FIN310 Class Web Page, Fall ' 24

Instructor: Maggie Foley

Jacksonville University

The Syllabus  Risk Tolerance Assessment Term Project

Weekly SCHEDULE, LINKS, FILES and Questions

Chapter

Coverage, HW, Supplements

- Required

References

Intro

Marketwatch Stock Trading Game (Pass code: havefun)

Use the information and directions below to join the game.

1. URL for your game:
https://www.marketwatch.com/game/jufin310-24fall

2. Password for this private game: havefun

3. Click on the 'Join Now' button to get started.

4. If you are an existing MarketWatch member, login. If you are a new user, follow the link for a Free account - it's easy!

5. Follow the instructions and start trading!

Discussion: How to pick stocks (finviz.com)

How To Win The MarketWatch Stock Market Game

Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar

IPO schedule: http://www.marketwatch.com/tools/ipo-calendar

Review of the Financial Market

U.S. Regional Banks Crisis in 2023 Video on youtube (fyi)

1. Background:

• In 2023, several U.S. regional banks faced significant financial distress due to a combination of rising interest rates and asset-liability mismatches. Banks like Silicon Valley Bank (SVB) and First Republic Bank were particularly affected. These banks had invested heavily in long-term securities when interest rates were low. As the Federal Reserve increased rates to combat inflation, the value of these securities plummeted, leading to massive unrealized losses on the banks' balance sheets.

2. The Trigger:

• When depositors, particularly those with large uninsured deposits, became aware of these losses, they began withdrawing their funds en masse, leading to a classic bank run. SVB, for instance, could not liquidate its assets quickly enough without incurring huge losses, leading to its collapse.

3. Contagion Effect:

• The crisis at SVB and other regional banks had a ripple effect across the financial system:
• Investment Banks: Many investment banks held significant exposure to the bonds and assets of these regional banks. As these banks' values plummeted, investment banks had to write down losses.
• Insurance Companies: Insurers that had invested in the bonds and stocks of these banks saw their portfolios lose value, affecting their solvency ratios and causing concerns about their ability to meet future claims.
• Pension Funds: Pension funds that had invested in these regional banks or in other financial products related to them faced significant losses. This situation put at risk the retirement savings of millions of individuals.
• Individuals: The crisis led to a loss of confidence among individual investors, who started pulling out their investments from related stocks, bonds, and mutual funds, further exacerbating the problem.

4. Government and Regulatory Response:

• To prevent the crisis from spreading further, the U.S. government and the Federal Reserve stepped in with emergency measures. This included backstopping deposits and providing emergency liquidity to other banks. The Federal Deposit Insurance Corporation (FDIC) also played a crucial role in managing the collapse of these banks to protect depositors.

5. Lessons Learned:

• The crisis underscored how interconnected the financial system is. The collapse of a single regional bank did not just affect its depositors; it had far-reaching consequences across the financial markets.
• Systemic Risk: This event highlighted the concept of systemic risk, where the failure of one institution can threaten the stability of the entire financial system. It showed that banks, investment banks, insurance companies, pension funds, and individual investors are all part of a larger ecosystem. When one part of this system fails, it can trigger a chain reaction affecting everyone.

Key Takeaways

• Interconnectedness: The financial market is like a web where every player is connected to others. A problem in one area can quickly spread to others, creating a systemic crisis.
• Role of Confidence: Confidence plays a crucial role in financial markets. When confidence erodes, even well-capitalized institutions can face difficulties.
• Importance of Diversification: The crisis showed the dangers of concentration risk—whether in a specific asset class, industry, or region.
• Regulatory Oversight: The role of regulators in maintaining stability in the financial markets is crucial, especially during times of crisis.

The U.S. economy in August 2024

· Economic Growth:

• U.S. real GDP growth is projected at approximately 0.7% for 2024, reflecting a slowdown due to the effects of tighter monetary policy.
• Consumer spending is expected to decelerate as savings diminish, wage growth slows, and student loan payments resume (J.P. Morgan | Official Website).

· Inflation and Monetary Policy:

• Inflation has moderated but remains a significant concern.
• The Federal Reserve has paused rate hikes, keeping the federal funds rate at 5.25%-5.50%.
• Ongoing debate on whether the Fed might be "behind the curve" with potential inflationary pressures persisting (Hancock Whitney).

· Financial Markets:

• Increased volatility in financial markets is driven by uncertainties around economic growth, inflation, and the Federal Reserve’s actions.
• Concerns about a possible recession have been amplified by disappointing employment reports (Hancock Whitney).

· Fiscal Policy:

• The fiscal deficit nearly doubled in 2023, providing a short-term economic boost.
• However, the fiscal stimulus is expected to taper off in 2024, potentially becoming a slight drag on growth as the government works to narrow the deficit (J.P. Morgan | Official Website) (Hancock Whitney).

· Election Uncertainty:

• The upcoming U.S. presidential election adds uncertainty, with potential shifts in economic policy based on the election outcome (Hancock Whitney).

Part I – The Feds: Steering Monetary Policy Quiz2

Fed Introduction Video by Invideo.ai (FYI)

1. The Federal Reserve System: Structure and Roles

· The Federal Reserve System:

• Overview: Established in 1913, the Federal Reserve (often referred to as "the Fed") is the central banking system of the United States. Its primary purpose is to ensure a stable and secure monetary and financial system.
• Public-Private Structure: The Fed is a blend of public and private elements. It operates independently within the government but is accountable to Congress.

· Board of Governors:

• Composition: The Board consists of seven members, including the Chair and Vice-Chair, each serving 14-year staggered terms. This long term is designed to insulate them from political pressures.
• Functions: The Board is responsible for guiding the overall monetary policy, supervising and regulating banks, and setting reserve requirements (the amount of funds that banks must hold against deposits).
• Key Roles:
• Chair of the Federal Reserve: The Chair (currently Jerome Powell) is the spokesperson for the Fed, leading the FOMC, and representing the Fed before Congress and the public. The Chair's influence is significant, guiding the direction of monetary policy.
• Vice-Chair: Assists the Chair and can represent the Fed in the Chair's absence. The Vice-Chair is also deeply involved in shaping monetary policy.

· 12 Regional Federal Reserve Banks:

• Function: These banks serve as the operational arms of the Fed in different regions. They gather economic data, conduct research, provide financial services to depository institutions, and play a key role in the implementation of monetary policy.
• Diversity of Perspective: Each regional bank provides unique insights into the economic conditions of its region, which is crucial for the FOMC’s decision-making process.

· Regional Bank Presidents:

• Role in the FOMC: While only five presidents vote on the FOMC at any time, all 12 contribute to discussions. This rotation ensures diverse regional perspectives are considered in monetary policy decisions.

2. The Federal Open Market Committee (FOMC): Decision-Making Body

· Composition of the FOMC:

• Voting Members: The FOMC comprises 12 voting members – the seven members of the Board of Governors and five of the 12 regional bank presidents.
• Non-Voting Members: The remaining regional bank presidents participate in discussions, providing input but not voting.

· Functions and Responsibilities:

• Monetary Policy: The FOMC is responsible for open market operations, which involve buying and selling government securities to influence the money supply and interest rates.
• Setting the Federal Funds Rate: This rate, determined by the FOMC, is the interest rate at which banks lend to each other overnight and serves as a benchmark for other interest rates.
• Economic Forecasts: The FOMC regularly reviews economic conditions and forecasts to make informed decisions about the direction of monetary policy.

