1. Chapter 30
The Monetary System

2. Key Terms
money reserves
medium of exchange fractional-reserve banking
unit of account reserve ratio
store of value money multiplier
liquidity bank capital
commodity money leverage
fiat money leverage ratio
currency capital requirement
demand deposits open-market operations
central bank discount rate
money supply reserve requirements
monetary policy

3. Two Choices
Make
or
Trade

4. Barter
Direct trade - stuff for stuff
No money
Double coincidence of
wants

5. Double coincidence of wants
Both sides have to want what the other side has

6. Money makes trade easier

7. Double coincidence of
wants
Both must want what
the other has at the
same time

8. What is money?

9. Money
Something people use to
trade with

13. Why would you accept a
cigarette if you didn’t smoke?

15. Functions of Money
medium of exchange
unit of account
store of value

16. Medium of Exchange
Buyers give to sellers
Sellers accept from buyers

17. Unit of Account
Measurement
Prices
Debts

18. Store of Value
Trading time for time
Today for tomorrow
Tomorrow for today
Earn - Save - Spend

19. Liquidity
How easy is it to convert
something to money

20. Kinds of Money
Commodity
Fiat

21. Commodity Money
Intrinsic value

22. Easy to carry
Easy to measure
Easy to verify
Hard to copy

23. Gold Standard
=
Central Bank will convert paper
money to gold at a fixed rate

24. Fiat Money
No intrinsic value
Declared money by
government decree

25. Fiat Money
Why do people accept fiat
money?
Trust that someone else
will also accept it

26. Money
Trust inscribed
If people lose trust,
money loses it value

27. Coins
Currency
Checks

28. Card Type Payment
Credit Defer
Debit Instant

29. Why credit and debit
cards are not money
Not a method of
payment, but a method of
making payment

30. Debit card is like a check
Takes money out of your
bank account

31. Credit Card
Defer the payment

32. Demand Deposits
Bank account that you
can access by writing a
check or using a debit
card

34. Saudi Arabia Monetary
Agency
The Central Bank of
Saudi Arabia
SAMA
sama.gov.sa

35. Central Bank
The bank that oversees
the banking system and
regulates the money
supply in a country

36. Dr. Fahad Al Mubarak
Chairman of the Board
Governor
Saudi Arabia Monetary
Agency
SAMA

38. Six Functions
• Issues national currency, the Saudi Riyal.
• Acts as a banker to the government.
• Supervises commercial banks.
• Manages Kingdom’s foreign exchange reserves.
• Conducts monetary policy for promoting
price and exchange rate stability.
• Promotes the growth and ensures the
soundness of the financial system.

40. Source: sama.gov.sa

41. Money Supply
The quantity of money
available in a country.

42. Monetary Policy
Setting the money
supply by the central
bank policymakers

43. Two Types of Banks
100 Percent Reserve
Fractional Reserve

44. 100-Percent Reserve Bank
All the deposits are kept
in a safe vault.
No loans

46. Fractional-Reserve Bank
Bank only holds a
fraction of the deposits
as reserves
Loans out the remainder

47. Reserve Ratio
The fraction of deposits
that banks hold as
reserves

48. Fractional-Reserve Banking
Creates money

49. How does 1000 become 10,000?
Reserve Loan
Bank Deposit
10% Remainder
1000 100 900
900 90 810
810 81 729
• • • •
• • • •
• • • •
Total 10,000

50. Money multiplier is the
reciprocal of the reserve ratio
Reserve Money
Fraction Reciprocal
Ratio Multiplier
100% 1 1÷1 1
50% 0.50 1 ÷ 0.50 2
25% 0.25 1 ÷ 0.25 4
10% 0.10 1 ÷ 0.10 10
5% 0.05 1 ÷ 0.05 20
1% 0.01 1 ÷ 0.01 100

51. Bank Capital
The money the bank’s
shareholders have put in
to the bank

52. Leverage
OPM
Using other people’s
money

53. Leverage
1. I have 10
2. I borrow 90 from you
3. I buy something for 100
4. I resell the item for 150
5. I pay back your 90
6. I keep the 60
7. I earned 50 profit on my 10

54. Leverage Ratio
The ratio of assets to
bank capital
Assets
Bank Capital

55. Bank Balance Sheet
Liabilities and
Assets
Owner Equity
Reserves 200 Deposits 800
Loans 700 Debt 150
Securities 100 Capital 50
Total 1000 Total 1000
Totals must balance or be equal

56. What is the leverage ratio?
Liabilities and
Assets
Owner Equity
Reserves 200 Deposits 950
Loans 800 Capital 50
Total 1000 Total 1000
Assets ÷ Capital
1000 ÷ 50 = 20

57. Leverage Ratio of 20
Owners put up 1
Depositors put up 19

58. Leverage is Risky!
If leverage ratio is 20,
5% increase in asset value
= 100% return to owners
5% decrease in asset value
= 100% loss to owners

59. Capital Requirement
Government rule on
minimum amount of
bank capital

60. Insolvent
Liabilities are more than
the assets
You owe more
than you own

61. Three Tools
of Central Banks
Open-Market Operations
Discount Rate
Reserve Ratio

62. Open-Market Operations
Purchase and sale of
government bonds
Buy bonds increases supply
Sell bonds decreases supply

63. Increase Money Supply?
Buy bonds for cash
Central Bank
Banks
now have
more cash to
loan
Public Banks

64. Decrease Money Supply?
Sell bonds for cash
Central Bank
Banks
now have less
cash to loan
Public Banks

65. Discount Rate
The rate the central bank
charges to make loans to
member banks
Called the Official Repo Rate
or ORR rate in Saudi Arabia

66. Official Repurchase Rate
or Discount Rate
2.0%
Dropped from 2.5% on
January 19, 2009

67. Dropped from
5.5% October 2008
to 2.0% by January 2009
Rate increased 3 month period of
as economy global financial crisis
heated up
SAMA Official Repo Rate

68. Reserve Ratio
Increase reserve ratio will
reduce money multiplier
Decrease reserve ratio will
increase money multiplier

69. The Power of the Reserve Ratio to Multiply Money
100%
90%
80%
70%
Reserve 60%
Ratio 50%
40%
30%
20%
10%
0%
1 2 4 6 8 10 12 14 16 18 20
Money Multiplier

70. Reserve Ratio
Not changed very often
What is the current reserve
ratio in Saudi Arabia? 7%
What is the Money Multiplier?
1÷7% = 14.28

71. Bank Deposit Insurance
Protects against bank runs
Moral Hazard to take more
risk because government
will pick up losses