NZ Financial SystemAnd the role of the Reserve Bank of NZ

NZ Financial System

Acts as NZ’s central bank. Has a number of functions which include:

◦ Banking for the NZ Gov’t◦ Registering and Supervising all Banks in NZ and

other Financial Institutions.◦ Operating Monetary Policy to achieve price

stability◦ Issue currency◦ Manage NZ Foreign Exchange (FX) reserves◦ Providing Banking Services for other banks

Want to know more…you will when we go there Tuesday 15th September 1pm!

The Reserve Bank of NZ…

Can only be called a bank if registered with the RBNZ.◦ To do this must provide

Transactional Accounts for Public/Business Loans Transfer of Funds Safe Custody/Storage of Valuables Foreign Exchange

◦ Also must meet strict requirements such as: Min Capital Outlay $15m Prudent Capital adequacy Ratio’s Have proven experience/Good reputation/ Transparency

Registered Banks in NZ

Currently there are only 18 registered banks in NZ.

So all other financial institutions may act like banks but can’t be called banks.

What they offer:◦ Loans – usually at higher interest rate (more risk)◦ Investment options – Shares, Property – Managed

Funds etc. Again higher rates of return promised but usually at higher risk.

◦ Other savings/banking services

Other Financial Institutions….

Do banks really create money?◦ Lets find out….

Key concepts◦ Reserve Ratio◦ Settlement Cash Deposits◦ Simplified Model of Bank lending◦ Primary v Secondary Expansion/Contraction of

Money Supply◦ The Credit Multiplier

Settlement Cash Deposits and Credit Creation…

In simple terms. Banks lend out more than they have in deposits.◦ Eg Kelly deposits $2000 into the McIntosh Bank

and Ms McIntosh lends out $1900 to Michael How much is Ms Mc keeping in reserve? Is this prudent?

A Reserve Ratio is how much banks keep of the original deposit in case the depositor’s claim there deposits back.◦ E.g. Kelly turns up an hour later and demand’s

here $2000 back

Reserve Ratio/Fractional Banking

Do we all bank with the same bank?◦ What happens when Alex decides to pay back

Claartje the $165 he owes her, assuming Alex banks with TSB and Claartje banks with Rabobank?

Each bank holds what are called Settlement Cash Deposits with the RBNZ – other countries equivalent

At the end of each day all banks Settlement Cash Deposits are debited or credited with the applicable amount.

Settlement Cash Deposits

What happens if TSB doesn’t have enough money in its account with the RBNZ to pay Rabobank?◦ They can borrow off the RBNZ at the OCR + .25%◦ If they are in credit the RBNZ will pay them

interest at the OCR - .25%

The OCR and Settlement Cash Deposit Accounts…

Combined balance sheet of all registered banks

Assets $m Liabilities $m

Reserves 200Loans to Public (Advances) 800

Transactional Account 1000Balances

1000 1000

Simplified Model of Bank Lending

Balance sheet for the RBNZ

Assets $m Liabilities $m

Loans to Govt 200Other 300

Transactional account 200Deposits of Registered Banks

Deposits of Govt 300

500 500

All registered banks are combined into 1 group and that all reserves are held as settlement cash deposits at the RBNZ

All consumers use their transactional accounts at the registered banks for all transactions (i.e. no use of notes and coins)

The Government banks with the RBNZ Hypothetical Numbers

Assumptions of the Model

Primary.◦ The first initial injection/withdrawal from the

financial system. Registered banks gain/lose new reserves. E.g. Changes in Gov’t spending, Switching in and out

of cash – i.e the public withdrawing more than they deposit and vice versa

Secondary◦ After the initial injections banks will hold more

reserves than their ratio. So they lend it out extra deposits until their reserves are equal to the reserve ratio. CREDIT CREATION

Primary v Secondary Expansion/contraction of the Money Supply

To see what the final increase in the money supply is use the following formula◦ M = 1/R x N

M = Money Supply N = Increase in new money (Reserves) R = prudential reserve ratio

◦ Ex: N = $1000 & R = 20%◦ M = 1000/.02 = $5000Limitations…the public don’t always deposit back loans cash..Tax payments, import payments, deposits to otherbanks…..bank may not lend out to the full reserve ratio tighten credit conditionsetc

The Credit Mulitiplier….