3. The Interest Rate Decision-Making Process

· Data Analysis:

• Types of Data Reviewed: The FOMC examines a wide range of economic indicators, including:
• Inflation: Measured by the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index.
• Employment and Unemployment Rates: Critical for assessing the health of the labor market.
• Gross Domestic Product (GDP): Indicates the overall economic activity.
• Consumer Spending and Business Investment: Reflects the confidence of consumers and businesses in the economy.
• Global Economic Developments: Events and trends in other countries can impact the U.S. economy and are closely monitored.

· Discussion and Debate:

• Diverse Opinions: FOMC members often have differing views on the state of the economy and the appropriate policy response, which can lead to robust debates.
• Economic Theories: Members may rely on various economic theories and models to argue their positions. For example, Keynesian economics might suggest more intervention in times of economic downturn, while a more monetarist approach might emphasize controlling inflation through money supply management.
• Policy Tools Considered: The FOMC debates the use of tools such as adjusting the federal funds rate, engaging in quantitative easing, or altering the reserve requirement ratio.

· Voting:

• Majority Rule: The FOMC votes on monetary policy actions, with decisions typically requiring a majority vote. The Chair’s vote holds significant sway due to their role in shaping the discussion.
• Dissenting Votes: It’s not uncommon for some members to dissent if they disagree with the majority view, reflecting the complexity of economic conditions and the challenges of consensus-building.

· Public Communication:

• FOMC Statements: After each meeting, the FOMC releases a statement summarizing their economic assessment and the rationale for their policy decision. These statements are closely analyzed by financial markets and economists.
• Press Conferences: The Fed Chair holds a press conference after select FOMC meetings to explain the decisions in more detail and answer questions from the media, providing transparency and clarity to the public and markets.
• Meeting Minutes: Detailed minutes of the FOMC meetings are published three weeks after the meeting, offering deeper insights into the discussions and debates.

4. Key Concepts and Tools in Monetary Policy (Continued)

· Federal Funds Rate (Continued):

• Influence on Economy: A lower federal funds rate typically encourages borrowing and investing by businesses and consumers, which can stimulate economic growth. Conversely, a higher rate can help cool down an overheating economy and curb inflation.
• Transmission Mechanism: The changes in the federal funds rate influence other interest rates, such as those on mortgages, car loans, and savings accounts, thereby impacting consumer and business spending.

· Open Market Operations:

• Primary Tool of the FOMC: Open market operations (OMOs) are the most frequently used tool for controlling the money supply and influencing the federal funds rate.
• Buying Securities: When the Fed buys government securities from banks, it increases the reserves in the banking system, which typically lowers the federal funds rate. This is used to stimulate the economy.
• Selling Securities: Conversely, when the Fed sells government securities, it reduces the reserves in the banking system, which can increase the federal funds rate. This is used to cool down inflationary pressures.
• Daily Operations: The New York Federal Reserve Bank conducts these operations on behalf of the FOMC. They are closely monitored by financial markets as they signal the Fed’s stance on monetary policy.

· Discount Rate:

• Definition: The interest rate the Fed charges commercial banks for short-term loans from its discount window.
• Relation to Federal Funds Rate: The discount rate is usually set above the federal funds rate to encourage banks to borrow from each other rather than from the Fed. However, in times of financial stress, the Fed might lower the discount rate to ensure banks have access to necessary liquidity.
• Impact: Changes in the discount rate can signal the Fed’s intentions regarding monetary policy and influence banks’ willingness to lend.

· Reserve Requirements:

• Definition: The proportion of depositors' balances that commercial banks must hold in reserve and not lend out.
• Policy Tool: By increasing or decreasing the reserve requirements, the Fed can directly affect the amount of funds banks have available to lend, thereby influencing the money supply and interest rates.
• Rarely Used: This tool is less frequently adjusted because small changes can have large and sometimes unpredictable effects on the banking system.

· Quantitative Easing (QE):

• Definition: A non-traditional monetary policy tool used when the federal funds rate is near zero, and traditional policy tools are no longer effective.
• Mechanism: The Fed purchases long-term securities, such as government bonds and mortgage-backed securities, to inject liquidity directly into the economy, lower long-term interest rates, and encourage borrowing and investment.
• Usage: QE was used extensively during the 2008 financial crisis and the COVID-19 pandemic to support the economy when standard policy tools were insufficient.
• Controversy: QE can lead to asset bubbles or long-term inflationary pressures if not carefully managed.

· Dual Mandate:

• Goals of the Fed: The Federal Reserve operates under a dual mandate from Congress:
• Maximize Employment: The Fed aims to create conditions that foster job creation and low unemployment.
• Stabilize Prices: The Fed seeks to keep inflation low and stable, typically around a 2% annual increase in the PCE price index.
• Balancing Act: The Fed must often balance these two goals, as actions to reduce unemployment can sometimes increase inflation, and efforts to reduce inflation can lead to higher unemployment.

5. Critical Thinking Points

· Who Makes the Decisions?:

· FOMC Members: Understand the distinct roles of the Board of Governors and the regional Federal Reserve Bank Presidents in the decision-making process. Recognize the influence of each member, especially the Fed Chair, and how their backgrounds, economic philosophies, and regional concerns shape their decisions.

· Rotation System: Consider how the rotation of voting rights among regional bank presidents ensures a broad range of perspectives are considered in monetary policy.

· How Is Policy Decided?:

· Data-Driven Decisions: Reflect on the importance of data in shaping monetary policy. Explore how different economic indicators, like unemployment, inflation, and GDP growth, influence the FOMC’s decisions.

· Diverse Opinions: Examine how the diversity of opinions within the FOMC can lead to complex policy debates. Consider the impact of dissenting votes and what they reveal about the challenges of setting a single monetary policy in a diverse and dynamic economy.

· Communication Strategy: Analyze the importance of clear communication from the Fed, especially in managing market expectations and maintaining public confidence in the economy.

· What Tools Does the Fed Use?:

· Impact of Interest Rates: Delve into how changes in the federal funds rate ripple through the economy, affecting everything from mortgage rates to business investment decisions. Explore the effectiveness and limitations of this tool in different economic conditions.

· Role of Open Market Operations: Study how the Fed uses OMOs to manage the money supply and control short-term interest rates. Understand the strategic use of buying and selling securities and how these actions influence the broader economy.

· Use of Non-Traditional Tools: Investigate the circumstances under which the Fed might use tools like QE. Consider the potential risks and benefits of such interventions and how they differ from traditional monetary policy actions.

· Why Does the Fed Matter?:

• Economic Stability: Understand the crucial role the Fed plays in maintaining economic stability through its control of monetary policy. Reflect on how the Fed’s actions influence inflation, employment, and overall economic growth.
• Global Impact: Consider the global significance of the Fed’s decisions. As the U.S. dollar is a major reserve currency, Fed policies can have far-reaching effects on global financial markets and economies.

6. 12 Regional Federal Reserve Bank Presidents

Nomination Process:

1. Selection by the Regional Board of Directors: The president of each of the 12 regional Federal Reserve Banks is selected by the bank's board of directors. The board of directors consists of nine members, divided into three classes:

· Class A: Three members representing member banks.

