Functions of commercial bank - buying government securities, Macroeconomics

Assignment Help:

Buying government securities: When a commercial bank buys government bonds, the effect is substantially the same as that of lending - new money is created.

To illustrate let us take the same hypothetical example of Bank A, the balance sheet of which stands as under:

Balance Sheet of Bank A

Liabilities                         Rs.                   Assets                           Rs.

Capital

5,00,000

Cash

50,000

Demand deposits

3,00,000

Reserves with RBI

6,45,000

 

 

Required liquid assets

1,05,000

For simplicity, let us assume that the RBI recognizes government bonds as 'acceptable' unencumbered securities which can be held by commercial banks to satisfy the liquid assets requirement. This means that the Bank A can now keep its required liquid assets in government bonds rather than in cash.

Bank A increases its reserves with the RBI to Rs.8,00,000 by depositing the cash with it and holdings of liquid assets. Now suppose that, instead of making a loan, the bank buys Rs.7,55,000 worth of government securities from a bond broker. The bank receives the high interest-bearing bonds which appear on its balance sheet as the assets 'securities' and gives the broker an increase in its demand deposits by the same amount. The balance sheet, then, would appear as follows:

Balance Sheet of Bank A

Liabilities                         Rs.                   Assets                           Rs.

Capital

5,00,000

Cash

-

Demand deposits

10,55,000

Reserves with RBI

8,00,000

 

 

Securities

7,55,000

The important point to note from the above balance sheet is that demand deposits, that is, the supply of money, have been increased by a total of Rs.7,55,000. The bank has accepted government bonds - which are not money - and gives the securities broker an increase in demand deposits - which is money. Thus, by buying government bonds, the bank has created money.

When the securities broker draws and clears the cheque of Rs.7,55,000 against the Bank A, the demand deposits and reserves of Bank A with RBI will reduce by Rs.7,55,000. Its reserves with RBI will be just meeting its 15 percent cash reserve requirement but it will have Rs.7,55,000 worth of government securities, an excess amount to meet its liquid assets requirement. Its balance sheet would show as follows:

Balance Sheet of Bank A

Liabilities                         Rs.                   Assets                           Rs.

Capital

5,00,000

Cash

-

Demand deposits

10,55,000

Reserves with RBI

45,000

 

 

Securities

7,55,000                                              


Related Discussions:- Functions of commercial bank - buying government securities

NATIONAL INCOME VARIATION, give and explain the different causes of nationa...

give and explain the different causes of national income variation

Index number, definition and charactoristics of index numbers.problems whil...

definition and charactoristics of index numbers.problems while constructing index numbers

Maintaining the building of explicit cost, An owner can lease her building ...

An owner can lease her building for $100,000 per year for the next three years. The explicit cost of maintaining the building is $35,000, and the implicit cost is $50,000. All reve

Highest willingness to pay, Since anyone is able to obtain a license, not n...

Since anyone is able to obtain a license, not necessarily the low cost suppliers of archery lessons, and it is not necessarily the individuals with the highest willingness to pay w

AS-AD model, evaluate the usefulness of the model in South Africa

evaluate the usefulness of the model in South Africa

Detetrmine gross investment and government expenditure, The following is th...

The following is the information from the national income accounts for a hypothetical country:  GNP                                                                  Rs. 5000.00

Help, Examine the graph below. The mayor has placed a $2 tax on the sale of...

Examine the graph below. The mayor has placed a $2 tax on the sale of each taco sold within the city. How large is the decrease in producer surplus?

Explain the basic characteristics of IS-curve, Q. Explain the basic charact...

Q. Explain the basic characteristics of IS-curve? IS-LM diagram IS-curve The IS curve shows all combinations of R and Y where the goods marketis in

Keynesian dyanamic multilpier, what is static and dynamic multiplier in key...

what is static and dynamic multiplier in keynesian theory?

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd