Money, Banking and The Financial System

CHAPTER
4 MONEY, BANKING AND THE FINANCIAL SYSTEM

LEARNING OUTCOMES

At the end of this chapter, students should be able to:

i) Discuss the definition, characteristics and functions of money

ii) Differentiate between transaction, precautionary and speculative motives of demand
for money.
iii) Discuss the concept of money supply (M1, M2 and M3).
iv) Explain the function of Central Bank and monetary policy (types and tools).
v) Explain the function of commercial bank and discuss the credit creation process.
vi) Describe Islamic financial/banking products.

SHORT NOTES

4.1 Money is something that is generally accepted as a medium of exchange for goods and services.
It is universally accepted in an economy both by sellers as a payment for goods and services and
by creditors as payment for debt.

Money can overcome the problem faced in barter system which:

i) Need double coincidence of wants
ii) No common measure of value
iii) Difficult in storing the value or wealth
iv) Heavy and fragile

Money should be accepted, durable, divisible, portable, uniform and relatively scarce.

4.2 Motives of demand for money

Transaction motive Precautionary motive Speculative motive

Refer to demand for money Precautionary money People held money to buy
for consumer expenditures balances are held because financial assets such as
and business transactions. of uncertainty about stocks and bonds for
expenditures of future future profit.
income.
The amount of money is Money demand is depending Money demand is
depending on disposable on disposable income depending on interest
income. rate.

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4.3 Money supply (M1, M2 and M3)

Currency (coins + paper money

M1
Checkable/ demand deposits/ current deposit +
traveler check
Fixed and savings deposits with Bank Negara

MONEY (M2 – M1)

BROAD NEAR MONEY/BROAD

MONEY/QUASI
Malaysia and commercial banks

QUASI MONEY (M3 – M1)

M2
Fixed deposits of all maturities at commercial banks

NEAR
Net issues of negotiable certificates of deposit

M3
(NCD) by commercial banks
Repo transactions effected by the commercial banks
Bank Negara certificates in the commercial banks
Saving deposits with other financial and banking institution
Fixed deposit with other financial and banking institution
Net issues of NCD with other financial and banking institution
Repo transactions with other financial and banking institution

4.4 Central Bank

Central bank is financial institution that oversees the financial system and the economy. Central
bank for Malaysia is Bank Negara Malaysia will regulate, supervises and is responsible for
policies concerning money.

4.5 Commercial bank

Commercial bank is privately owned and profit-making institution that try to achieve maximum
profit and guarantee the safety of public deposits. Income generated by commercial bank is
from providing services to the public such as financial advice, provide loan and ATM machine.

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MULTIPLE CHOICES

1. There are more characteristics of money. Which of the following is not the characteristic of
money?

A. Divisibility
B. Portability
C. Acceptability
D. Shared responsibility

2. The speculative motive of demand for money depends mainly on the

A. general price level

B. money supply
C. interest rate
D. level of income

3. The main reason that people hold money - 'to buy things' - is referred to as

A. the precautionary motive.

B. the profit motive.
C. the transactions motive.
D. the speculation motive.

4. A bank can create money by:

A. selling some of its public sector securities.

B. getting its borrowers to repay their loans.
C. lending its excess reserves.
D. printing more cheques.

5. Which of the following not represent the example of Islamic financial product?

A. Al Bai Bithaman Ajil.

B. Al-Musyarakah.
C. A-Fai.
D. Al-Ijarah.

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FILL IN THE TABLE WITH CORRECT DEFINITION

Barter system

Fiat money

Narrow money

Commercial bank

Credit creation

Money multiplier

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MATCH THE SENTENCE WITH THE CORRECT TERM

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STRUCTURED QUESTION

QUESTION 1

The following table shows the money supply in year 2018.

Component of Money Supply RM (Million)

Fixed deposit at commercial bank 4000
Fiat money 5000
Fixed and saving deposit at other financial institution 7000
Negotiable certificate issued by other financial institution 6000
Negotiable certificate placed with commercial bank 2000
Bank Negara certificate 8000
Current deposit at commercial bank 6000
Saving deposit at commercial bank 3000

Calculate:

a) The value of money supply, M1.

b) The value of money supply, M2.

c) The value of money supply, M3.

d) Define barter system and list any two (2) problems of barter system.