· Class B: Three members representing the public, elected by member banks.

· Class C: Three members representing the public, appointed by the Board of Governors.

The Class B and Class C directors play a primary role in the selection process, with the final candidate needing to be approved by the Board of Governors in Washington, D.C.

2. Approval by the Board of Governors: Once the regional board of directors selects a candidate, the appointment must be approved by the Board of Governors of the Federal Reserve System.

Term Duration:

• Length of Term: The presidents of the regional Federal Reserve Banks serve 5-year terms.
• Start of Term: These terms start on March 1 of years ending in 1 or 6.
• Reappointment: Presidents can be reappointed for additional 5-year terms, pending approval from the Board of Governors.

7. Federal Reserve Chair and Vice Chair

Nomination Process:

· Nomination by the President: The Chair and Vice Chair of the Federal Reserve Board are nominated by the President of the United States from among the sitting members of the Board of Governors.

· Confirmation by the Senate: The nominations must be confirmed by the U.S. Senate through a majority vote.

Term Duration:

• Chair and Vice Chair Term: The Chair and Vice Chair serve 4-year terms.
• Reappointment: The Chair and Vice Chair may be reappointed for additional 4-year terms, as long as they remain members of the Board of Governors.
• Overall Service: While the Chair and Vice Chair serve 4-year terms, their overall service on the Board of Governors is subject to the standard 14-year term limit for Board members.

8. Board of Governor

Nomination Process:

• Nomination: The President of the United States nominates candidates for the Board of Governors.
• Confirmation: The U.S. Senate must confirm the nominees through a majority vote.

Term Duration:

• Length of Term: Each member of the Board of Governors serves a 14-year term.
• Staggered Terms: The terms are staggered so that one term expires on January 31 of every even-numbered year, ensuring continuity and stability within the Board.
• Reappointment: A member who has served a full 14-year term may not be reappointed. However, a member appointed to fill an unexpired term may be reappointed for a full 14-year term thereafter.
• Chair and Vice Chair: The President also designates one of the Board members as the Chair and another as the Vice Chair for a four-year term. These appointments are also subject to Senate confirmation and can be renewed.

Summary

• Regional Fed Bank Presidents: Appointed by their respective regional boards of directors, approved by the Board of Governors, and serve 5-year terms.
• Fed Board of Governors: Appointed by the U.S. President, confirmed by the Senate, and serve 14-year terms.
• Fed Chair and Vice Chair: Appointed from among the Board of Governors by the U.S. President, confirmed by the Senate, and serve 4-year terms.

9. Chair The Fed Simulation Game

Game 1: https://lewis500.github.io/macro/

Game 2: https://www.fedchairsim.com/

Homework 1-1: Understanding the Role of the Fed Chair (due with the first midterm exam)

Objective: Play the FOMC Simulation Game and analyze the challenges faced by the Federal Reserve Chair. Provide thoughtful advice based on your experience with the simulation and understanding of monetary policy.

Instructions:

1. Play the Simulation:

2. Reflection Questions:

o Challenges as Fed Chair:

• Based on your experience with the simulation, discuss why being a Fed Chair is a challenging job.
• Reflect on the complexities involved in making monetary policy decisions. How do the constraints and trade-offs affect the role of the Fed Chair?

o Advice to Fed Chair Jerome Powell:

• Given your insights from the simulation, what advice would you offer to Jerome Powell as he navigates his role as Fed Chair?
• Consider current economic challenges and uncertainties. What strategies or approaches would you recommend to address issues such as inflation, economic growth, or financial stability?

In Plain Enlgish Fed St. Louise (Cool video about Fed)

***** FRB – Federal Reserve Banks *******

Federal Reserve Bank of Atlanta

https://www.atlantafed.org/

Federal Reserve Bank of Atlanta's Boardroom Video (youtube)

https://www.atlantafed.org/about/atlantafed/directors

The Fed Explains Monetary Policy (video)

The Tools of Monetary Policy (video)

Segment 406: Open Market Operations(video of Philadelphia Fed)

********** Fed Funds Rate *********

Release date: July 1, 2024 https://fred.stlouisfed.org/series/FEDFUNDS

What is the Fed Fund rate (youtube)

Segment 406: Open Market Operations (youtube, by the Fed)

Part II – The Mechanics of Monetary Policy: Tools and Outcomes Quiz1 Quiz3

Introduction to Monetary Policy

Monetary policy involves the actions undertaken by a central bank, such as the Federal Reserve in the United States, to influence the availability and cost of money and credit to help promote national economic goals. It revolves around managing the economy's money supply and interest rates to control inflation, stabilize currency, and achieve a sustainable level of economic growth and employment.

Key Tools of Monetary Policy

1. Open Market Operations (OMOs):

• Purpose: These are the primary means of implementing monetary policy. The process involves the buying and selling of government securities in the open market to expand or contract the amount of money in the banking system.
• Impact: Purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite.

2. The Discount Rate:

• Purpose: This is the interest rate charged to commercial banks and other financial institutions for loans they receive from the Federal Reserve's discount window.
• Impact: A lower discount rate encourages borrowing and expanding economic activity, whereas a higher rate is used to curb excessive growth and inflation.

3. Reserve Requirements:

• Purpose: This tool requires banks to hold a specific percentage of their deposits in reserve either in their vaults or at the Federal Reserve.
• Impact: Changing these requirements can influence how much money banks have to lend, thereby affecting the money supply.

Goals of Monetary Policy

• Controlling Inflation: By manipulating interest rates and the money supply, central banks can control inflation to maintain the currency's buying power.
• Managing Employment Levels: Monetary policy aims to achieve a 'natural rate' of unemployment. Lower interest rates provide more jobs, but excessively low rates may lead to inflation.
• Stabilization of the Financial System: By adjusting the cost of credit, the central bank can stabilize the financial system, particularly during periods of economic turbulence.

Outcomes of Monetary Policy

• Economic Growth: Effective monetary policy supports economic growth by adjusting the cost of credit and ensuring adequate liquidity in the system.
• Currency Stability: By controlling inflation, monetary policy helps stabilize the currency's value, which is crucial for international trade relations.
• Interest Rates Stability: Predictable and stable interest rates encourage investment and saving, which are beneficial for overall economic health.

Challenges in Monetary Policy

• Timing and Lag: The effects of monetary policy decisions typically take time to manifest in the economy, making timing decisions challenging.
• Global Influence: In an interconnected global economy, external factors such as exchange rates and foreign economic policies can impact domestic monetary policy effectiveness.
• Balancing Act: Striking the right balance between stimulating economic growth and controlling inflation can be delicate and complex.

Homework 1-2: Monetary Policy (due with the first midterm exam)

1. Explore the interactive simulation at https://www.jufinance.com/fin310_24f/money_interest.html to understand the relationship between money supply and interest rates.

Question: Based on current economic indicators, do you support the Federal Reserve's decision to lower interest rates in September 2024? Provide reasons for your stance.

2. Velocity of Money Simulation

Engage with the simulation game at https://www.jufinance.com/fin310_24f/chair_fed.html to learn about the dynamics between money supply, interest rates, and the velocity of money.

Question: What is the concept of the velocity of money? How can changes in interest rates influence this monetary indicator? What is the current velocity of money according to the latest data? In your opinion, is this velocity too high, too low, or optimal for the current economic environment?

Nominal Interest Rates and the Market for Money

Beggs, Jodi. "How Money Supply and Demand Determine Nominal Interest Rates." ThoughtCo, Apr. 5, 2023, thoughtco.com/nominal-interest-rates-and-money-supply-and-demand-1147766.

Like many economic variables in a reasonably free-market economy, interest rates are determined by the forces of supply and demand. Specifically, nominal interest rates, which is the monetary return on saving, is determined by the supply and demand of money in an economy. 

There is more than one interest rate in an economy and even more than one interest rate on government-issued securities. These interest rates tend to move in tandem, so it is possible to analyze what happens to interest rates overall by looking at one representative interest rate.

What Is the Price of Money?

Like other supply and demand diagrams, the supply and demand for money is plotted with the price of money on the vertical axis and the quantity of money in the economy on the horizontal axis. But what is the "price" of money? 

As it turns out, the price of money is the opportunity cost of holding money. Since cash doesn't earn interest, people give up the interest that they would have earned on non-cash savings when they choose to keep their wealth in cash instead. Therefore, the opportunity cost of money, and, as a result, the price of money, is the nominal interest rate.

Graphing the Supply of Money

The supply of money is pretty easy to describe graphically. It is set at the discretion of the Federal Reserve, more colloquially called the Fed, and is thus not directly affected by interest rates. The Fed may choose to alter the money supply because it wants to change the nominal interest rate.

Therefore, the supply of money is represented by a vertical line at the quantity of money that the Fed decides to put out into the public realm. When the Fed increases the money supply this line shifts to the right. Similarly, when the Fed decreases the money supply, this line shifts to the left.

As a reminder, the Fed generally controls the supply of money by open-market operations where it buys and sells government bonds. When it buys bonds, the economy gets the cash that the Fed used for the purchase, and the money supply increases. When it sells bonds, it takes in money as payment, and the money supply decreases. Even quantitative easing is just a variant on this process.

Graphing the Demand for Money

The demand for money, on the other hand, is a bit more complicated. To understand it, it's helpful to think about why households and institutions hold money, i.e., cash.

Most importantly, households, businesses and so on use the money to purchase goods and services. Therefore, the higher the dollar value of aggregate output, meaning the nominal GDP, the more money the players in the economy want to hold to spend it on this output.

However, there's an opportunity cost of holding money since money doesn't earn interest. As the interest rate increases, this opportunity cost increases, and the quantity of money demanded decreases as a result. To visualize this process, imagine a world with a 1,000 percent interest rate where people make transfers to their checking accounts or go to the ATM every day rather than hold any more cash than they need to.

Since the demand for money is graphed as the relationship between the interest rate and quantity of money demanded, the negative relationship between the opportunity cost of money and the quantity of money that people and businesses want to hold explains why the demand for money slopes downward.

Just like with other demand curves, the demand for money shows the relationship between the nominal interest rate and the quantity of money with all other factors held constant, or ceteris paribus. Therefore, changes to other factors that affect the demand for money shift the entire demand curve. Since the demand for money changes when nominal GDP changes, the demand curve for money shifts when prices (P) or real GDP (Y) changes. When nominal GDP decreases, the demand for money shifts to the left, and, when nominal GDP increases, the demand for money shifts to the right.

Equilibrium in the Money Market

As in other markets, the equilibrium price and quantity are found at the intersection of the supply and demand curves. In this graph, the supply of and demand for money come together to determine the nominal interest rate in an economy.

Equilibrium in a market is found where the quantity supplied equals the quantity demanded because surpluses (situations where supply exceeds demand) pushes prices down and shortages (situations where demand exceeds supply) drive prices up. So, the stable price is the one where there is neither a shortage nor a surplus.

Regarding the money market, the interest rate must adjust such that people are willing to hold all of the money that the Federal Reserve is trying to put out into the economy and people aren't clamoring to hold more money than is available. 

Changes in the Supply of Money

When the Federal Reserve adjusts the supply of money in an economy, the nominal interest rate changes as a result. When the Fed increases the money supply, there is a surplus of money at the prevailing interest rate. To get players in the economy to be willing to hold the extra money, the interest rate must decrease. This is what is shown on the left-hand side of the diagram above.

When the Fed decreases the money supply, there is a shortage of money at the prevailing interest rate. Therefore, the interest rate must increase to dissuade some people from holding money. This is shown on the right-hand side of the diagram above.

This is what happens when the media says that the Federal Reserve raises or lowers interest rates—the Fed isn't directly mandating what interest rates are going to be but is instead adjusting the money supply to move the resulting equilibrium interest rate.

Changes in the Demand for Money

Changes in the demand for money can also affect the nominal interest rate in an economy. As shown in the left-hand panel of this diagram, an increase in the demand for money initially creates a shortage of money and ultimately increases the nominal interest rate. In practice, this means that interest rates increase when the dollar value of aggregate output and expenditure increases.

The right-hand panel of the diagram shows the effect of a decrease in demand for money. When not as much money is needed to purchase goods and services, a surplus of money results and interest rates must decrease to make players in the economy willing to hold the money.

Using Changes in the Money Supply to Stabilize the Economy

In a growing economy, having a money supply that increases over time can have a stabilizing effect on the economy. Growth in real output (i.e., real GDP) will increase the demand for money and will increase the nominal interest rate if the money supply is held constant.

On the other hand, if the supply of money increases in tandem with the demand for money, the Fed can help to stabilize nominal interest rates and related quantities (including inflation).

That said, increasing the money supply in response to a demand increase that is caused by an increase in prices rather than an increase in output is not advisable, since that would likely exacerbate the problem of inflation rather than have a stabilizing effect.

Key Takeaways:

1. Concept of Nominal Interest Rates:

• Definition: Nominal interest rates are the monetary returns on savings, driven by the supply and demand of money within an economy.
• Variability: Multiple interest rates exist, particularly for government securities, though they generally move together.

2. The Price of Money:

• Understanding Price: The "price" of money refers to its opportunity cost, represented by the nominal interest rate.
• Opportunity Cost: This is the foregone interest from not investing cash in interest-bearing options.

3. Supply and Demand Representation:

• Supply of Money: Controlled by the Federal Reserve and represented graphically by a vertical line. Changes in supply are enacted through policies like open-market operations.
• Demand for Money: Depicted as a downward-sloping curve reflecting the inverse relationship between the nominal interest rate and the quantity of money demanded. Shifts occur with changes in nominal GDP.

4. Market Equilibrium:

• Equilibrium Determination: Found where the supply and demand curves intersect, setting the nominal interest rate.
• Market Dynamics: Surpluses drive rates down, while shortages push them up.

5. Impact of Federal Reserve Actions:

• Increasing Supply: Lowers interest rates by creating a money surplus.
• Decreasing Supply: Raises interest rates by creating a money shortage.
• Indirect Control: The Fed influences rates not by decree but through adjusting money supply.

6. Influence of Demand Changes:

• Economic Activity: Increases in economic output or spending can heighten the demand for money, raising interest rates.
• Economic Downturns: Reductions in spending or output decrease money demand, lowering rates.

