Economics
Chapter 3
Money and Banking system
What is money?

People use money to:



Money is



settle payment
pay for goods and services
generally accepted means of payment
a medium of exchange
Definition

Money can be anything that is generally accepted
as a means of payment or a medium of exchange.
Barter system

Before using money



Exchange of goods directly.
E.g. a loaf of bread  a jar of wine
Limitation

Double coincidence of wants*



Both parties want the goods from others
No trade if can’t match other’s need
From barter to the use of money




1st stage fish vegetable
Fish  salt / sugar / metal / jewels
Fish  shells / precious metals
Fish  coins and notes
Functions of money
1. As a medium of exchange


A means of payment
Avoid the need for double coincidence of wants
Functions of money
2. As a store of value




Money is a form of asset
Store the value of purchasing power
 use the power to purchase later
Avoid perishable goods, high storing cost
Types of assets and liquidity
Types
Liquidity
Real estate
Extremely low
Jewellery
Quite low, cost
Share and bonds
Quite low, cost of trading
Money
High, cost of keeping it
Functions of money
3. As a unit of account




For measurement
How much…?
Price / revenues / income…
Value for comparison
4. As a standard of deferred payment




Outstanding accounts
Wages
Mortgages
Instalments
Properties of money
1.
Generally accepted


2.
Scarce and has a stable value



3.
As a medium of exchange
Without acceptance by people, no use
Hard to obtain, otherwise no one wants
Without stable value, purchasing power can’t be
stored
Limitation: inflation or deflation is inevitable
Durable


If perishable, can’t store the value
If easy to wear out, high cost to use
Properties of money
4.
Homogeneous and easily recognised


5.
Divisible

6.
Uniform standard  value and authenticity
Reduce argument when using
Can be divided into smaller value for small-value
transaction
Portable

Easy to carry out transaction in different location
Barter vs. Using money
Barter
Using money
As a medium of
exchange
Lack of double
coincidence of
wants
Generally
accepted
As a store of value
Some goods are
perishable
Durable
Indivisible
Divisible
No common
measure of value
A unit for
measurement
Some goods are
heavy
Portable
As a unit of account
Easy to carry?
Determination of money (Properties)
Cash
(coins and
banknotes)
Cheque
Octopus
card
Credit
Card
EPS
(system)
Generally
accepted





Scarce and has a
stable value





Durable





Homogeneous





Divisible





Portable





Money
Are they money?
Determination of money (function)
Cash
(coins and
banknotes)
Cheque
Octopus
card
Credit
Card
EPS
(system)
As a medium of
exchange





As a storage of
value





As a unit of
account

As a standard of
deferred payment

Money








The cheque or card itself is not money.
The deposits for the service is money.
Money in modern society

Legal tender (Cash)



Coins
Banknotes
Deposit



EPS payment
Credit card payment
Payment by cheque
Money supply


the total amount of money in a region
Formula:
Money supply = Cash + Deposits

Cash held by the public


Deposits (in deposit-taking institutes in HK)




Money that circulated in the market
Licensed banks
Restricted licence banks (RB)
Deposit-taking companies (DTC)
Total money supply
= Money supply of HKD + foreign currencies
Money supply

Types of deposits
Characteristics
Demand deposit
Savings deposit
Time deposit
Negotiable
certificate of
deposit (NCD)
• Cheque account
• No interest
• High liquidity
• Saving account
• With interest
• Can be withdrawn at any time
•
•
•
•
Fixed maturity period
Can’t be withdrawn before maturity
Higher interest
Low liquidity
• Fixed maturity period
• Higher interest
• Tradable at any time
Accepted by
• Licensed bank
• All authorized
institutes
Cheque
or bearer 持票人
Measuring money supply

Types of deposits
Focus
M1
• Medium of exchange
(narrow)
M2
• Medium of exchange
• Store of value
• Savings in licensed banks
(broader)
M3
• Medium of exchange
• Store of value
• Savings in all authorized
institutions
(the broadest)
Include
• Cash
• Demand deposits
•
•
•
•
M1
Saving deposits in licensed bank
Time deposits in licensed bank
NCDs by licensed bank (held by
public)
• M2
• Deposits in RB and DTC
• NCDs by RB and DTC (held by
public)
Cash in circulation / Cash held by the public
Demand deposits
Savings and time deposits in licensed banks
Time deposits in restricted licence banks and
deposit-taking companies
Negotiable certificates of deposit issued by deposittaking companies and held by the publics



$
80
70
120
20
40
M1 = Cash + Demand deposits
= $80 + $70 = $150
M2 = M1 + deposits in licensed banks
= $150 + 120 = $270
M3 = M2 + Deposits & NCDs in RBs & DTCs
= $270 + $20 + $40 = $330
Money supply
Describe the immediate effect the transaction below
have on M1, M2 and M3.
(a) John deposits $500 cash into a current account.
M1 remains unchanged.
M1 = Cash + Demand deposits.
With cash decreases by $500 but
demand deposits increases by $500,
M1 remains unchanged.
There is no effect on M2 and M3.
Money supply
Describe the immediate effect the transaction below
have on M1, M2 and M3.
b) Mary transfer $1,000 from a current account to a
saving account.
M1 decreases by $1,000 because demand
deposits are part of M1.
M2 remains unchanged because both
demand deposits and savings deposits
are components of M2.
There is no effect on M3.
Banking System

What is a Bank?


