Republic of the Philippines

CATANDUANES STATE UNIVERSITY

COLLEGE OF BUSINESS AND ACCOUNTANCY
Virac, Catanduanes

LEARNING MATERIAL
In

FMP6
Monetary Policy and Central Banking
A compilation of lessons/ activities

MELINDA V. ABICHUELA, MBA

August, 2020
 Disclaimer

This learning material is used in compliance with the flexible teaching-

learning approach espoused by CHED in response to the pandemic that has

globally affected educational institutions. Authors and publishers of the contents

are well acknowledged as such the college and its faculty do not claim ownership of

all sourced information. This learning material will solely be used for instructional

purposes not for commercialization.

CatSU College of Business and Accountancy

 OVERVIEW

This learning material is prepared as a reference for students taking up

Bachelor of Science in Business Administration, major in Financial
Management course at the College of Business and Accountancy this 1 st
Semester, SY 2020-2021.

The coverage of this learning material is as follows:

Chapter 1 : The Essence of Central Banking.

Chapter 2 : Banker and Advisor to Government.

Chapter 3 : discusses the process of induction, training and development

of employees.

The Author
 Table of Contents

Page

Disclaimer

Module Overview 1
Learning Outcomes 1
Module Map 2
Introduction 3

Essence of Central Banking Chapter 1 4

Activity 1 5
Activity 2 5
Activity 3 6
Activity 4 8
Activity 5 9
Activity 6 10

Banker and Advisor to Government Chapter 2 10

Activity 7 13
Activity 8 13
Activity 9 13

Management of Money and Banking System Chapter 3 14

Activity 10 15

Activity 11 15

Activity 12 15

Answers 16

Assessment of Learning 17

References 21

Module 1
Monetary Policy and Central Banking
Module 1
Monetary Policy and Central Banking

Central Banks play a vital role in ensuring economic and financial stability. They conduct
monetary policy to achieve low and stable inflation. In the wake of the global financial crisis, Central
banks have expanded their toolkits to deal with risks to financial stability and to manage volatile
exchange rates. Central Banks need clear policy frameworks to achieve their objectives.

This module will show you how the global financial crisis, central banks, eased monetary
policy by reducing interest rates until short-term rates came close to zero, which limited the option to
cut policy rates further (i.e., limited conventional monetary options). With the danger of deflation
rising, central banks undertook unconventional monetary policies, including buying long-term bonds
with the aim of further lowering long term rates and loosening monetary conditions. A module map is
accessible to help you generate a rational map of the foremost concepts in the module. Learning
inputs and activities were gently chosen and established to ease your mastery of the content. At the
end of this module is an assessment of learning to, determine if the intended learning outcomes
have been ideally achieved.

This module includes the topics as contained in the course syllabus for Monetary Policy and
Central Banking. Discussion, examples and illustrations for every lesson or topic were direct-to-the-
point to facilitate easy learning and mastery of the course.

Module Part I (Midterm coverage) has 3 topics:

1. Essence of Central Banking

2. Banker and Advisor to Government
3. Management of Money and Banking System

Learning Outcomes

After remarkably completing this module, the student shall be able to:

1. Describe the milieu of the Central Bank: the Financial system; explain the context of
monetary policy: financial stability; discuss the components of the balance sheet of a Central
Bank; elucidate the simplicity of money creation; list the categories of Central Bank
functions,

2. Expound the CB markets; elucidate the Central Bank’s role in liquidity management; know
the function as banker to government,

3. Describe the CB function as banker to private sector; detail the CB function as settlement of
interbank claims; discuss CB role in the supervision of the payments system; explain the CB
as a lender of last resort.

4. Convey gratitude for humanity and for monetary and central banking, towards financial
stability of a country.

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Monetary Policy and Central Banking
 Module Map

Presented below is a Module Map of Part 1 containing the topics

covered in the duration of the Mid-term Examination. Included also is the

allotted number of hours per lesson/unit/chapter.

