OLORUNMOWAJU DAVID DARE 13AC1154 ACCOUNTING BANKING AND MONEY CREATION CONCEPT OF BANKING: Banking may be viewed as an international economic activity which provides an array of risky financial services, which includes the taking of financial decisions involving activities such as the acceptance of money deposits(cash and specie), mobilization, channeling and creation of money and credits, incurring financial obligations to acquire claims such as guarantees/bonds and providing a debt clearing mechanism that ensures economic growth in industry and commerce. John M. Keynes (1930) stated that the modern banker performs two sets of services; that he will supply a substitute for state money by acting as a clearing house and transfering current payments backwards and forwards between his different customers by means of book entries on the credit and debit sides. That he will also act as a middleman in a particular type of lending, receiving deposits from the public, which he will employ in purchasing securities, or making loans to industry and trade, mainly to meet the demand for working capital. In simple words, banking is the business of a bank. Having examined the nature and definition of banking, it is now expedient to consider the institution under which banking activities are being carried out, which is, the bank. According to Person Perry (1979), a bank is an establishment which deals in money, receiving money on deposit from customers and honouring customers drawings against such deposits on demand, collecting cheques from customers and lending or investing such surplus money until itis required. In simple words, we can say a bank is a financial institution that undertakes banking activities. CONCEPT OF MONEY CREATION Money creation is the process by which the money supply of a country is increased, which could be through the central bank or the commercial banks. Through fractional reserve banking, the modern banking system expands the money supply of a country beyond the amount initially created by the central bank. There are two types of money in a fractional-reserve banking system: currency originally issued by the central bank, and bank deposits at commercial banks: 1. Central bank money (all money created by the central bank regardless of its form, e.g. banknotes, coins, electronic money) 2. Commercial bank money (money created in the banking system through borrowing and lending) ? sometimes referred to as checkbook money. When a commercial bank loan is extended, new commercial bank money is created. As a loan is paid back, that commercial bank money disappears from existence. Since loans are continually being issued in a normally functioning economy, the amount of broad money in the economy remains relatively stable. Because of this money creation process by the commercial banks, the money supply of a country is usually a multiple larger than the money issued by the central bank; that multiple is determined by the reserve requirements or other financial ratios (primarily the capital adequacy ratio that limits the overall credit creation of a bank) set by the relevant banking regulators in the jurisdiction. However, the scope of this topic examines the creation of money via commercial banks. Therefore the way and manner in which commercial banks create money shall be discussed below. HOW BANKS CREATE MONEY This sub-topic examines how bank activities generate additional money in the economy. In other words, how bank activities( I.e Banking) expand money supply in the economy. Below are some of the ways banks create money; 1. DEPOSITS: A bank depends on a hard-core funding base to be genrated from current savings, and term deposit accounts. To a large extent, the deposit base forms the bedrock of banks loans and advances and other investments from which it derives its income. 2. BANK CHARGES: Income also come from performing services to customers and charging them certain sum e.g commission on turnover(COT), on draft, on bank cheque, on foreign exchange transactions etc, thereby creating money. 3. FINANCIAL INTERMEDIATION: In the process of the banks performing their most important function of financial intermediation, commercial banks mobilize deposits and grant loans and advances to their customers. The banks require deposits to back up their lending and investment activities. Banks create money from the loan advances made to customers by charging interest on the loan. 4. SELLING OF SHARES: Banks create money by selling the companys shares to the public. When all the portions allocated are pulled together, it will amount to the companys authorized share capital. 5. INVESTMENT: Banks create money when they invest. For example, if a bank buys government securities like treasury bills or treasury certificates, it will pay by. Issuing a cheque drawn on its current account with the central bank. This is a form of lending to the government, since the centra bank will debit the current account of the bank and credit the government account. The bank has therefore allowed the government to acquire new balances on their current accounts and has therefore created money. CONCLUSION In conclusion, it is obvious that there is a working relationship between the two concepts i.e banking and money creation. In other words, there is a direct relationship between the activities of a bank (banking) and money creation i.e the resultant effect of the activities of a bank is money creation. Therefore, banking creates money. REFERENCE 1. S.O James (2010), Elements of Banking and Finance Made Easy, Eleojo Publishers, Anyigba. 2.Mankiw, N. Gregory (2002). Macroeconomics (5th ed.). Worth. pp.?81?107.
Posted on: Sun, 19 Jan 2014 17:52:15 +0000
Trending Topics
Recently Viewed Topics
© 2015