Chapter 8: How Banks Work
Bank: financial intermediary that accept deposits from savers and makes loans to
efficient at matching savers with borrower because banks are good at 1. Pooling funds
and 2. Gathering info about borrowers
saves time, and transaction costs
Asymmetric information: when one party knows more than another.
causes 2 problems:
1. Adverse Selection: when people or firms that are worse than avg. are more likely
to seek a loan.(bad borrowers are more likely to seek out a loan than good
2. Moral hazard: the existence of a contract such as a loan changes behavior of
individuals for the worse.
banks require collateral: an asset the borrower promises to give to the bank if that
have borrower maintain a certain net worth
covenant: legally enforced part of a loan that requires borrower to ask in a certain way
How do banks earn profits
Assets= Liabilities + Equity Capital
reserves: banks vault cash and its deposits at the Fed reserve
securities: debt securities
loans(most of profits come from here)
transaction deposits: funds in checking accounts of various types, some of which pay
interest and some of which do not.
nontransaction deposits: savings deposits, CD’s, MMDAs