A bank is a financial intermediary which
provides special types services relating
to finance.
A bank is a company which carries on
“banking business” with a valid banking
license. (Banking Ordinance)
Banking System

2 types of bank


Central banks
Commercial banks
Central banks

A central bank

a non-profit making government body
monitoring the monetary system
 controlling the money supply
 Accepting deposit from and providing loans
to commercial banks
(bankers’ bank)

Central banks

USA:
 The Federal Reserve System (The Fed)
美國聯邦儲備局

China
 People’s Bank of China (PBC)
中國人民銀行


UK
 Bank of England 英倫銀行
HK
 Hong Kong Monetary Authority (HKMA)
香港金融管理局

HSBC 香港上海匯豐銀行
Functions of a central bank
1.
Issuing banknotes and coins
 ensuring circulation & stability of value
 in HK:




HSBC
Standard Chartered Bank
Bank of China
HKMA
Acting as the government’s banker
2.


offering bank services to the gov’t
in HK: HKMA + HSBC
Functions of a central bank
Providing discount windows (貼現窗) services
3.




borrow loans to commercial banks
named as: “discount window”
interest rate: “discount rate” (貼現率)
in HK: HKMA
Lender of the last resort (最後貸款人)
4.



to help banks or financial institutions survive a bank run.
avoid widespread bank failure &
collapse of banking system
in HK: HKMA
Functions of a central bank
Monitoring commercial banks
5.



formulate banking regulations
monitor irregular banking business
in HK: HKMA
Formulating monetary policies
6.



money supply and interest rate
increase interest rate to reducing C and I (not in HK)
in HK: Financial Secretary and HKMA
Functions of a central bank
Acting as a clearing house (結算所)
7.



cheque clearing for commercial banks
settle cheque payment
in HK:
Hong Kong Interbank Clearing Limited (HKICL)
香港銀行同業結算有限公司(結算公司)
A’s
bank
A
4. HKICL sends the cheque to A’s bank
5. A’s bank agree the
payment
1. Mr. A
writes a
cheque to
Mr. B
HKICL
B
2. Mr. B
saves the
cheque to
his account
B’s
bank
6. B’s bank receive
the payment
3. B’s bank sends the cheque
to the clearing house
Who has the role of a central bank in HK?
Functions
Institution(s) in HK
1. Issuing banknotes and coins
• Coins and $10 notes: HKMA
• Banknotes: HSBC, SCB & BOC
2. Gov’t banker
• HKMA + HSBC
3. Discount window services
• HKMA
4. Lender of the last resort
• HKMA
5. Monitoring commercial banks
• HKMA
6. Implementing monetary policies
• Financial Secretary + HKMA
7. Clearing house
• HKICL
Commercial banks

3 Tier system

Licensed bank (LBs) 持牌銀行

Restricted licence banks (RBs) 有限制牌照銀行

Deposit-taking companies (DTCs) 接受存款公司
Deposit-taking institutes in HK
(The 3-tier banking system)
Accept…
Licensed banks
(持牌銀行)
Restricted licence
banks
(有限制牌照銀行)
Deposit-taking
companies
(接受存款公司)
• current and savings accounts,
• deposits of any size and maturity
• pay or collect cheques drawn by or
paid in by customers.
• Merchant banking
• deposits of any maturity of
HK$500,000 and above.
Exampls
• Hong Kong Bank
• Bank of China
• AIG Finance
(Hong Kong)
Limited
• specialised activities, including
• Promise Co., Ltd.
consumer finance and securities
• PrimeCredit
business.
Limited
• deposits of HK$100,000 or above with
• Octopus Cards
an original term of maturity of at least
Limited
three months.
Functions of a commercial bank







Receive deposits of various types including
demand, savings and time deposits
Make loans of various types including bank
overdraft, mortgage, tax loans and trade finance
Issue letters of credit (LC) (信用證) and bills of
exchange (BOE) (匯票)
Accept and pay bank drafts
Rent safety deposit boxes
Currency exchange
Gift cheque
Deposit-taking institutes in HK
(The 3-tier banking system)
Deposit
Minimum paid-up
capital
Type
Amount
Maturity
LB
$300 million
Any
Any
Any
RB
$100 million
Time deposits
NCDs
$500,000 or
above
Any
DTC
$25 million
Time deposits
NCDs
$100,000 or
above
3 months or
above
HK as an international
financial centre
1.
China market


Economic reform in China 
allow export from & import to China
HK provides:
Re-exports
Commercial services
a.
b.




