Central Bank, Origin, Function,
of the the national currency.
Structure
Central banking- The central monetary authority
which provides policy direction in the areas of
money, credit, and banking.
It supervises the operation of banks and regulates
the activities of non-bank financial intermediaries.
It is responsible for maintaining financial sovereignty
and economic stability of a country, especially in
underdeveloped countries.
Traditional Functions:
 Bank of issue
 Government’s banker, agent, and advisor
 Custodian of cash reserves of commercial
banks
 Custodian of international currency
 Bank of rediscount
 Lender of last resort
 Bank of central clearance, settlement, and
transfer
 Controller of Credit
Non-Traditional Functions:
 Developing specialized financial institutions
 Influencing money market and capital market
 Collecting statistical data
Banko Sentral ng Pilipinas
-Established July 3, 1993
-The BSP took over from the Central Bank of
Philippines, which was established on 3 January
1949, as the country’s central monetary authority.
The BSP enjoys fiscal and administrative autonomy
from the National Government in the pursuit of its
mandated responsibilities.
-The BSP’s primary objective is to maintain price
stability conducive to a balanced and sustainable
economic growth. The BSP also aims to promote
and preserve monetary stability and the convertibility
The BSP Vision
The BSP aims to be recognized globally as the
monetary authority and primary financial system
supervisor that supports a strong economy and
promotes a high quality of life for all Filipinos.
The BSP Mission
To promote and maintain price stability, a strong
financial system, and a safe and efficient payments
and settlements system conducive to a sustainable
and inclusive growth of the economy
Under the New Central Bank Act, the BSP performs
the following functions:
Liquidity Management- formulates and implements
monetary policy aimed at influencing money supply
consistent with its primary objective to maintain price
stability.
Currency issue- has the exclusive power to issue
the national currency. All notes and coins issued by
the BSP are fully guaranteed by the Government
and are considered legal tender for all private and
public debts.
Lender of last resort- extends discounts, loans and
advances to banking institutions for liquidity
purposes.
Financial Supervision- supervises banks and
exercises regulatory powers over non-bank
institutions performing quasi-banking functions.
Management of foreign currency reserves- seeks
to maintain sufficient international reserves to meet
any foreseeable net demands for foreign currencies
in order to preserve the international stability and
convertibility of the Philippine peso.
Determination of exchange rate
policy- determines the exchange rate policy of the
Philippines. Currently, the BSP adheres to a
market-oriented foreign exchange rate policy to
ensure orderly conditions in the market.
Other activities- functions as the banker, financial
advisor and official depository of the Government, its
political subdivisions and instrumentalities and
government-owned and controlled corporations
Organizational structure of BSP
Monetary Policy of Bangko
Sentral ng Pilipinas
The primary objective of the BSP's monetary policy
is “to promote price stability conducive to a balanced
and sustainable growth of the economy” (Republic
Act 7653). The adoption of inflation targeting
framework of monetary policy in January 2002 is
aimed at achieving this objective.
Inflation targeting is focused mainly on achieving a
low and stable inflation, supportive of the economy’s
growth objective. This approach entails the
announcement of an explicit inflation target that the
BSP promises to achieve over a given time period.
To achieve the inflation target, the BSP uses a suite
of monetary policy instruments in implementing the
desired monetary policy stance. The reverse
repurchase (RRP) or borrowing rate is the
primary monetary policy instrument of the BSP.
Other monetary policy instruments include the
following:
1. Reverse repurchase facility
With the implementation of the IRC system, the RRP
facility was transformed into an overnight facility and
offered using a fixed-rate and full-allotment method,
where individual bidders are awarded a portion of
the total offer depending on their bid size. Fixed-
rate, full allotment method will help ensure that the
overnight rate sits close to the BSP policy rate. The
features of the O/N RRP facility can be accessed on
the monetary operations page.
2. Acceptance of term deposits
The BSP, like other central banks, offers term
deposits as one of the monetary tools to absorb
liquidity. In November 1998, the BSP offered the
Special Deposit Accounts (SDA) to banks and trust
entities of banks and non-bank financial institutions.
With the adoption of the IRC system in 2016, the
SDA facility was replaced by the term deposit
auction facility (TDF).
The TDF is a key liquidity absorption facility used by
the BSP for liquidity management and used to
withdraw a large part of the structural liquidity from
the financial system to bring market rates closer to
the BSP policy rate. A more detailed discussion on
the features of the TDF can be accessed on the
monetary operations page.
3. Standing liquidity facilities
The BSP offers standing liquidity (lending and
deposit) windows that help counterparties adjust
their liquidity positions at the end of the day. These
standing overnight facilities are available on demand
to qualified counterparties during BSP business
hours. The two standing facilities that form the upper
and lower bound of the corridor are set at ± 50 basis
points (bps) around the target policy rate (the
overnight RRP rate under the new IRC structure).
4. Rediscounting
The BSP extends discounts, loans and advances to
banking institutions in order to influence the volume
of credit in the financial system. The rediscounting
facility allows a financial institution to borrow money
from the BSP using promissory notes and other loan
papers of its borrowers as collateral.
The rediscounting facility has two categories
namely, Peso Rediscount Facility and Exporters
Dollar and Yen Rediscount Facility (EDYRF). The
