this is a summary of the modules that involves studying the financial system of the economy. Here you will find information in regards to banking systems and the foreign exchange markets and the important role that it has on the economy.
The financial system
Financial intermediaries are organisations which enable money to be transferred from
savers to borrowers. They channel funds into places where the best return can be made
and give financial advice to customers. In addition, they facilitate the spreading of risks and
the acquisition of liquidity.
Institutions under financial intermediaries
The financial intermediaries can be classified into two principal groups.
Deposit taking institutions
Non-deposit taking institutions
Deposit taking institutions are essentially banks. These fall into two further groups.
, Retail banks or commercial banks
Wholesale and investment banks
Because these institutions accept deposits from the public, both individuals and
organisations, and because of their central role in the economy, they are formally or
informally supervised by the central bank. In the UK, the central bank is the Bank of
England, in the US, the Federal Reserve Board and for the Eurozone countries, the
European Central Bank.
Thus there are two main types of banks in operation, retail banks or commercial
banks and wholesale banks.
Role of commercial banks
Role of wholesale banks
In addition to retail banks there are also wholesale banks. These are also known as
investment or secondary banks. The most common of these banks are the merchant
banks and overseas banks. In addition, the large commercial banks will have
investment bank subsidiaries e.g. Barc is the investment banking arm of Barclays bank
, A bill of exchange is a trading contract, usually for three months, upon which a trader can
usually get credit.
Non-deposit taking financial institutions
Credit creation
In their role of financial intermediaries, banks have the ability to create credit. This ability
arises because:
depositors do not withdraw all of their funds in cash in any one period. Experience
suggests that considerably less than 10% would be withdrawn in this way.
even when cash is withdrawn by a customer, some may return as income from
other customers dealing with the first.
The proportion of cash withdrawals to total deposits is known as the cash ratio. This in turn
makes possible the multiple creation of credit by banks. Let us understand this process of
credit creation by banks through an example.
The proportion of cash withdrawals to total deposits is known as the cash ratio.
The process of credit creation can continue as long as the ratio of cash or liquid assets to
total deposits is maintained. The term deposit multiplier denotes the amount by which
total deposits can increase as a result of the bank acquiring additional cash. This amount
equals the reciprocal of the cash ratio.
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