Course Link:

What is a Bank, a Shadow Bank, a Central Bank?


Assets (Liquidity) Liabilities (Solvency)
Loans Deposit accounts
Securities Other borrowing
Cash Reserves Net worth

Shadow Banks

Liquidity Solvency
RMBS (Residential Mortgage Backed Securities) Money Market Borrowing
IRS (Interest Rate Swaps) - RP (Repurchase Agreement)
CDS (Credit Default Swaps) - ED (Eurodollars)
- ABCP (Asset-Backed Commercial Paper)

The Four Prices of Money

  • Par, today
  • Interest rate, future
  • Exchange rate, foreign
  • Price level, commodities

"All banking is a swap of IOUs"

Hierarchy of Financial Instruments

  • Ultimate money: gold
  • National currency: promise to pay gold
  • Bank deposits: promise to pay currency on demand
  • Securities (credit): promise to pay currency in the future
  • From bank's perspective, deposits and securities are credit.
  • From consumer's perspective, only securities are credit.
  • From international monitory's perceptive, currency, deposits and securities are credit.

Hierarchy of Financial Institutions

  • Outside money: gold
  • Inside money is some form of credit

Central Bank

Liquidity Solvency
Gold Currency

Banking System

Liquidity Solvency
Currency Deposits

Private Sectors

Liquidity Solvency
Deposits Securites

Dynamics of the Hierarchy

  • Horizontal axis represents quantity
  • Vericle axis represents quality
  • In a economic boom, credit expands and qualitative difference becomes less as the hierachy flattens; it contracts in economic slowdown.

Discipline and Elasticity, Currency Principle and Banking Principle

  • Scarcity of (ultimate) money; discipline
  • Elasticity of (derivitive) credit

History of Market Makers

  • Security dealers: interest rate
  • Banking system: par
  • Central bank: exchange rate

Managing the Hierarchy

  • Central bank: lender of last resort
  • What do central banks do?
  • Exchange rate
  • Par