Peso Rediscount Facility interest rates are based on
the latest avialable BSP overnight lending rate plus
the applicable term premia per Circular No. 964
dated 27 June 2017. The EDYRF interest rates are
based on the 90-day London Inter-Bank Offered
Rate for the last working day of the immediately
preceding month plus 200 basis points plus the
applicable term premia for loan maturities exceeding
90 days pursuant to Circular No. 807 dated 15
August 2013.
5. Reserve requirements
Reserve requirements refer to the percentage of
bank deposits and deposit substitute liabilities that
banks must set aside in deposits with the BSP which
they cannot lend out, or where available through
reserve-eligible government securities. Changes in
reserve requirements have a significant effect on
money supply in the banking system, making them a
powerful means of liquidity management by the
BSP.
Reserve requirements are imposed on the peso
liabilities of universal/commercial banks (UBs/KBs),
thrift banks (TBs), rural banks (RBs) and
cooperative banks (Coop Banks), and non-bank
financial institutions with quasi-banking functions
(NBQBs). Reservable liabilities include demand,
savings, time deposit and deposit substitutes
(including long-term non-negotiable tax-exempt
certificates of time deposit or LTNCTDs)
The existing reserve requirement ratios vary across
bank types and liabilities. The current headline
reserve requirement ratio of 20 percent is imposed
on certain liabilities of UBs/KBs and NBQBs.
Previously, the eligible forms of compliance to the
reserve requirements included banks' deposits in
their demand deposit account (DDA) with the BSP,
reserve-eligible government securities, and vault
cash. Effective on the reserve week beginning on 6
April 2012, the BSP excluded vault cash (for banks)
and demand deposits (NBQBs) as eligible forms of
reserve requirement compliance. 4 At the same
time, the BSP unified the existing statutory reserve
requirement and liquidity reserve requirement into a
single set of reserve requirement as well as
discontinued the renumeration of the unified reserve
requirements.
The Creation of Money
- is the process in which the banking system
creates checkable deposits by lending excess
reserves
Money
- medium of exchange
- a measure of value or a means of payment
Cash
- ready money
Cash vs Money
- Cash refers usually only to dollar bills or paper
money while money is all types of currency;
bills, credit cards, plastic debit cards, paper
money and coins.
- The concept of money includes more than
peso bills and coins.
 - Most of what we call money is bank balances,
not cash
Three Functions of money
Medium of exchange
- is accepted as payment for goods and
services (and debts)
Store of value
- can be held for future purchases
Standard of value
- serves as a yardstick for measuring the prices
of goods and services
Bank
- is a financial institution licensed to receive
deposits and make loans.
Deposit
- money placed into banking institutions for
safekeeping.
Loans
- is money, property or other material goods
given to another party in exchange for future
repayment of the loan value or principal
amount, along with interest or finance
charges.
Banks perform two essential functions:
- Banks transfer money from savers to
spenders by lending funds (reserves) held on
deposit.
- The banking system creates additional money
by making loans in excess of total reserves.
Constraints on Money Creation
- Bank Deposits
- Willing Borrowers
- Willing Lenders
- Government Regulation
Balance Sheet of a bank
Assets – what a bank owns
- Cash in the vault
- Deposits at the BSP
- Loans made to customer
- Government securities bought by the banks
- Others (building, computers, land, etc.)
Liabilities – what a bank OWES
- Checking Deposits of Customers
- Savings Accounts
- Loans borrowed by the bank from the BSP or
other banksNet Worth – left over if a bank
goes out of business selling all of its assets
and paying off all of its liabilities.
How is money created?
- Money is created in a form of debt.
- Commercial banks lending creates money in
the form of bank deposits.
Deposit Creation
- the creation of transaction deposits by bank
lending.
- When banks lend, they create money and
increase the money supply
How do banks create money?
History
Goldsmith Banking: The Origin of the Fractional
Reserves system of banking
In the 16th century gold was used as a medium
of exchange. Goldsmiths had safes for gold and
precious metal.
The Goldsmiths then issued receipts for these
deposits. These receipts came to be used as money
in place of gold because of their convenience.
 The Goldsmiths became aware that much of - the amount of cash deposits that the bank
the stored gold was never redeemed, people just must keep on the premises.
used the receipts.
Required Reserve Ratio
Goldsmiths realized they could “loan” gold by issuing
- is the ratio of required reserves to total
more receipts to borrowers, who agreed to pay back
deposits.
gold plus interest.
Excess Reserves
Hence, the Goldsmith created money.
- are reserves held in addition to required
Such loans began “Fractional Reserve reserves.
Banking” because the actual gold in the vaults
Money Supply
became only a fraction of the receipts held by
borrowers and owners of gold. - total value of money available in an economy
at a point of time.
Present:
- M1 – country’s basic money supply that’s
Banks create money during their normal used as a medium of exchange. It includes
operations of accepting deposits and making loans. cash, checkable deposits, and traveler’s
check.
With the interest they earn on their loans, Potential Money Supplier
banks are able to pay interest to their depositors, The increase in the money supply that
cover their own operating costs, and earn a profit. is potentially generated by a change in
demand depots.
Fractional Reserve Banking
It can be find out by a simple formula:
is a practice whereby banks takes deposits, create
M= ID / LRR
credits or make loans and holds reserve (to satisfy
demands for withdrawals) that are less than the
M- Money supply
amount of customer deposits.
ID- Initial Demand Deposit
Legal Reserve Requirements LRR- Legal reserve requirement

is a central bank regulation that sets minimum

fraction of customer’s deposit that each commercial SUPPLY OF and DEMAND FOR MONEY
bank must hold as reserves rather than lend out.

Total Reserves = Cash in vault + Deposits at INFLATION

Central Bank
Inflation is a qualitative measure of the rate at
Required Reserves = Required Reserved Ratio * which the average price level of a basket of selected
Demand Deposits goods and services increases over a period of time.

Excess Reserves = Total Reserves – Required

Reserves
INFLATION RATE
Required Reserves
 Inflation rate is the rate of change in the
weighted average prices of goods and services
typically purchased by the consumers.
INFLATION TARGETING
Inflation targeting is a framework for monetary
policy that focuses mainly on achieving the price
stability as the ultimate objective of monetary policy.
THE MONEY SUPPLY
The money supply is the total quantity of
money circulating in the economy at the particular
time. It is the entire stock of currency or other liquid
instruments in the country. It includes cash, coins,
balances held in checking and saving accounts and
other near money substitutes. Money supply is also
known as the money stock.
KEY MEASURES FOR THE MONEY SUPPLY
The money supply reflects the different types
of liquidity each type of money has in the economy.
 M1: Narrow Money
- Refers primarily to money used as a
medium of exchange.
- It includes currency in circulation held
by the nonbank public, demand
deposits, other checkable deposits,
and traveler’s checks.
 M2: Broad Money
- Refers primarily to money used as a
store of value.
- In addition to M1, this measures
includes money held in savings
deposits, money market deposits
accounts, non - institutional money
market mutual funds and other short-
term money market assets.
 M3: Broad Money Liabilities
- Refers primarily to money used as a
unit of account.
- Consists of M2 plus peso deposit
substitutes, such as promissory notes
and commercial papers.
 M4:
- Consists of M3 plus transferable and
other deposits in foreign currency
HOW SUPPLY AFFECTS THE INFLATION
An increase in the supply of money typically
lowers interest rates. This encourages private
consumptions. In addition, this increase the nominal
output or the Gross Domestic Product (GDP). Thus,
increases inflation rate.
A decrease in the supply of money, increase the
interest rates. This is mirrored by an equal decrease
in the nominal output. Also, this will decrease the
consumer spending. Thus, decreasing the inflation
rate.
SUPPLY CURVE
The supply curve of money shows the
relationship between the quantity of money supplied
and the market interest rate, all other things remain
unchanged.
The quantity of reserves is determined by the
Federal Reserve policy. In connection with this, we
assume that the supply curve for money is drawn as
a vertical line.
  Transaction demand – Money demanded for
day-to-day payments through balances held
Int
𝑀𝑠 by households and firms. This kind of demand
varies with GDP; it does not depend on the
ere
rate of interest.
st
rat
 Precautionary demand – Money demanded
es
as a result of unanticipated payments or
M unexpected events.