Insurances
Loans
Foreign exchange
Infrastructure development connected to Mainland, such as
highway, railway…
HK as an international
financial centre
Professionals:
c.



Financial experts
 Security markets
Law experts
 Contract
Science experts
 New inventions
HK as an international
financial centre
2.
HK has well-developed infrastructure
Judicial system


Law and order to protect business
Financial and banking system


Ease the running of business
Communication system


Ease the communication with oversea businessmen
HK as an international
financial centre
3.
Government policies





A free flow of information
Local and foreign investors can enter and leave
HK freely
A free port
No foreign exchange control
Low tax rates and simple tax structure
HK as an international
financial centre
4.
Favourite time zone

Continuous trading: New York + London + HK
City
Security market
New York
London
Hong Kong
Closed
Running
Closed
Running
Closed
Closed
Closed
Closed
Running
Benefits to HK economy
1.
Wealth creation
GDP:




2.
Banking (8%)
Insurance (1.3%)
Others, e.g. financial consultation, legal related (3.4%)
Employment



Banking (2.2%)
Insurance (1.3%)
Others (1.7%)
Benefits to HK economy
3.
Providing investment opportunities


Security market, for capital raising
Further enhance investment
Negative effect to HK economy
1.
Fluctuates with external factors


2.
Lack of autonomy

3.
International financial crisis (e.g. Lehman’s mini-bond)
Rely on capital from China (e.g. hot money from China)
Easily affected by the change of interest rate
in USA and worldwide
Speculations against linked exchange rate

Chance to be damaged by international speculators
(to be discussed later)
MC Questions
Arrange the following assets from high
to low liquidity:
(1) Real estate
(2) Bonds
(3) Cash
(4) Demand deposits
A. (1), (3), (2), (4)
B. (3), (1), (4), (2)
C. (3), (4), (2), (1)
D. (4), (2), (3), (1)
MC Questions
Which of the following properties must an item
have to be used as money?
A.
B.
C.
D.
Its face value is the same as its intrinsic value.
It can be exchanged for precious metals.
It is legal tender issued by the government.
It is generally accepted as a medium of
exchange.
MC Questions
Compared with paper banknotes, the
advantage of polymer banknotes is _______
and the disadvantage is _______.
A. being portable … being difficult to be
divisible into smaller units
B. having higher value … having lower
general acceptance
C. being more durable and more difficult to
reproduce … being more expensive to
produce
D. being more easily recognised … being
less popular
MC Questions
Which of the following statements about time
deposits and demand deposits is incorrect?
A. Demand deposits are a means of
payment but time deposits are not.
B. Demand deposits have a higher liquidity
than time deposits.
C. Time deposits offer higher returns than
demand deposits.
D. Both of them are included in M1.
MC Questions
Miss Wong plans to make a 2-month time
deposit of HK$450,000. Which of the following
institutions can accept her deposit?
(1) Licensed banks
(2) Restricted licence banks
(3) Deposit-taking companies
A. (1) only
B. (1) and (2) only
C. (2) and (3) only
D. (1), (2) and (3)
MC Questions
Suppose Mr Chan transfers his money from
a savings account to a current account.
Which of the following is correct?
A. M2 and M3 remain unchanged.
B. M1 increases while M2 decreases.
C. M1 remains unchanged while M2
increases.
D. M1 decreases while M2 remains
unchanged.
MC Questions
Suppose all shops in Hong Kong accept
payment by Octopus. The ratio of
A
M2 to M3 increases.
B. M1 to M2 remains unchanged.
C. M1 to M2 increases.
D. M1 to M3 decreases.
MC Questions
‘Savings deposits’ and ‘deposits in restricted
licence banks’ are both included in _______ in
Hong Kong.
(1) M1
(2) M2
(3) M3
A. (2) only
B. (3) only
C. (1) and (2) only
D. (2) and (3) only
MC Questions
Which of the following deposit-taking
institutions in Hong Kong can accept savings
deposits?
A. Licensed banks
B. Restricted licence banks
C. Deposit-taking companies
D. All of the above
MC Questions
The most important economic function of
commercial banks is
A. issuing banknotes.
B. setting the best lending rate.
C. acting as a financial intermediary.
D. acting as the lender of last resort.
MC Questions
Which of the following are the functions of
the Hong Kong Monetary Authority?
(1) Managing the assets of the Exchange Fund.
(2) Setting the best lending rate.
(3) Acting as the lender of last resort for banks.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
Cash in circulation
Cash held by authorized institutions
Demand deposits
Savings and time deposits in licensed banks
Negotiable certificates of deposit issued by licensed
banks and held by the public
Time deposits in restricted licence banks and deposittaking companies
M2 (in $billion) is
A. 112
B. 152
C. 158
D. 168
$ billion
20
6
12
80
40
10