Chapter Topics Allotted

No. of Hours

1 Essence of Central Banking 8.5 hrs.

2 Banker and Advisor to Government 7.0 hrs.
3 Management of Money & Banking System 10.0 hrs.
Mid-Term Examination 1.5 hrs.
TOTAL 27.0 hrs

2
Monetary Policy and Central Banking
Introduction

A key role of central banks is to conduct monetary policy to achieve price stability (low and
stable inflation) and to help manage economic fluctuations. A central bank is an independent national
authority that conducts monetary policy, regulates banks, and provides financial services including
economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and
prevent inflation.

Most central banks are governed by a board consisting of its member banks. The country's
chief elected official appoints the director. The national legislative body approves him or her. That
keeps the central bank aligned with the nation's long-term policy goals. At the same time, it's free of
political influence in its day-to-day operations. Central banks affect economic growth by controlling
the liquidity in the financial system. They have three monetary policy tools to achieve this goal.

First, they set a reserve requirement. It's the amount of cash that member banks must have on hand
each night. The central bank uses it to control how much banks can lend.

Second, they use open market operations to buy and sell securities from member banks. It changes
the amount of cash on hand without changing the reserve requirement. They used this tool during
the 2008 financial crisis. Banks bought government bonds and mortgage-backed securities to
stabilize the banking system.

Third, they set targets on interest rates they charge their member banks. That guides rates for loans,
mortgages, and bonds. Raising interest rates slows growth, preventing inflation. That's known
as contractionary monetary policy. Lowering rates stimulates growth, preventing or shortening
a recession. That's called expansionary monetary policy.

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Monetary Policy and Central Banking
Chapter 1. ESSENCE OF CENTRAL BANKING

1.1 Milieu of the Central Bank: The Financial System

The financial system is essentially concerned with borrowing and lending and has six parts
or elements:
– Lenders and borrowers
– Financial intermediaries
– Financial instruments
– Financial markets
– Price discovery

Elements of Financial System:

1. Lenders (Surplus economic unit)/Borrowers (deficit economic units)-lenders try and

earn the maximum on their surplus money and borrowers try and pay the minimum for
money borrowed.
2. Financial Intermediaries – intermediates the lending and borrowing process. They
interpose themselves between the ultimate lenders and borrowers and endeavor to
maximize profits from the differential between what they pay for liabilities (borrowings) and
earn on assets (overwhelmingly loans). This is also called “bank margin”
Obviously, they endeavor to pay the least on deposit and earn the most on loans.
3. Financial Instruments – created to satisfy the financial requirements of the various
participants. Example, marketable securities
4. Creation of money –as you know banks (collectively) have the unique ability to create their
own deposits (=money) because we the public generally accepts their deposits as a means
of payment.
5. Financial Markets – the institutional arrangements and conventions that exist for the issue
and trading (dealing) of the financial instruments.
6. Price discovery (price of shares, price of debt) – it is made and determined in the financial
markets. Financial analysis research plays a major role in price discovery.

Principal Participants in the Financial System

• Lenders
• Borrowers
• intermediaries

Non-Principal Participants
in the Financial System:
• Financial exchanges and broker-dealers
• Fund managers
• Regulators
• Rating agencies

4
Monetary Policy and Central Banking
Activity 1. From the choices given below, answer the following questions, write your answer on the
spaces before each number:
________________________ 1.The Makati stock exchange is an example
of_______________
________________________ 2.A bank is an example of
________________________ 3.Monetary policy is best described as: attempts to keep
inflation___
________________________ 4.Carla obtains a home improvement loan from Pag-Ibig fund.
The loan is Carla’s ________________.
________________________ 5.Financial instruments are used by the holder as
a____________.

Choices for activity 1

Financial institution Store of value
Liability Financial market Low

Activity 2. After reading the statement/s, write on the spaces provided before each number, True if
the statement is correct and write False if the statement is wrong.
___ 1.A stock is a debt security that promises to make periodic payments for a specific
_ period of time.
___ 2.Monetary policy affects interest rates but has little effect on inflation or business
_ cycles.
___ 3.The government organization responsible for the conduct of monetary policy in the
_ Philippines is the Bureau of Treasury.
___ 4.A financial intermediary borrows funds from people who have saved.
_
___ 5.A mutual fund is not a depository institution.
_

1.2 The Context of Central Banking: Financial Stability

Financial Stability has two legs:
– Price stability
_ Stable condition in the financial system
Price stability- Is low and stable (non-volatile) changes in the general price level, generally referred
to as inflation rate. 2% - 3% inflation rate is tolerable because it has no material impact on the
decision making process of economic units.

