Regulation of Financial Institutions - Business Finance - ثاني ثانوي

Link to digitat lessen 2.3 Regulation of Financial Institutions OXO www.ren.edu.sa Key Terms Required reserves Excess reserves Correspondent bank Secondary reserves Commercial banks and other savings banks are subject to government regulation, whose purpose is to protect the banks' creditors, especially their depositors. The very nature of banking implies that when a commercial bank fails, substantial losses could be sustained by the bank's depositors. This is exactly what occurred during the Great Depression of the 1930s, which originated in the United States, when the failure of many commercial banks imposed substantial losses on depositors. These losses led to increased regulation of commercial banks and the establishment of deposit insurance, both of which are designed to protect depositors. Such protection promotes a viable banking system and eases the flow of savings into investment. In Saudi Arabia, both commercial and development banks are regulated by the Saudi Central Bank (SAMA), which was established in 1952. SAMA fulfills a range of important functions such as regulating and supervising the financial sectors and banking operations, issuing currency, and managing the country's monetary policy. Rejured reserves Funds that banks must hold against their deposit liabilities 2.3a Reserves Commercial banks and all other depository institutions (savings and loan. associations, mutual savings banks, and credit unions) must keep funds in reserve against their deposit liabilities (that is, required reserves). The minimum amount that all banks must maintain as a reserve is determined by the Saudi Central Bank (SAMA). While holding reserves against deposit liabilities may increase the safety of the deposits, such safety is not the prime reason for having reserve requirements. The reserve requirement is one of the tools of monetary control. This element of control, not safety, is the reason for having a reserve requirement against the deposit liabilities of banks. 70 Business Finance .

The amount of the reserve requirement varies with the type of account. For example, according to the Saudi Central Bank, the reserve requirement on saving deposits is 4% (as of May 2008), and the reserve requirement on demand deposits is 7% (as of November 2008). Commercial banks may hold their reserves in two forms: (1) cash in the vault or (2) deposits with another bank, especially the Saudi Central Bank. If the bank's reserve requirement is 7% for demand deposits and the bank receives SAR 100 cash in a checking account, it must hold SAR 7 in reserve against the new demand deposit. The entire SAR 100 in cash is considered part of the bank's total reserves, but the bank must hold only SAR 7 against the deposit liability. The bank may choose to hold a small proportion of the required reserves in cash in the vault (to meet cash withdrawals) and the remainder in the Saudi Central Bank. The remaining SAR 93 are funds that the bank does not have to hold in reserve. In this example, these excess reserves (the difference between the bank's total reserves and its required reserves) total SAR 100-SAR 7=SAR 93. A commercial bank's excess reserves may be lent to borrowers or used for some other purpose, such as purchasing government securities. If a commercial bank does not have any excess reserves, it is said to be "fully loaned up." To acquire additional income-earning assets, such as a government security or a business loan, the bank would have to acquire additional excess reserves. Commercial banks (and other depository institutions) may deposit their reserves in the Saudi Central Bank, or they may deposit their reserves in other banks called correspondent banks. Correspondent banks in many cases are large, metropolitan commercial banks, such as Saudi National Bank, which fulfills this role for over 900 banks across the globe. These large correspondent banks frequently provide additional services. For example, they have efficient mechanisms for clearing checks that facilitate check clearing for smaller banks. The correspondent banks also have research staffs and give management advice and investment counsel. Thus, they are important to the well-being of the small, local banks. Of course, the correspondent banks are willing to provide these services because a small bank's deposits are like any other deposits: they are a source of funds that the larger banks may use. The large commercial banks use the funds deposited in them by small banks to purchase income earning assets. EXCESS (EXEIVES The amount of funds a bank bolds invaddition to the amount of funds it is required to hold Conspundent bank A financial institution which performs services for one or more other financial institutions and often serves as a point of liaison between clomestic and international financial institutions وزارة التعليم CHAPTLH 2 The Role of Financial Markets and Financial Intermediaries 71

Secondrys Short term secunties held by banks to Increase their liquidity In addition to the required reserves, commercial banks also hold secondary resorvos. These are high-quality, short-term marketable securities such as government securities that may be readily sold. Thus, short-term marketable securities offer a bank both a source of interest income and a means to obtain funds quickly to cover a shortage in its reserves. The importance of reserves and reserve requirements cannot be exaggerated. The commercial banking system, through the process of loan creation, can expand or contract a nation's supply of money. The ability of commercial banks and other depository institutions to lend depends on their excess reserves. Thus, anything that affects their reserves alters their ability to lend and create money and credit. Many financial transactions affect commercial banks' reserves, including the government's methods of financing a deficit or the operations of the Saudi Central Bank. While commercial banks are required to have sufficient reserves necessary to fulfill their obligations, central banks of individual countries also hold national reserves. Figure 2.11 lists the Saudi Central Bank's official reserves assets in March 2022. FIGURE 2.31 The Saudi Central Bank's official reserves assets i Mard 2022 in illiun Riyal) Dificul Reserves Assets Munetary Yank SDRs special Drawing is ints IMF Untemational Monetary Fund Reserve Position Toreign Cupancy, Reserves usiness Finance Enter Reserve Assets 1,502,599 1,021 19,946 14,348 1.396,68Z D Source: Saudi Central Bank https://www.sama.gov.salen-US/Indices/Pages/reserve assets.aspx (published 5/5/20221

Exercises Choose the correct answer. 1. Funds kept in reserve against a commercial bank's deposit liabilities are called required reserves. True/False 2. A commercial bank is not allowed to use excess reserves to lend to borrowers. True/False 3. In Saudi Arabia. both commercial and development banks are regulated by the: a. Saudi Central Bank. b. Public Investment Fund. c. Saudi Commercial Bank Management Association. d. Ministry of Finance. وزارة التصليدر " CHAPTLH 2 The Role of Financial Markets and Financial Intermediaries 73