 Speculative demand – Money demanded

because of expectations about interest rates
HOW CENTRAL BANK CHANGES MONEY in the future. This means that people will
SUPPLY? decide to expand their money balances and
hold off on bond purchases if they expect
1. Changing Reserve Requirements – the interest rates to rise. This kind of demand has
regulation requiring banks to hold a fraction of a negative relationship with the interest rate.
checkable deposits as vault cash or deposits

2. Discount Window – Central banks make discount

loans to banks, serving as the channel for meeting
the liquidity needs of banks.
3. Discount Policy – the policy tool of setting the
discount rate and the terms of discount lending.
4. Open Market Operations – the purchasing and
sales of securities of the central bank in the financial
market.
THE DEMAND CURVE
The demand curve for money shows the
quantity for money shows the quantity of money
demanded at each interest rate, all other things
unchanged. The quantity of money demanded is
inversely proportional to the interest rates. An
increase in the interest rate reduces the quantity for
money demanded. Ad, a reduction of interest rate
increases the quantity for the money demanded.

THE MONEY DEMAND

Int 𝑀𝑑
The demand for money refers to how much ere
assets individuals with to hold in the form of money. st
It is sometimes referred to as liquidity preference. The rat
es
𝑀𝑑
demand for the money is related to income, interest
rates and whether people prefer to hold cash (money) M
or illiquid assets like money

MONEY MARKET EQUILIBRIUM

REASONS/MOTIVES FOR THE DEMAND OF
MONEY
 Occurs at the interest rate at which the
quantity of money demanded is equal to the quantity
of money supplied. SHIFTS IN THE SUPPLY OF MONEY

𝑀₁𝑆 𝑀₂𝑆
𝑠
𝑀 Int
Int i₁
ere ere
st i st
i₂
rat rat 𝑀𝑑
es 𝑀𝑑 es
M M

SHIFTS IN THE DEMAND FOR MONEY

• Income Effect

𝑀𝑠
Int i₂
ere
st
rat
𝑀₂𝑑
es i₁ 𝑀₁ 𝑑
M

 Price Level

𝑀𝑠
Int i₂
ere
st
rat
𝑀₂𝑑
es i₁ 𝑀₁ 𝑑
M
 MONETARY BASE
Monetary Base than one dollar. The increase in the money supply is
the money multiplier.
What is Monetary Base

 A monetary base is the total amount of a

currency that is either in general circulation in
the hands of the public or in the commercial
bank deposits held in the central bank's The 4 player in money supply process are:
reserves. This measure of the money supply
typically only includes the most liquid 1. The Central Bank
currencies; it is also known as the "money -the government agency that
base." oversees the banking system and its
 The monetary base is a component of a responsible for the conduct of
nation’s money supply. It refers strictly to monetary policy.
highly liquid funds including notes, coinage
2. Banks
and current bank deposits. When the Federal
Reserve creates new funds to purchase - the financial intermediaries that
bonds from commercial banks, the banks see
accept deposits from individuals and institutions
an increase in their holdings, which causes
and make loans
the monetary base to expand.
3. Depositors

How money supply determines? -individuals and institutions that hold

deposits in banks
he money supply is determined by the interaction of
four groups: commercial banks and other Overview of the Feds ability to control the monetary
depositories, depositors, borrowers, and the central base
bank.
-individuals and institution that borrow
many in banks

Who control it?

Money supply are controlled by one national

institution, usually a country’s central bank. They can
Central Bank Balance sheet
usually change the monetary base (either expanding
or contracting) through open market operations or Central Bank
monetary policies.

Assets Liabilities

Monetary base and Money multiplier

Government Currency in
The money created by the Federal Reserve is Securities circulation
the monetary base, also known as high-
powered money. Banks create money by making Discount Loans Reserves
loans. A one-dollar increase in the monetary
base causes the money supply to increase by more
 Monetary Liabilities  When open market sale the Central
Bank sells bond, the monetary base
 Currency in circulation- money in decrease.
hands of the
public, not including those in banks.
• Reserves- vault cash and commercial Open market purchase from a bank
bank deposits
at the Fed. Suppose the Central Bank buys 100 bonds
from the bank with check.
Banking System
Assets
Assets Liabilities
 Government securities- holdings by
the Fed that affect money supply and
earn interest Securities -
Php100
• Discount loans -lending to
commercial banks
Reserves
+Php100

The Formula in Monetary Base Central Bank

MB= C+R
Assets Liabilities
MB= Monetary Base (High- powered money)

C= money in circulation Securities Reserves

+Php100 +Php100
R= total reserves in the banking system

Open Market Operation

When the Central Bank buys or sells securities from
its member banks, it's engaging in what's known as
Open Market Operations. The securities are
Treasury notes or mortgage-backed securities.
OMOs serves as one of the major tools the Central
Bank uses to raise or lower interest rates.
• Net result: reserves (R) have increased by
100; currency (C) is unchanged.
• Monetary base (MB =C + R) has risen by
100.
Open market purchase from nonbank public -
case one

• Suppose a person or a film sell bonds of

P100 to the Central Bank and then deposits
 When open market purchase the the Fed’s check in a local bank.
Central Bank purchase bonds, the
monetary base increase.
 • Identical result as the Central Bank
purchases from the bank: reserves increases
P100, monetary base increases P100.
Nonbank Public
• The effect of an open market purchase on
reserves depends on whether the seller of
the bonds keeps the proceeds from the sale
in currency or in deposits.

