An Introduction to The Economics of Money Banking and Financial Market:
The economics of money banking and financial market is integral to the proper functioning of the
banking system of an
economy. It not only prevents
overheating of the
economy by letting appropriate quantity of money flow in the economy. Besides, anyone trying to figure out the basics of
monetary and credit policy must possess an in-depth knowledge of
the economics of money banking and financial market.
Understanding the basics of economics of money banking and financial market:
Money Banking:
The definitive money in the nation that consists of all the base money in private hands comes from the monetary base created by the Fed. Besides this money(in the particular country's currency) is also held by government and foreign central banks but this is not included in the
Federal Reserve notes.
Commercial banks are also an important player in
the economics of money banking and financial market. Their main function is however bilateral. On one hand they lend out in the form of a deposit to the borrower which he can withdraw according to his wish. This money however is not counted as base money but is a form of base money on demand. On the other hand they accept cash deposits which is converted into credit when the bank lends it out in the market.
A bank however can't lend out all the money it accepts as deposits as banks have to store away a portion of the money. These official reserve are in the form of vault cash and deposits at the Fed. Banks can also hold secondary reserve in the form of
Treasury Bills. A bank complying with all the conditions laid down by the Fed may still be insolvent if its liability exceeds its other assets(principal assets being the recoverable as well as unrecoverable loans) and reserves.
So far so good, the quantity of money in circulation is ultimately decided by the public. The central bank just replenishes the lost reserves. The liquidity of the
banking system is in jeopardy if the attempts made by the central bank fails. There is a monetary crisis and a deflationary situation is created. The interest rate adjustment then comes into play to correct the situation.
Financial Market:
A
financial market is crucial for the smooth functioning of
the economics of money banking and financial market. Financial market refers to the place where creation and exchange of
financial instruments take place. Usually these are the
stock exchanges in countries, but they also include online and distant communication and transactions between buyers and sellers. These include markets for transaction of
stocks, bonds, foreign exchange.
Money market and
capital market are the two broad parts of a
financial market.
Money market deals mainly with
short-term debt instruments such as
Treasury Bills,
commercial paper,banker's acceptance and
certificate of deposits. The maturity period of most of these instruments are less than one year.
Capital market on the other hand mainly deals with equity and
long-term debt securities. With a
maturity period of more than one year.
The economics of money banking and financial market is a huge subject that is ever changing and is without any prescribed syllabus. The above is only an attempt to understand the basics.