added money, even though each individual bank only lends out its excess reserve. Because each bank can lend only funds that it has, how can the entire banking system create new money? Money creation by the banking system sometimes strikes the student as being almost as mysterious as the processes of the medieval alchemist, who was trying to create gold out of baser metals.

call loan participation

call loan participations extended by city to their country correspondents is another avenue of entrance into the money market that is available for banks outside the money market centers. Although loan participations with city correspondents have long been standard practice, only in recent years have city banks been willing to extend this participation to call loans. This major innovation was generally introduced in the mid-1950 ’S and is now usually a vailable to country correspondents. When available, such call loan participations represent an attractive employment of short-term funds, because the call feature makes the loan available within one day of call. Furthermore, the interest return on such loan is considerably above the lower yields at the short end of the money market. Country banks sharing in these call loan participations, however, are usually expected to leave their funds in such employment at least a week or two. In some cases country banks have continuously employed funds in call loan participations for a number of months at a time.

correspondent balances of commercial bank

correspondent balances also are a form of primary reserves, or cash, of commercial banks. A city correspondent requires its country correspondent to maintain a balance sufficient to cover the cost of services that are furnished to the country correspondent. Despite these services, however, it is always in the interest of the country bank to keep its city correspondent balances as low as possible. These correspondent balances sometimes get so low in relation to the cost of the services being performed that the city bank finds it necessary to encourage the country bank to maintain a balance somewhat larger than it has been running. if the account continues to be unprofitable, the city correspondent may even terminate the relationship, though such extreme action is unlikely. Correspondent accounts normally yield a comfortable profit for the city bank. Indeed, the likelihood of profit from such accounts leads most large city banks to seek out actively correspondent deposit business.

forecasting Bank Reserve Requirements

The money desk managers, who manage the cash reserve position in large commercial banks must still keep close track of the factors that determine reserve requirements, mainly a change in both demand and time deposits. Often, for large city banks at least, future required reserve are projected for several weeks ahead with daily or even hourly revisions of the projections. the money desk must also make certain that the bank has an adequate amount of highly liquid assets, such as treasury bills, that can be liquidated, if needed, to add to the supply of loanable funds, or to restore the legal reserve position of the bank.

Managing the money position of a bank

the entry of a commercial bank into the money market comes in connection with the management of its money position, which means the management of the liquid assets of the bank in such a manner as to avoid either excesses or deficiencies of required reserves on an average daily basis for a reserve period, which is now a week-Thursday to Wednesday for all member banks. Required reserves for the current week are now determined by the average deposits of the bank in the reserve week two weeks prior to the current week. This change to a lagged period in computing reserve requirements for member banks was made by the federal Reserve Board in 1968. This change greatly assists the money desk manager in the minimization of excess reserve. Moreover, both excess reserves and reserves deficiencies may now be carried over into the next reserve week.

clearing procedures and securities markets(3)

By holding securities in street name and using clearing houses, brokers can reduce the cost of transfer operations. But even more can be done: certificates can be immobilized almost completely. The Depository Trust Company (DTC) accomplishes this by maintaining computerized records of the securities "owned" by its member firms (brokers,banks,etc.) Member deposit certificates, which are credited to their accounts. The certificates are transferred to the DTC on the books of the issuing corporation and remain registered in its name unless a member subsequently withdraws them. Whenever possible, one member will " deliver" securities to another by initiating a simple bookkeeping entry in which one account is credited and the other debited for the shares involved. Dividends paid on securities held by DTC are simply credited to member's accounts based on their holdings and may be withdrawn in cash.
The Securities Acts Amendments of 1975 instruct the Securities and Exchange commission to develop a central system of this sort to eliminate the movements of stock certificates and possibly eliminate stock certificates entirely. Eventually, at dividend time, corporations’ computers may deal directly with other computers that are in touch with still other computers in banks, brokerage firms, and so on. Moreover, the central market system may be integrated with the central clearing system, so that agreement of two parties to the terms of a transaction will automatically bring about the transfer of ownership required to complete the trade.