7. Stabilizing the Economy Through Monetary Policy:

• Money Supply Management: Proper adjustments in the money supply can help stabilize interest rates and economic conditions.
• Avoid Inflation Traps: Increasing the money supply in response to price-driven demand increases can worsen inflation.

Chapter 2 What is Money quiz4

Ppt

Part I What is Money?   Let’s start by Playing a game https://www.jufinance.com/game/money_supply.html

·         There is no single "correct" measure of the money supply: instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates.

•         Narrow measures include only the most liquid assets, the ones most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.)

Type of money	M0	MB	M1	M2	M3
Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency)	✓	✓	✓	✓	✓
Notes and coins in bank vaults (Vault cash)		✓
Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks)		✓
Traveler’s checks of non-bank issuers			✓	✓	✓
Demand deposits			✓	✓	✓
Other checkable deposits (OCDs)			✓	✓	✓
Savings deposits				✓	✓
Time deposits less than $100,000 and money market deposit accounts for individuals				✓	✓
Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets					✓
All money market funds

·         M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.

·         MB: is referred to as the monetary base or total currency.  This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.

·         M1: Bank reserves are not included in M1. (M1 and Components @ Fed St. Louise website)

·         M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation. (M2 and components @ Fed St. Louise website)

·         M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank. However, there are still estimates produced by various private institutions. (M3 and components at Fed St. Louise website)

Let’s watch this money supply video: Khan academy money supply M0, M1, M2 (video)

https://tradingeconomics.com/united-states/money-supply-m0

https://tradingeconomics.com/united-states/money-supply-m1

https://tradingeconomics.com/united-states/money-supply-m2

Key Takeaway: VIDO (FYI) by invideo.ai

• M0 (Base Money):

· Definition: M0 represents the most basic form of money, including physical currency (coins and paper money) in circulation and reserves held by banks at the central bank. It is the foundation of the money supply and the most liquid form of money.

· Role: M0 is crucial because it forms the base upon which the broader money supply (M1 and M2) is built. It reflects the amount of cash and bank reserves that can be quickly used by banks to meet withdrawal demands or create more money through lending.

• M1:

• Definition: M1 includes M0 (physical currency) along with demand deposits (checking accounts) and other checkable deposits. It represents the money immediately available for transactions and spending.
• Recent Changes: The reclassification of savings accounts into M1 in 2020 led to a sharp increase, reflecting the increased liquidity and accessibility of savings during the pandemic.

• M2:

• Definition: M2 includes M1 plus savings deposits, money market mutual funds, and small time deposits. It captures the broader money available in the economy, including both liquid assets and savings that can be quickly converted into cash.
• Recent Changes: M2 grew significantly during the COVID-19 pandemic due to increased savings, deposits, and fiscal stimulus, reflecting the economy’s response to uncertainty and economic support measures.

• Recent Trends and Major Changes:
• COVID-19 Impact:
• M0 Stability: While M0 remained relatively stable, reflecting the steady amount of physical currency in circulation, the broader measures of money supply (M1 and M2) saw significant increases.
• M1 Surge: The pandemic and associated monetary policy changes caused a surge in M1, primarily due to the reclassification of savings accounts and an increase in demand deposits as people prioritized liquidity.
• M2 Expansion: M2 expanded rapidly as households and businesses increased their savings amid economic uncertainty. This growth was further fueled by government stimulus payments and low-interest rates, which encouraged deposits.
• Role of Banks:

• Credit Creation: Banks play a key role in expanding M2 through credit creation. When banks issue loans, new deposits are created, increasing the money supply. This process is built on the foundation of M0 and expands through M1 and M2.
• Fractional Reserve Banking: Banks keep only a fraction of deposits as reserves (M0) and lend out the rest. This practice amplifies the growth of M2, as loans lead to more deposits in the banking system, thereby multiplying the money supply.

• Economic Impact:

· Stimulating Economic Activity: The growth in M1 and M2 during the pandemic helped stimulate economic activity by making more funds available for spending and investment, which was crucial for economic recovery.

· Inflationary Pressure: The significant increase in the money supply has also raised concerns about inflation, as more money in circulation can lead to rising prices if it outpaces economic growth.

· Central Bank Policy: The Federal Reserve closely monitors these trends and adjusts policies, such as interest rates, to balance economic growth with inflation control, ensuring that the expansion of M1 and M2 does not lead to excessive inflation.

Homework (due with the first midterm exam)

Imagine you're the Chair of the Federal Reserve during the COVID-19 pandemic. You have to make decisions that will affect M0, M1, and M2.

1. Define M0, M1, and M2 in your own words. How do they differ from each other?
2. Scenario: During the pandemic, people are saving more money, and banks are giving out lots of loans. Explain how these actions impact M1 and M2.
3. Decision Time: To keep the economy stable, you can either increase or decrease the money supply. Which would you choose and why? How might your choice affect inflation or interest rates?

Part II What is Fractional Reserve Banking System? Play the game!

The Money Multiplier (video)

Money creation in a fractional reserve system | Financial sector | AP Macroeconomics | Khan Academy

Fractional Reserve Banking

By JULIA KAGAN Updated August 10, 2022, Reviewed by SOMER ANDERSON

https://www.investopedia.com/terms/f/fractionalreservebanking.asp#:~:text=Fractional%20reserve%20banking%20is%20a,systems%20use%20fractional%20reserve%20banking.

What Is Fractional Reserve Banking?

Fractional reserve banking is a system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is done to theoretically expand the economy by freeing capital for lending. Today, most economies' financial systems use fractional reserve banking.

KEY TAKEAWAYS

· Fractional reserve banking describes a system whereby banks can loan out a certain amount of the deposits that they have on their balance sheets.

· Banks are required to keep on hand a certain amount of the cash that depositors give them, but banks are not required to keep the entire amount on hand.

· Often, banks are required to keep some portion of deposits on hand, which is known as the bank's reserves.

· Some banks are exempt from holding reserves, but all banks are paid a rate of interest on reserves.

Understanding Fractional Reserve Banking

Banks are required to keep on hand and available for withdrawal a certain amount of the cash that depositors give them. If someone deposits $100, the bank can't lend out the entire amount. Nor are banks required to keep the entire amount on hand. Many central banks have historically required banks under their purview to keep 10% of the deposit, referred to as reserves. This requirement is set in the U.S. by the Federal Reserve and is one of the central bank's tools to implement monetary policy. Increasing the reserve requirement takes money out of the economy while decreasing the reserve requirement puts money into the economy.

Historically, the required reserve ratio on non-transaction accounts (such as CDs) is zero, while the requirement on transaction deposits (e.g., checking accounts) is 10 percent. Following recent efforts to stimulate economic growth, however, the Fed has reduced the reserve requirements to zero for transaction accounts as well.

Fractional Reserve Requirements

Depository institutions must report their transaction accounts, time and savings deposits, vault cash, and other reservable obligations to the Fed either weekly or quarterly. Some banks are exempt from holding reserves, but all banks are paid a rate of interest on reserves called the "interest rate on reserves" (IOR) or the "interest rate on excess reserves" (IOER). This rate acts as an incentive for banks to keep excess reserves.

Reserve requirements for banks under the Federal Reserve Act were set at 13%, 10%, and 7% (depending on what kind of bank) in 1917. In the 1950s and '60s, the Fed had set the reserve ratio as high as 17.5% for certain banks, and it remained between 8% to 10% throughout much of the 1970s through the 2010s.

During this period, banks with less than $16.3 million in assets were not required to hold reserves. Banks with assets of less than $124.2 million but more than $16.3 million had to have 3% reserves, and those banks with more than $124.2 million in assets had a 10% reserve requirement.

Beginning March 26, 2020, the 10% and 3% required reserve ratios against net transaction deposits was reduced to 0 percent for all banks, essentially removing the reserve requirements altogether.

Prior to the introduction of the Fed in the early 20th century, the National Bank Act of 1863 imposed 25% reserve requirements for U.S. banks under its charge.

Fractional Reserve Multiplier Effect

"Fractional reserve" refers to the fraction of deposits held in reserves. For example, if a bank has $500 million in assets, it must hold $50 million, or 10%, in reserve.

Analysts reference an equation referred to as the multiplier equation when estimating the impact of the reserve requirement on the economy as a whole. The equation provides an estimate for the amount of money created with the fractional reserve system and is calculated by multiplying the initial deposit by one divided by the reserve requirement. Using the example above, the calculation is $500 million multiplied by one divided by 10%, or $5 billion.

This is not how money is actually created but only a way to represent the possible impact of the fractional reserve system on the money supply. As such, while is useful for economics professors, it is generally regarded as an oversimplification by policymakers.

What Are the Pros of Fractional Reserve Banking?

Fractional reserve banking permits banks to use funds (i.e., the bulk of deposits) that would be otherwise unused and idle to generate returns in the form of interest rates on new loans—and to make more money available to grow the economy. It is thus able to better allocate capital to where it is most needed.

What Are the Cons of Fractional Reserve Banking?

Fractional reserve banking could catch a bank short of funds on hand in the self-perpetuating panic of a bank run. This occurs when too many depositors demand their cash at the same time, but the bank only has, say 10% of deposits in liquid cash available. Many U.S. banks were forced to shut down during the Great Depression because too many customers attempted to withdraw assets at the same time. Nevertheless, fractional reserve banking is an accepted business practice that is in use at banks worldwide.

Where Did Fractional Reserve Banking Originate?

Nobody knows for sure when fractional reserve banking originated, but it is certainly not a modern innovation. Goldsmiths during the Middle Ages were thought to issue demand receipts for gold on hand that exceeded the amount of physical gold they had under custody, knowing that on any given day only a small fraction of that gold would be demanded.

In 1668, Sweden's Riksbank introduced the first instance of modern fractional reserve banking.

Example: You deposited $1,000 in a local bank

Iteration #	Deposited by	Amount Held	Amount	Total Amount that	Total Amount that	Total Amount	Total Amount that
	Customer	in Reserve	Currently	“Can” be	Has Been	Held in Reserve	Customers Believe
		from Deposit	Available to	Lent Out	Lent Out		They Have
			Lend Out
			from Deposit
1	1,000.00	100	900	900	0	100	1,000.00
2	900	90	810	1,710.00	900	190	1,900.00
3	810	81	729	2,439.00	1,710.00	271	2,710.00
4	729	72.9	656.1	3,095.10	2,439.00	343.9	3,439.00
5	656.1	65.61	590.49	3,685.59	3,095.10	409.51	4,095.10
6	590.49	59.05	531.44	4,217.03	3,685.59	468.56	4,685.59
7	531.44	53.14	478.3	4,695.33	4,217.03	521.7	5,217.03
8	478.3	47.83	430.47	5,125.80	4,695.33	569.53	5,695.33
9	430.47	43.05	387.42	5,513.22	5,125.80	612.58	6,125.80
10	387.42	38.74	348.68	5,861.89	5,513.22	651.32	6,513.22
….

Homework of chapter 2 (due with the first mid term) Play the game at https://jufinance.com/game/money_multiplier.html

1. Imagine that you deposited $5,000 in Bank A. Reserve ratio is 0.1. Imagine that the fractional banking system is fully functioning. After Eight cycles, what is the amount that has been deposited and what is the total amount that has been lent out?

Chapter 11 - 14: Commercial Banking and Investment Banking

Ppt 1 commercial banking I

PPT2 Commercial banking II (Balance sheet)

Part I – Commercial Bank’s Financial Statement Analysis Quiz

Let’s Play a game on Banks’ Balance Sheet

Wells Fargo’s Balance Sheet https://www.nasdaq.com/market-activity/stocks/wfc/financials

Period Ending:	12/31/2023	12/31/2022	12/31/2021	12/31/2020
Current Assets
Cash and Cash Equivalents	$865,469,000	$788,415,000	$910,870,000	$891,499,000
Short-Term Investments	--	--	--	--
Net Receivables	--	--	--	--
Inventory	--	--	--	--
Other Current Assets	--	--	--	--
Total Current Assets	--	--	--	--
Long-Term Assets
Long-Term Investments	$1,501,537,000	$1,544,466,000	$1,546,605,000	$1,500,003,000
Fixed Assets	$9,266,000	$8,350,000	$8,571,000	$8,895,000
Goodwill	$25,175,000	$25,173,000	$25,180,000	$26,392,000
Intangible Assets	--	--	--	--
Other Assets	$78,815,000	$75,838,000	$67,259,000	$87,337,000
Deferred Asset Charges	--	--	--	--
Total Assets	$1,932,468,000	$1,881,020,000	$1,948,068,000	$1,952,911,000
Current Liabilities
Accounts Payable	$71,210,000	$68,740,000	$70,957,000	$74,360,000
Short-Term Debt / Current Portion of Long-Term Debt	$89,559,000	$51,145,000	$34,409,000	$58,999,000
Other Current Liabilities	$1,358,173,000	$1,383,985,000	$1,482,479,000	$1,404,381,000
Total Current Liabilities	--	--	--	--
Long-Term Debt	$18,495,000	$20,067,000	$9,424,000	$16,509,000
Other Liabilities	--	--	--	--
Deferred Liability Charges	--	--	--	--
Misc. Stocks	$1,708,000	$1,986,000	$2,504,000	$1,032,000
Minority Interest	--	--	--	--
Total Liabilities	$1,746,733,000	$1,700,793,000	$1,760,462,000	$1,768,231,000
Stock Holders Equity
Common Stocks	$9,136,000	$9,136,000	$9,136,000	$9,136,000
Capital Surplus	$201,136,000	$187,968,000	$180,322,000	$162,683,000
Retained Earnings	-$92,960,000	-$82,853,000	-$79,757,000	-$67,791,000
Treasury Stock	$60,555,000	$60,319,000	$60,196,000	$60,197,000
Other Equity	-$11,580,000	-$13,791,000	-$2,348,000	-$681,000
Total Equity	$185,735,000	$180,227,000	$187,606,000	$184,680,000
Total Liabilities & Equity	$1,932,468,000	$1,881,020,000	$1,948,068,000	$1,952,911,000

Wells Fargo’s Income Statement https://www.nasdaq.com/market-activity/stocks/wfc/financials

Period Ending:	12/31/2023	12/31/2022	12/31/2021	12/31/2020
Total Revenue	$115,340,000	$83,442,000	$83,081,000	$82,227,000
Cost of Revenue	$16,503,000	$2,349,000	$388,000	$2,804,000
Gross Profit	--	--	--	--
Operating Expenses
Research and Development	--	--	--	--
Sales, General and Admin.	$55,562,000	$57,205,000	$53,758,000	$56,131,000
Non-Recurring Items	--	--	--	$1,499,000
Other Operating Items	$5,399,000	$1,534,000	-$4,155,000	$14,129,000
Operating Income	--	--	--	--
Add'l income/expense items	--	--	--	--
Earnings Before Interest and Tax	$37,876,000	$22,354,000	$33,090,000	$7,664,000
Interest Expense	$16,240,000	$6,725,000	$3,527,000	$5,159,000
Earnings Before Tax	$21,636,000	$15,629,000	$29,563,000	$2,505,000
Income Tax	$2,607,000	$2,251,000	$5,764,000	-$1,157,000
Minority Interest	--	--	--	--
Equity Earnings/Loss Unconsolidated Subsidiary	$113,000	$299,000	-$1,690,000	-$285,000
Net Income-Cont. Operations	$19,142,000	$13,677,000	$22,109,000	$3,377,000
Net Income	$19,142,000	$13,677,000	$22,109,000	$3,377,000
Net Income Applicable to Common Shareholders	$17,982,000	$12,562,000	$20,818,000	$1,786,000

Understanding How Banks Operate: A Case Study on Wells Fargo (based on a prior study) Quiz

1. Introduction to Banking Operations

Banks are essential financial institutions that play a vital role in the economy. They manage money, facilitate transactions, provide credit, and offer various financial services to individuals, businesses, and governments. We'll use Wells Fargo's financial data as a case study to illustrate these concepts.

2. Core Functions of a Bank

Deposits and Loans:

• Deposits: Banks collect deposits from customers, which become the primary source of funds that banks use to lend to others. These deposits are a liability for the bank since they must be returned to customers upon demand.
• Loans: Banks lend money to individuals, businesses, and governments. The interest charged on these loans is a primary source of income for banks.

Interest Income and Net Interest Margin (NIM):

• Interest Income: The difference between the interest earned on loans and the interest paid on deposits is known as the Net Interest Margin (NIM). A higher NIM indicates that a bank is earning more from its loans than it is paying on its deposits, which is crucial for profitability.

Investments:

• Banks invest in various securities, including government bonds, corporate bonds, and mortgage-backed securities, to generate additional income.

Fee-Based Services:

• Banks offer services such as wealth management, underwriting, payment processing, and advisory services. These services generate fees, which contribute to the bank's overall revenue.

3. Understanding Key Financial Statements

Balance Sheet:

• The balance sheet provides a snapshot of the bank's financial position at a specific point in time, showing its assets, liabilities, and equity.
• Assets: What the bank owns, including loans, investments, and cash reserves.
• Liabilities: What the bank owes, including customer deposits and borrowed funds.
• Equity: The residual interest in the assets of the bank after deducting liabilities, representing the ownership interest of the shareholders.

Income Statement:

• The income statement summarizes the bank's revenue and expenses over a period, showing how the bank earns its income and incurs costs.
• Revenue: Includes interest income from loans and fees from services.
• Expenses: Includes interest paid on deposits, operating expenses, and loan losses.

4. Wells Fargo Case Study: Key Financial Metrics (2020-2023)

Using Wells Fargo's financial data, let's explore key metrics that indicate the bank's financial health:

Total Revenue:

• Wells Fargo’s total revenue increased from $82.2 billion in 2020 to $115.3 billion in 2023, reflecting strong income growth despite economic challenges.

Cost of Revenue:

• The cost of revenue rose from $2.8 billion in 2020 to $16.5 billion in 2023, indicating potential pressures from rising interest rates or increased costs associated with generating income.

Net Income:

• Wells Fargo’s net income grew significantly from $3.4 billion in 2020 to $19.1 billion in 2023, showing improved profitability and effective cost management.

Operating Income (EBIT):

• Operating income increased from $7.7 billion in 2020 to $37.9 billion in 2023, indicating enhanced operational efficiency.

Total Assets and Liabilities:

• Wells Fargo's total assets and liabilities have remained relatively stable, with assets totaling $1.93 trillion and liabilities totaling $1.75 trillion in 2023. The stability suggests strong balance sheet management.

5. Identifying Bank Vulnerabilities

Declining Net Interest Margin (NIM):

• A shrinking NIM can indicate that the bank is struggling to generate sufficient income from its lending activities. Continuous monitoring of NIM is essential to ensure profitability.

High Loan Defaults:

• A significant increase in loan defaults can lead to financial instability. Rising non-performing loans (NPLs) indicate that more borrowers are unable to repay their loans, which can strain the bank's capital reserves.

Increasing Cost of Revenue:

• A disproportionate increase in the cost of revenue relative to income can signal inefficiencies or higher borrowing costs. This could compress margins and affect overall profitability.

High Leverage:

• Excessive reliance on borrowed funds to finance operations can make a bank more vulnerable to market fluctuations. Monitoring the bank’s leverage ratio is crucial to maintaining financial stability.

Declining Liquidity:

• Insufficient liquid assets to meet short-term obligations can lead to a liquidity crisis. A bank must maintain adequate liquidity to ensure it can handle sudden demands for cash, such as during a bank run.

6. Safety Tips for Managing and Analyzing Banks

Diversify Assets:

• Banks should diversify their loan portfolios and investments to reduce risk exposure. A well-diversified bank is less likely to suffer severe losses from sector-specific downturns.

Maintain Adequate Reserves:

• Banks need sufficient capital reserves to absorb potential losses and meet regulatory requirements. Monitoring the Capital Adequacy Ratio (CAR) helps ensure the bank has a buffer against unexpected losses.

Monitor Loan Quality:

• Regular assessment of the loan portfolio is essential to identify early signs of trouble. Keeping track of the ratio of non-performing loans (NPLs) to total loans is a good indicator of loan quality.

Ensure Liquidity:

• Maintaining adequate liquidity is critical for meeting short-term obligations without selling long-term investments at a loss. The Liquidity Coverage Ratio (LCR) measures the bank’s ability to withstand short-term financial stress.

Stress Testing and Scenario Analysis:

• Conducting stress tests and scenario analyses can help banks prepare for economic downturns, interest rate changes, and other financial shocks. This proactive approach helps identify vulnerabilities and develop contingency plans.

Regulatory Compliance:

• Banks must comply with various regulations, including those related to capital adequacy, liquidity, and consumer protection. Staying updated on regulatory changes and ensuring compliance is crucial for long-term stability.

7. Practical Application: Analyzing Wells Fargo

Here’s how we can apply these concepts using Wells Fargo’s data:

• Examine the Income Statement: Assess trends in revenue, cost of revenue, and net income to evaluate profitability.
• Analyze the Balance Sheet: Review assets, liabilities, and equity to understand the bank’s financial position.
• Calculate Key Ratios:

• Net Interest Margin (NIM): To assess profitability from lending.
• Loan-to-Deposit Ratio (LDR): To evaluate how well the bank is using deposits to generate loans.
• Capital Adequacy Ratio (CAR): To determine if the bank has enough capital to cover potential losses.
• Identify Potential Risks: Use the data to identify any signs of vulnerability, such as declining liquidity or rising defaults.

