ECON 1009

INTERNATIONAL FINANCIAL INSTITUTIONS AND

MARKETS 2021
Tutorial Two/Week Three

Short Tutorial Questions (one to two sentence answers)

1) What does a balance sheet record? A Balance sheet is basically a statement of

financial position as it shows assets and liabilities and therefore net worth at a single point
in time

2) If the value of assets goes up and the value of liabilities goes down, what happens
to net worth?

net worth would increase

3) If you take on new debts to pay for your spending on goods and services, what
happens to your level of liabilities? Your net worth?

this means its assets are worth less than its liabilities. Secondly, a bank may become
insolvent if it cannot pay its debts as they fall due, even though its assets may be
worth more than its liabilities. This is known as cash flow insolvency, or a 'lack of
liquidity'.

4) True or false: If I lack the income to repay my debts, and I have negative net worth, I
will be insolvent. Explain your answer.

True, if they are unable to pay their debts and for instance they lost their job then they
are like to face insolvency

5) What happens to the balance sheet of a central bank when it (i) lends to a commercial
bank;

Reserves move one becomes credited and the other becomes debited

Asset and liability increase

(ii) when the commercial bank uses its reserves to repay that loan;

Asset and Liabilties Both decrease

(iii) when the commercial bank pays interest on such a loan?

Assets don’t change, funds are debited from the ESA’s account

= Net Worth increases

6) Why is it not possible for the Reserve Bank of Australia to be insolvent?

•Central banks cannot run out of their own currency, and cannot therefore be insolvent

Material for Group Discussion

‘The State, therefore, comes in first of all as the authority of law which enforces the
payment of the thing which corresponds to the name or description in the contract.
But it comes double when, in addition, it claims the right to determine and declare
what thing corresponds to the name, and to vary its declaration from time to time –
when, that is to say it claims the right to re-edit the dictionary. This right is claimed by
all modern states and has been so claimed for some four thousand years at least.’

(John Maynard Keynes, A Treatise on Money (1930))

On 8 November 2016, the Government of India announced they were soon to

withdraw legal tender status from bank notes making up the majority of all the
currency in circulation in India.
The purpose was to take action against illegal and untaxed economic activity,
eliminating counterfeit notes and forcing people to pay money into the bank system,
so that the authorities could detect tax evasion.

This was a controversial decision, and its full consequences are not yet known. It
created difficulties for low income people living in rural areas, without easy access to
the banking system, where the old notes could be deposited or exchanged for new
cash.

One forecast which appears to have been proved wrong is that significant sums of
the old notes would not be paid into bank deposits or converted into new currency. It
appears that well over 90% of those notes being withdrawn were paid in, or
exchanged for new currency.

However, some of the old notes – perhaps 500bn rupees, or US$ 7bn – were not paid
into the central bank. These notes still exist in physical form, but are now worthless
as anything except curiosities and future collectors’ items.

You no longer have the right to use them to redeem your debts, as they are not legal
tender, and they can no longer be used to pay taxes, or to make other payments to
 the Indian Government or Reserve Bank of India.

1) The notes are still ‘promissory notes’ of the Reserve Bank of India. How can the
Reserve Bank (India’s central bank) simply cancel this promise to pay?

They are the currency issuer, so they can decide if or not to use currency

2) Why is this former money no longer accepted as having value in exchange in

India?

Because its identified as tax evasion money

3) What will have happened to the balance sheet and net worth of the Reserve Bank
of India as a consequence of 500bn worth of rupees being cancelled?

Liabilities decrease therefore net worth increases

4) Suppose the Reserve Bank of India then ‘pays out’ the 500bn rupees to the Indian
Government as a dividend. What has happened to the balance sheet and net
worth of the Reserve Bank? The balance sheet and net worth of the Indian
Government?

Government balance increase (liabilities), this would also decrease net worth

Asset and net worth increases

5) It was a purpose of the so-called ‘demonetization’ to identify tax evasion and

thereby reduce the Indian Government’s budget deficit (or fiscal deficit). Suppose
no tax evasion had been detected, but some currency had been cancelled. What
would have happened to the Indian Government’s fiscal deficit?

Liabilities increase, therefore fiscal deficit

increases

Sources

Economist Magazine 2017 ‘Many rupee returns. The high cost of India’s demonetisation’, Print
edition, January 7th, 2017

http://www.economist.com/news/finance-and-economics/21713842-benefits-withdrawing-86-rupees-circulation-
remain elusive

Keynes, J.M 1930 A Treatise on Money, MacMillan, London.