QUESTION 2
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 Money, Banking and The Financial System

The following table shows the money supply in year 2018.

Component of Money Supply RM (Million)

Fixed deposit at commercial banks 18500
Paper money 19500
Negotiable certificate issued by other financial institution 10500
Checkable deposit 5500
Bank Negara certificate 19800
Savings deposit at commercial bank 18800
Fixed and saving deposit at other financial institution 16800
Negotiable certificate placed with another commercial bank 8800
Coins 7500

a) Define fiat money and calculate its value.

b) Calculate the value of money, M2.

c) Calculate the value of money, M3.

e) The value of narrow quasi money.

f) The value of broad quasi money.

QUESTION 3

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The table shows the monetary items for country VOV in year 2018.

Component of Money Supply RM (Million)

Deposit placed with other banking institutions 1900
Negotiable certificate placed with other banking institutions 1600
Fixed and saving deposits in commercial banks 1800
Coins 1300
Demand deposits at commercial bank 1500
Currency in circulation 1700
Bank Negara Certificates 1550
Negotiable certificates 1430

a) Calculate the amount of:

i) paper money.

ii) money supply, M1.

iii) money supply, M2.

iv) money supply, M3.

v) broad quasi money.

b) Define near money.

QUESTION 4
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 Money, Banking and The Financial System

The following table shows the money supply in year 2018.

Component of Money Supply RM (Million)

Fixed and saving deposit at commercial bank 11600
Paper money 11800
Fixed and saving deposit at other financial institution 11100
Negotiable certificate issued by Bank Rakyat 16600
Negotiable certificate placed with commercial bank 19500
Bank Negara certificate 15100
Demand deposit at commercial bank 11200
Saving deposit at another commercial bank 16800

a) Calculate the amount of coins if fiat money is RM10, 500.

b) Calculate the value of money, M2.

c) Calculate the value of money, M3.

d) Calculate narrow quasi money.

QUESTION 5

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Given the Liquidity Reserve Requirement stated by Central Bank is 25%. A customer, Bingo
deposited RM75, 000 in GREY Bank.

a) Find the excess reserve by GREY Bank.

b) Show a balance sheet for GREY Bank.

c) Compute the amount money created by GREY Bank.

d) If another customer of GREY Bank deposited a sum of money of RM100, 000. Find the total
money supply created by GREY Bank now.

QUESTION 6

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The following data shows the balance sheet of Bank PINK for the year ended 2018.

ASSETS LIABILITIES
Cash 12,000 Deposits 60,000
Loans 48,000
TOTAL 60,000 TOTAL 60,000

Based on the information, answer the following questions.

a) Calculate cash reserve ratio.

b) Calculate total money supply and total credit created.

c) What would happen to the total amount of money supply if the cash ratio is increase to 30%.

d) Assuming Siti took a loan of RM48,000 from Bank PINK and return to Bank PINK to deposit
the money. With the same cash reserve ratio as a), show the new balance sheet of Siti.

QUESTION 7

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Assuming Bank BLUE receive a deposit of RM10, 000 million from Amni and faces a required cash
reserve of 15%.

a) Show the balance sheet of Bank BLUE.

b) Calculate the money created by using a money multiplier.

c) Assuming Amin took a loan from Bank BLUE and deposited back into Bank BLACK. With the
same cash reserve ratio, show the balance sheet of Bank BLACK.

d) Assuming both banks wish to hold another 5% of the excess reserve, how would this affect the
total change in money supply. Why?

e) List any three (3) limitations of the credit creation.

1) ____________________________________
2) ____________________________________
3) ____________________________________

QUESTION 8

The following data shows the balance sheet of International GREEN Bank for the year ended 2018.
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ASSETS LIABILITIES
Cash 15,000 Deposits 50,000
Loans 35,000
TOTAL 50,000 TOTAL 50,000

Based on the information, answer the following questions.

a) Define cash reserve ratio. Find the value of cash reserve ratio.

b) Compute the total money supply and total money created by International GREEN Bank.

c) What would happen to the total amount of credit created if the cash ratio is decreased to
10%.

d) Let’s assume that a loan of RM35,000 from International GREEN Bank was given to a
borrower named Awin. Awin deposited the money in another Bank YELLOW. Show the new
balance sheet of Bank YELLOW, using the same cash reserve ratio as found in the above
question (c).

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