8. Conclusion on Wells Fargo

Wells Fargo’s financial performance from 2020 to 2023 demonstrates a bank that has effectively managed its operations despite various economic challenges. The consistent growth in revenue and net income, coupled with stable asset management, reflects the bank’s strong financial position. However, the significant rise in the cost of revenue in 2023 could be a potential risk factor that needs to be monitored closely.

Part III: Governmental Regulations on Banking Industry (FYI)

A Brief History of U.S. Banking Regulation (FYI)

By MATTHEW JOHNSTON

Reviewed by MICHAEL J BOYLE on July 30, 2021

https://www.investopedia.com/articles/investing/011916/brief-history-us-banking-regulation.asp

As early as 1781, Alexander Hamilton recognized that “Most commercial nations have found it necessary to institute banks, and they have proved to be the happiest engines that ever were invented for advancing trade.” Since then, America has developed into the largest economy in the world, with some of the biggest financial markets in the world. But the path from then to now has been influenced by a variety of different factors and an ever-changing regulatory framework. The changing nature of that framework is best characterized by the swinging of a pendulum, oscillating between the two opposing poles of greater and lesser regulation. Forces, such as the desire for greater financial stability, more economic freedom, or fear of the concentration of too much power in too few hands, are what keep the pendulum swinging back and forth.

Early Attempts at Regulation in Antebellum America

From the establishment of the First Bank of the United States in 1791 to the National Banking Act of 1863, banking regulation in America was an experimental mix of federal and state legislation.1 2 The regulation was motivated, on the one hand, by the need for increased centralized control to maintain stability in finance and, by extension, the overall economy. While on the other hand, it was motivated by the fear of too much control being concentrated in too few hands.

Despite bringing a relative degree of financial and economic stability, the First Bank of the United States was opposed to being unconstitutional, with many fearing that it relegated undue powers to the federal government. Consequently, its charter was not renewed in 1811. With the government turning to state banks to finance the War of 1812 and the significant over-expansion of credit that followed, it became increasingly apparent that financial order needed to be reinstated. In 1816, the Second Bank of the United States would receive a charter, but it too would later succumb to political fears over the amount of control it gave the federal government and was dissolved in 1836.

Not only at the federal level, but also at the level of state banking, obtaining an official legislative charter was highly political. Far from being granted on the basis of proven competence in financial matters, successful acquisition of a charter depended more on political affiliations, and bribing the legislature was commonplace. By the time of the dissolution of the Second Bank, there was a growing sense of a need to escape the politically corrupt nature of legislative chartering. A new era of “free banking” emerged with a number of states passing laws in 1837 that abolished the requirement to obtain an officially legislated charter to operate a bank. By 1860, a majority of states had issued such laws.

In this environment of free banking, anyone could operate a bank on the condition, among others, that all notes issued were back by proper security. While this condition served to reinforce the credibility of note issuance, it did not guarantee immediate redemption in specie (gold or silver), which would serve to be a crucial point. The era of free banking suffered from financial instability with several banking crises occurring, and it made for a disorderly currency characterized by thousands of different banknotes circulating at varying discount rates. It is this instability and disorder that would renew the call for more regulation and central oversight in the 1860s.

Increasing Regulation from the Civil War to the New Deal

The free banking era, characterized as it was by a complete lack of federal control and regulation, would come to an end with the National Banking Act of 1863 (and its later revisions in 1864 and 1865), which aimed to replace the old state banks with nationally chartered ones. The Office of the Comptroller of the Currency (OCC) was created to issue these new bank charters as well as oversee that national banks maintained the requirement to back all note issuance with holdings of U.S. government securities.

While the new national banking system helped return the country to a more uniform and secure currency that it had not experienced since the years of the First and Second Banks, it was ultimately at the expense of an elastic currency that could expand and contract according to commercial and industrial needs. The growing complexity of the U.S. economy highlighted the inadequacy of an inelastic currency, which led to frequent financial panics occurring throughout the rest of the nineteenth century.

With the occurrence of the bank panic of 1907, it had become apparent that America’s banking system was out of date. Further, a committee gathered in 1912 to examine the control of the nation’s banking and financial system. It found that the money and credit of the nation were becoming increasingly concentrated in the hands of relatively few men. Consequently, under the presidency of Woodrow Wilson, the Federal Reserve Act of 1913 was approved to wrest control of the nation’s finances from banks while at the same time creating a mechanism that would enable a more elastic currency and greater supervision over the nation’s banking infrastructure.

Although the newly established Federal Reserve helped to improve the nation’s payments system and created a more flexible currency, it's a misunderstanding of the financial crisis following the 1929 stock market crash served to roil the nation in a severe economic crisis that would come to be known as the Great Depression. The Depression would lead to even more banking regulation instituted by President Franklin D. Roosevelt as part of the provisions under the New Deal. The Glass-Steagall Act of 1933 created the Federal Deposit Insurance Corporation (FDIC), which implemented regulation of deposit interest rates, and separated commercial from investment banking. The Banking Act of 1935 served to strengthen and give the Federal Reserve more centralized power.

1980s Deregulation and Post-Crisis Re-Regulation

The period following the New Deal banking reforms up until around 1980 experienced a relative degree of banking stability and economic expansion. Still, it has been recognized that the regulation has also served to make American banks far less innovative and competitive than they had previously been. The heavily regulated commercial banks had been losing increasing market share to less-regulated and innovative financial institutions. For this reason, a wave of deregulation occurred throughout the last two decades of the twentieth century.

In 1980, Congress passed the Depository Institutions Deregulation and Monetary Control Act, which served to deregulate financial institutions that accept deposits while strengthening the Federal Reserve’s control over monetary policy.6 Restrictions on the opening of bank branches in different states that had been in place since the McFadden Act of 1927 were removed under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Finally, the Gramm-Leach-Bliley Act of 1999 repealed significant aspects of the Glass-Steagall Act as well as the Bank Holding Act of 1956, both of which had served to sever investment banking and insurance services from commercial banking.7 From 1999 onwards, a bank could now offer commercial banking, securities, and insurance services under one roof.

All of this deregulation helped to accelerate a trend towards increasing the complexity of banking organizations as they moved to greater consolidation and conglomeration. Financial institution mergers increased with the total number of banking organizations consolidating to under 8000 in 2008 from a previous peak of nearly 15,000 in the early 1980s.8 While banks have gotten bigger, the conglomeration of different financial services under one organization has also served to increase the complexity of those services. Banks began offering new financial products like derivatives and began packaging traditional financial assets like mortgages together through a process of securitization.

At the same time that these new financial innovations were being praised for their ability to diversify risk, the sub-prime mortgage crisis of 2007 that transformed into a global financial crisis and the need for the bailout of U.S. banks that had become “too big to fail” has caused the government to rethink the financial regulatory framework. In response to the crisis, the Obama administration passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, aimed at many of the apparent weaknesses within the U.S. financial system.9 It may take some time to see how these new regulations affect the nature of banking within the U.S.

The Bottom Line

In antebellum America, numerous attempts at increased centralized control and regulation of the banking system were tried, but fears of concentrated power and political corruption served to undermine such attempts. Nevertheless, as the banking system grew, the need for ever-increasing regulation and centralized control, led to the creation of a nationalized banking system during the Civil War, the creation of the Federal Reserve in 1913, and the New Deal reforms under Roosevelt.4 While the increased regulation