Stable condition in the financial system- Are accomplished when there is a high degree of confidence
that the financial intermediaries and markets are stable. Example, meeting obligations without
disruption

How is Financial Stability Achieved Domestically?

The measures of the Central Bank:
• Ensure the availability of notes and coin in circulation in convenient denomination to serve
as a means to effect financial transactions.
• Create an efficient national payments and interbank settlement system
• Support the development of efficient money, bond, and foreign exchange markets
• Supervise the financial risks of the banks
• Support the development of an efficient banking system
 • Provide accommodation (liquidity) to solvent banks in extraordinary circumstances in order
to safeguard the financial system, known better as the lender of the last resort

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Monetary Policy and Central Banking

Activity 3. Answer the following questions based on your readings in 1.2:

1. _______ Which three of the following are core functions of the Central Bank?
(Select 1 combination of 3 letters, please write the letter on the space before the
statement)
a) Maintaining the integrity and value of the currency
b) Setting interest rates via the Monetary Policy Committee
c) Maintaining the stability of the financial system
d) Setting exchange rate
e) Setting tax rates

a) a, b, d
b) b, c, d
c) a, b, c
d) b, c, e
e) a, c, e

2. _______Where short-term financial instruments are bought and sold at prices below their
redemption value on maturity.
(Write the letter of the correct answer, on the space before the statement.)
a) Primary capital markets
b) Secondary markets
c) Euromarket
d) Sterling certificates
e) Discount market

3. ______It is now well recognized that countries with low inflation also experience
a) High employment
b) Low unemployment
c) Relatively higher economic growth
d) A more stable political climate

4. Financial contagion is the spillover effect of bank failures. (Write T if the statement is correct
and F if it is wrong).
a)True
b)False

5. A Central bank regulates a nation’s money supply and financial institutions in an attempt to
provide the nation with stable economic environment and an effective payments system.
(Write T if the statement is correct and F if it is wrong).
A)True
b)False

1.3 Balance Sheet of the Central Bank

• Liabilities:
– Notes and Coins
– Deposits: Government
 – Deposits: Bank
– Foreign Loans
– Central Bank Securities

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Monetary Policy and Central Banking

• Assets
– Foreign Assets
– Loans to government
– Loans to bank

Notes and Coins

• This is not the amount printed or minted, but the total amount that has been issued to the
banks and public via the banks.
• Central bank is the sole issuer of notes and coins
• M3 is also called the stock of money including of bank deposits (M3= Notes and coins +
Bank deposits held by Non-bank private sector)

Deposits
Deposits: Government
• Custodian of the funds of the government
Deposits: Banks
• Banks have two accounts in the Central Bank: Reserve Account and Settlement Account

What are Reserves?

• In most countries, banks have a reserve requirement, and obliged to hold required reserves
(RR) equal to the total deposits times the reserve requirement ratio (r).

• Central Bank does not pay interest on bank balances of loans provision and this creates
deposits, therefore, the required reserve increase continually

Interbank Settlement
• Clearing takes place over the banks’ account at the Central Bank.
• How does interbank settlement work?
_Bank clients move deposits around the system every day. At the end of the day, banks
close
off their books every day, the amounts are settled via reserve accounts.

Foreign Loans
In exceptional circumstances, central banks do undertake foreign loans – usually when they
experience balance of payments problems.

Central Bank Securities

Debentures, Bills, Short-term securities

ASSETS

Foreign Asset
 • Foreign assets are usually comprised of gold bullion holdings and foreign investments.
• Many central banks make use of forex swaps to influence bank liquidity. These are similar to
repurchase agreements.

7
Monetary Policy and Central Banking

Loans to Government
It usually comprised of treasury bills (short term debt obligation) and government bonds.

Loans to Bank
• Is at the heart of monetary policy.
• In normal times, most central banks compel to borrow reserves from them (BR) at their key
interest rate (KIR ) at all times.
• Key Interest Rates (KIR) has many manes discount rate, repo rate, bank rate.

Activity 4. Prepare a Balance Sheet of the Central Bank using the given data. (Answer will be sent
soon to students (after I received answer from 100% of my students) through their facebook
account.)

A. Notes and coins P1,000.00

B. Deposits
1.Government 900.00
2.Bank’s reserves (TR) 500.00
Required reserves (RR) (500)
Excess reserves (ER) (0)
C. Foreign loans 50.00
D. Central Bank securities 50.00
E. Foreign assets 1,000.00
F. Loans to government 1,100.00
G. Loans to banks 400.00

1.4 MONEY CREATION

• Bank assets and liabilities are not static (changeable).
• They increase mainly as a result of new bank loans/ money creation.

Money Supply
 M
=
C
+
8
Monetary Policy and Central Banking

In this chapter, we’ll see that the money supply is determined not only by the Central Bank Reserve,
but also by the behavior of households (which hold money) and banks (where money is held).

The deposits that banks have received but have not lent out are called reserves. Consider the case
all deposits are held as reserves: banks accept deposits, place the money in reserve, and leave the
money there until the depositor makes a withdrawal or writes a check against the balance.

Sample Problem (Solution is directly provided to students through their own FB private message.)

• Company A is a producer of goods required by Company B. Company B requires finance of

P 10 M in order to purchase the goods, and approaches Bank A for a loan. After a credit
check, the bank grants Company B an overdraft facility.
• Company B draws a check for P10M on its overdraft facility and presents the check to
company A and takes delivery of the goods. The check is put through the interbank clearing
system.
• Show the balance of the respective parties
Activity 5. Answer the problem below. (Solution is directly sent to students, as soon as 100% of
the students have submitted.)
Suppose that people deposit the economy's supply of currency of P1 million into First bank. If the
bank holds 100 percent of these deposits in reserve, then the bank has no influence on the money
supply. Yet under a system of fractional-reserve banking, the bank need not keep all of its deposits
in reserve; it must have enough reserves on hand so that reserves are available whenever
depositors want to make withdrawals, but it makes loans with the rest of its deposits.

1. If First bank has a reserve-deposit ratio of 20 percent, then how much will be lend to
borrowers?
2. Show the balance sheet of First bank after loans have been made.
3. By making these loans, First bank increases the money supply by how much?
4. How much is the total money supply?

Money creation does not stop with First bank. If the borrowers deposit their P 800, 000.00 of
currency in Second bank, then Second bank can use these deposits to make loans.

1. If Second bank also has a reserve deposit ratio of 20 percent, then it keeps how much in the
reserves?
2. How much the second bank did lend out?
3. By lending out this money, Second bank increases the money supply by how much?
4. What is now the total money supply

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Monetary Policy and Central Banking

1.5 Functions of Central Bank

• Formulation and implementation of monetary policy

– Formulation of monetary policy framework
– Influence on level of interest rates ( through bank liquidity management)
– Open market operations
• Banker and advisor to government
– Banker to government
– Public debt Management
– Administration of exchange controls
• Management of the money and banking system
– Lender of the last resort
– Currency management (notes and coins)
– Banker to private sector banks
– Settlement of interbank claims
– Bank supervision
 – Supervision of payments system
– Management of gold and foreign exchange reserves
– Development of Debt market

Cristina Mae U. Lagmay

Bsba -fm2A
2021-00903
Activity 6. From the choices after each sentence, underline the correct answer.

1. Which of the ff. are commonly the functions of the Central Bank? (1.Conduct of monetary policy, 2.Lending to the
general public, 3.Supervising the stock market, 4.Lending to the commercial banking system) Final answer: ( 2 &
4/ 1 2 & 4/ 1 &3/ 1 & 4)
2. If banks are operating with a reserve ratio of 10%, and the public's cash ratio is 5%, then the relationship between
broad money and the monetary base will be: (10:1, 5:1, 7:1, 1:1, 15:1)
3. Open market operations are best described as: They are used by Central banks to buy and sell government
securities in order to adjust interest rates. (True, False)
4. Monetary policy is what a central bank operates to manage the amount of money and the rates of interest charged
in its economy. (True, False)
5. Processing credit card payments is not an activity of the central bank. (True, False)

CHAPTER 2. BANKER AND ADVISOR TO GOVERNMENT

2.1 The interbank markets

• Three interbank markets:
– Bank-to-Central bank interbank market
– Central Bank to bank interbank market
– Bank-to-bank interbank market
–
We present the balance sheet of the CB and the banks. The highlighted items are the accounts
through which the interbank markets (IBMs) function.

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Monetary Policy and Central Banking

BALANCE SHEET 1: CENTRAL BANK (Peso Billions)

Assets Liabilities

A.Notes and coins 1,000

D.Foreign assets 1,000
B.Deposits

1.Government 900
E.Loans to government 1,100 2.Banks’ reserve accounts (TR) 500
a.Required reserve (RR=500)
b.Excess reserves(ER=0)
 F.Loans to banks(borrowed reserves- 400 C.Foreign loans 100
BR

To 2,500 Tot 2,500

tal al

BALANCE SHEET 2: BANK (Peso Billions)

Assets Liabilities

C.Notes and coins 100

A.Deposits of NBPS (BD) 5,000
D.Reserves with central bank (TR) 500
1.Required reserves (RR=500)
2.Excess reserves (ER=0) B.Loans from central bank (BR) 400
E.Loans to government 1,000
F.Loans to private sector 3,800

To 5,400 Tot 5,400

tal al

The IBMs are where the settlement of interbank claims take place and where monetary policy
begins. In some countries banks have two accounts with the central bank: a reserve account in
which required reserves (RR) are held and a settlement account (SA) over which settlement of
interbank claims takes place. In some other countries banks have one account with the central bank
it has many names: reserve account, settlement account, cash reserve account, and so on. Here we
refer to it as reserve account. On these accounts the banks hold their required RR and (if any) their
excess reserves (ER). The total of the two amounts we call total reserves (TR). Thus: TR= RR +
ER.

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Monetary Policy and Central Banking

2 Accounts of Central Bank

• Reserve Account – it has many names: reserve account, settlement account, cash reserve
account.
• Settlement Account- the settlement of interbank claims takes place

Interbank Markets
• The Bank-to-Central Bank Interbank Market – it is an administrative market in which the flow
is one way: from the banks to the central banks in the form of the cash reserve requirement.
What is cash reserve requirement?

Cash Reserve Requirement

 Cash reserve requirement referred to as the required reserves (RR). The banks’ RR are held
on their reserve accounts with the Central Bank.
Required reserve earn no interest, which is essential element in monetary policy.
What is monetary policy?

Monetary Policy
Is the process by which the authority of a country controls the supply of money often
targeting an inflation rate or interest rate to ensure price stability and general trust in the
currency.
(illustrate the computation required reserve)

Interbank Market
• The Central Bank-to-bank interbank market – it is an administrative market. It represents
loans from the central to the banks. The loans from central bank also called the borrowed
reserves. The central bank proves key interest rates (KIR).
• KIR has many names – discount rate, repo rate, bank rate or base rate. This has a major
influence on bank deposit’s rate.
• The Bank-to-Bank interbank Markets – This is a true market.
• This market operates during the banking day but particularly at the close of business each
day (banks close off their books every day)
(illustrate sample problem)
Company A withdraws 100 B deposits from Bank A and deposit it with Bank B. How does
the settlement of this transaction takes place?
• Assume that at the close of the business yesterday the two banks were not borrowing from
the central bank and they did not have surpluses with the central bank. How does the
electronic interbank settlement system presents the two banks with the above information?
Illustrate
• The bank place funds with or receive funds from other banks depending on the outcome of
the clearing.
• Surpluses are placed at the IBM rate.
• A critical issue here is that this rate is closely related to KIR because banks endeavor to
satisfy their liquidity needs in this market before last resort borrowing from the Central Bank
at KIR.

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Monetary Policy and Central Banking

Activity 7. Modified True or False. If your answer is TRUE, explain why?, and if the answer is
FALSE, explain also why?

1. Ignoring any reserve requirements, bank reserves will be higher than otherwise if the central bank pays a positive
return on overnight reserves held by the commercial banks equal to its current policy rate.
2. When a country runs a small current account deficit and the private domestic sector is saving overall, the
government budget balance will always be in deficit.

2.2 Bank Liquidity Management

• Money market identity is an indicator of bank liquidity.

• Show balance sheet
• On the left side of identity, Net Excess Reserve (NER) = B2b - G
 • On the right hand side of identity, Net Excess Reserve (NER) = (E + F) – (A + B1 + B2a + C
+ D)
• Grouping the related liability and asset items, we have, Net Excess Reserve (NER) = (E – C)
+ (F – B1) – A – B2a – D
• There are so called the “Balance Sheet Sources of Change”
• Net Foreign Asset (E-C) i.e. forex swaps
-Net Loans to Government (F-B1) i.e. purchases/sales of securities and changes in
government deposits
-Note and coins in circulation
-Required reserve
-Central Bank Securities

Activity 8. From the choices given below the questions, fill in the blanks with the correct
answer/s.
1. A/an __________________________is an asset which can be converted into cash easily, which has a relatively
stable price and is reversible.
2. When a financial institution sells asset to manage liquidity it faces_______________________________. They lose
the future earnings on those assets.
3. ______________________________________is when the financial institution borrows money in the money market
to meet liquidity needs.
4. The________________________________is the total difference between the sources and uses of funds.
5. _____________________________________are the assets the bank must by law hold behind its deposits.

Choices of answers
Purchased(borrowed liquidity Opportunity costs Liquidity gap
Legal reserves Liabilities Liquid asset

2.3 Banker To Government

• In most countries, Central Bank is the sole banker to government

• Generally, the Central Bank does not provide banking services to provincial governments,
local authorities or state enterprises.

Activity 9.

1. Discuss : A Central Bank as a banker to government.

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Monetary Policy and Central Banking

LESSON 3. MANAGEMENT OF MONEY AND BANKING SYSTEM

3.1 Banking to Private Sector

• Central Bank act as custodian of the reserves that banks are legally required to hold with the
banks’ required reserve.
• The Central bank has the authority to change the reserve requirement to influence bank
liquidity.
• In some other countries, the banks are required to maintain two accounts the “Reserve
Accounts” and “Current Accounts”
• The “reserve account”, where the required amount of reserves must be held at all times.
• The Current Account”, which the clearing/settlement of interbank claims takes place.
• The banks’ balances on their reserve accounts are usually kept to the minimum required for
a simple reason, the Central Bank does not pay interest on the RR or the ER of the banks

Origin of the Central Function

• It began in the days of the London silver and goldsmiths in the 17th century.
• The London wealthy began making use of the secure facilities of the goldsmiths for their
wealth, which was then comprised of precious metal coins.
• They deposited their coins with the goldsmiths and latter issued a receipt for the gold.
• They deposited their coins with the goldsmiths and latter issued a receipt for the gold.

Banking to Private Sector

• Later, it was found out that these receipts were a convenient means of payment for goods
and services, and it came to pass that the goldsmiths were requested to split receipts into
smaller denomination and to issue them without being payable to a person. i.e. Mr. A
deposited 100 one pound gold coins the goldsmiths-banker would be asked for receipts,
each with a face value of one pound. These receipts became the principal means of
payment.
• Thus at this stage the amount of money in circulation was the sum total of gold coins plus
goldsmith-banker receipts in the possession of the public.
• The receipts became money because they were convertible into gold, i.e. any holder of a
receipt could present it to relevant goldsmith and demand gold. At the time loans were made
by the goldsmiths in the form of the gold in their possession.
• The goldsmith overtime became more involved in banking business which led to the name:
goldsmiths-bankers, and later just bankers.
• It did not take long foe a goldsmith banker to realize that if their receipts were being used as
the means of payment, then loan demand could be satisfied not by gold coins, but by the
issue of new goldsmith-banker receipts.
• This was a historical event of momentous proportions and changed the economics of the
world forever.
• The most significant event in banking – money creation by the new banks – was born, which
endures to this day. It liberated economies from the often stifling shortage of precious metals
from which money was struck.

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Monetary Policy and Central Banking

• It is appropriate from here on to refer to goldsmith-banker receipts as bank notes and to the
goldsmith banker as bank.
• The gold standard was abolished in the 20 th century. Once abolished, there was nothing
backing up bank liabilities.
• The acceptable reserves then became bank notes of and deposits at the Central Bank
• Now many countries, including Philippines have abolished CB Notes, this paved way to
fractional reserve banking, where Central Banks are able to control bank lending/deposit
creation by restricting the amount of reserves created. CB can create CB money.
• This paved way for excessive money creation and hyperinflation, when central banks were
pressured by governments to create reserves on demand.
• The hyperinflation was coined during the first half of the 20th century.
Activity 10.

1. Explain: Central bank banking to private sector.

3.2 Settlement of Interbank Claims

• Sample Problem:
There are three banks, all of which have a so-called “out clearing book” indicating
new deposits they have receive in the form of checks drawn on other banks. Determine the total
claims on and against.

Activity 11.

1. Discuss the settlement of interbank claims.

3.3 Supervision of Payments System

• In most countries there are three payment systems:
– Real time gross settlement (RTGS)
– Automated Clearing Bureau (ACB)
– Automated Teller Machine(ATM)

• The three system are called National Payment System (NPS). The system all make use of
the settlement facility at the Central Bank, and because of this, the system is secure. When
payments are made by banks they are made from their existing reserves.

• If these payments leave individual banks short of RR at the end of business day, they are
required to find the funds in the interbank market, or from CB in the form of loans against
collateral.

Activity 12.

1. Elucidate the supervision of payment system

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Monetary Policy and Central Banking

Answers

Activity 1.
1.financial management 3.low 5.store of value
2.financial institution 4.liability

Activity 2.
1.False F 3.False F 5.True T
2.False F 4.True T
Activity 3.
1.c(abc) 3.a 5.T
2.a 4.F

Activity 4. Answers may vary

Activity 5. Answers may vary

Activity 6.
1. 1 & 4 2. 7:1 3. True
4. True 5. True

Activity 7. Modified True or False. If your answer is TRUE, explain why?, and if the answer is
FALSE, explain also why?

Answers may vary.

Activity 8.
1. Liquid asset 2. Opportunity costs 3. Purchased liquidity
4. Liquidity gap 5. Legal reserves

Activity 9.- 12. Answers may vary

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Monetary Policy and Central Banking

Assessment of Learning

Test I. Choose the correct letter that corresponds to your answer and write the letter before each
item number.

1. It is the surplus economic unit.

a. Lenders
b. Borrowers
c. Intermediaries
 d. None of the above
2. It is the deficit economic units
a. Intermediaries
b. Lenders
c. Borrowers
d. None of the above
3. They interpose themselves between the ultimate lender and borrower and endeavor to
maximize profit.
a. Lenders
b. Intermediaries
c. Banks or microfinance
d. None of the above
4. It is the institutional arrangement and conventions that exist for the issue and trading of
the financial instrument
a. Financial markets
b. Financial instrument
c. Financial intermediaries
d. None of the above
5. The supply of bank loans is limited only by the demand for loans and the credit
worthiness/project viability of the_______________________?
a. Individual, Government, & Banks
b. Individual, Companies, & Government
c. Individual, Commercial Banks & Government
d. None of the above
6. The Central is required to manage the short-term interest rates, particularly the lending
rates of banks, and influence the demand for loans/money creation.
a. Monetary Policy
b. Financial System
c. Central Banking
d. None of the above

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Monetary Policy and Central Banking

7. What are the principals of the financial system?

a. Rating agencies, regulators, and fund managers
b. Lenders, borrowers, and financial intermediaries
c. Financial exchanges, fund managers, and regulators
d. None of the above
8. It is an administrative market in which the flow is one way.
a. Bank-to-Central Bank Interbank Market
b. Central-Bank-to-Bank Interbank Market
 c. Bank-to-Bank Interbank Market
d. None of the above
9. It is an administrative market and it is at the center of the vast majority of countries’
monetary policy.
a. Bank-to-Central Bank Interbank Market
b. Central-Bank-to-Bank Interbank Market
c. Bank-to-Bank Interbank Market
d. None of the above
10. This market operates during the banking day but particularly at the close of business each
day.
a. Bank-to-Central Bank Interbank Market
b. Central-Bank-to-Bank Interbank Market9
c. Bank-to-Bank Interbank Market
d. None of the above

Test II. Explain the following concepts:

11. Inflation- Inflation is the increase in the general prices of goods and services in the economy.
This decreases the purchasing power of your money. Put simply, you need more money to
buy the same amount of goods than you did in the past. For example, you notice how the
price of coffee increases every year.Inflation is the increase in the general prices of goods
and services in the economy. This decreases the purchasing power of your money. Put
Simply, you need more money to buy the same amount of goods than you did in the past.
For example, you notice how the price of coffee increases every year.
12. Settlement of interbank transfer- In interbank transfer, the amount of beneficiary is
transferred into the account of a different bank. While in intra bank transfer, the amount of
beneficiary is transferred into the account within the same bank.
13. Central Bank Securities
14. Notes and Coins- Currency notes and coins are called fiat money
They do not have intrinsic value like that of gold or silver coin. Unlike commodity money,
fiat money is not backed by any physical commodity instead it is backed by the order or
authority of the government
15. Bank Liquidity- Liquidity is the risk to a bank's earnings and capital arising from its inability to
timely meet obligations when they come due without incurring unacceptable losses. Bank
management must ensure that sufficient funds are available at a reasonable cost to meet potential
demands from both funds providers and borrowers
Test III (16-30). Extract the components of the equation from the balance sheet of the Central Bank
by applying the knowledge in Net Excess Reserve.
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Monetary Policy and Central Banking

Balance Sheet 1: Central Bank (In Billions)

ASSETS LIABILITIES
E. Foreign assets A. Notes and Coins
F. Loans to Government (Government B. Deposits
Securities) 1. Government
2. Banks
a. RR
b. ER
G. Loans to Banks C. Foreign Loans
D. Central Bank Securities
Give the equation of the following:
 On the left hand side of the identity (5 points)
 On the right hand side of the identity (5 points)
 If we group the related liability and asset items in the right hand side of the identity ( 3
points)
 A change in the net excess reserve (2 points)

Test III. Item Nos. 31-40. Problem solving (Total 10 points) MONEY CREATION

Suppose that people deposit the economy's supply of currency of P1 million into First bank. If the
bank holds 100 percent of these deposits in reserve, then the bank has no influence on the money
supply. Yet under a system of fractional-reserve banking, the bank need not keep all of its deposits
in reserve; it must have enough reserves on hand so that reserves are available whenever
depositors want to make withdrawals, but it makes loans with the rest of its deposits.

5. If First bank has a reserve-deposit ratio of 20 percent, then how much will be lend to
borrowers?
6. Show the balance sheet of First bank after loans have been made.
7. By making these loans, First bank increases the money supply by how much?
8. How much is the total money supply?

Money creation does not stop with First bank. If the borrowers deposit their P 800, 000.00 of
currency in
Second bank, then Second bank can use these deposits to make loans.

5. If Second bank also has a reserve deposit ratio of 20 percent, then it keeps how much in the
reserves?
6. How much the second bank did lends out?
7. By lending out this money, Second bank increases the money supply by how much?
8. What is now the total money supply
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Monetary Policy and Central Banking

Test IV. Item Nos. 41-50. Case Problem (Total 10 points)

Illustrate how three banks (A, B, & C) have settled interbank claims if Bank A has a new deposit of P
2000 from client A; the checks is drawn on Bank B; thus, Bank B owes Bank A P 2,000.Similarly, Bank
C has new deposit of P 5000 from client G, the check is drawn on Bank A, thus Bank A owes Bank C
P 5,000.
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Monetary Policy and Central Banking

REFERENCES:

http://bsp.gov.ph

https://www.imf.org/en

https://www.sciencedirect.com

https://corporatefinanceinstitute.com/resources/knowledge

https://www.kobo.com/us

https://world101.cfr.org/global-era-issues/monetary-policy-and-currencies/

Faure, A.P. (2017). Central Banking and Monetary Policy: An Introduction,

Bookbon.com.

Fajardo, Feliciano R. and Manansala, Manuel M. (2017). Business Finance.

Manila,NBS

Hansen, A. (2018). Monetary Theory & Fiscal Policy. Papamoa Press.

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Monetary Policy and Central Banking