Assets Liabilities Open Market Sale

•
Securities -P100 Checkable deposits Nonbank Public
+P100 Central Bank
Assets Liabilities
Assets Liabilities
Central Bank Securities -P100
Open
Securities -P100 Currency in
Assets Liabilities Currency +P100 circulation –P100

Securities +P100 Reserves +P100

market purchase from nonbank public case two
• The person/firm selling the bonds cashes the
Central Bank check for currency.
• Net result reserves are unchanged currency
in circulation increases by the amount of the
open market purchase.
• Monetary base increases by the amount of
the open market purchase.
• Suppose an individual buys the bonds from
the Central Bank with 100 cash (currency).
• Reduces the monetary base and currency by
the amount of the sale, reserves remain
unchanged.
• If the individual buys with check, reserve
reduces, monetary base reduces, currency
unchanged.

Nonbank Public Shifts from deposits into currency

Open
Central Bank
market
Assets Liabilities purchase
summary Assets Liabilities
Securities
+P100 • The Securities +P100 Currency in
effect of an
Circulation +P100
open
Currency -P100 market
purchase
on the monetary base always increases the
base by the amount of the purchase.
 Nonbank Public • Monetary liabilities of the Fed increases by
P100

Assets Liabilities • Monetary base also increases by P100

Banking System
Checkable
deposits +P100
Assets Liabilities
Currency –P100
Reserves +P100 Discount Loans –
P100

(borrowing from
Central Bank
Fed)

Assets Liabilities
Central Bank

Currency in
circulation +P100 Assets Liabilities

Reserves -P100 Discount loans Reserves +P100

+P100
• Net
Banking System Effect on • Suppose the bank pays off the P100
monetary discount loan.
liabilities
Assets Liabilities • Net effect on monetary base is a reduction of
is zero
P100
Reserves +P100 Checkable • Monetary base changes one-for-one with a
deposits -P100 change in the borrowings from the Central
Bank.

Banking System
• Reserves are changed by random
fluctuations Assets Liabilities
• Monetary base is a more stable variable
Reserves –P100 Discount loans –P100

(borrowing from Fed)

Discount Loan

• Suppose the Central Bank makes a P100

discount loan to a bank
 thus causes reserves in the banking system
Central Bank and the monetary base to fall.
• Thus Treasury deposits at the Central Bank is
Assets Liabilities determined by the Treasury’s actions and
affects the monetary base but are not fully
controlled by the Central Bank.
Discount loans -P100 Reserves –P100
•
(borrowing from Fed)
Overview of the Feds ability to control the
monetary base

Other factors affecting the monetary base

 Float and Treasury deposits at the Central
• Floats
Bank which are not in control of the Fed can
• Treasury deposits at the Central Bank cause short-term (a week) fluctuations in
monetary base.
• But the Central Bank can offset these short-
Float term fluctuations by its open market
operations
• When the Central Bank clears checks for maintain its control over monetary base.
banks, it often credits the amount of the check
to a bank that has deposited it (increases the
banks reserves) but only later debits
(decreases the reserves of) the bank on which
the check is drawn.
• The resulting temporary net increase in the
total amount of reserves in the banking
CENTRAL BANKING AND
system (and hence in the monetary base) MONETARY POLICY
occurring from the Feds check-clearing
process is called float. Block A (10:30-12:00)

• Float is affected by random events such as MEMBERS:

the weather, which affects how quickly checks
BACLAO, Leile
are presented for payment, is not controlled
by the Fed, but affects the monetary base. CAMBA, Athena Ma. Shane
MANGENTE, Ma. Lyriana

Treasury Deposit NAPAY, Alfred

• When the Countries’ Treasury moves NOPRE, Jovilyn

deposits from commercial banks to its PALAJE, Cleo Nicole
account at the Central Bank, leading to a rise
in Treasury deposits at the Central Bank, it SORIAGA, Patricia Ann
causes a deposit outflow at these banks and
REYEG, Kathy