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Chapter 2 Banking in the New Cyberworld PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Fundamental Issues 1. What is the difference between stored-value cards and smart cards? 2. Is digital cash less secure than physical cash? 3. What are the rationales for regulating cyberbanking? 4. Does e-money matter for monetary policy? Copyright © 2004 South-Western. All rights reserved. 2–2 Stored-Value and Debit-Card Systems • Closed stored-value system: An e-money system in which consumers use cards containing prestored funds to buy specific goods and services offered by a single issuer of the cards. • Open stored-value system: An e-money system in which consumers buy goods and services using cards containing prestored funds that are offered by multiple card issuers and accepted by multiple retailers. Copyright © 2004 South-Western. All rights reserved. 2–3 Card Systems (cont’d) • Debit card: A plastic card that allows the bearer to transfer funds to a merchant’s account, provided that the bearer authorizes the transfer by providing personal identification. Copyright © 2004 South-Western. All rights reserved. 2–4 A Debit-Card System Figure 2–1 Copyright © 2004 South-Western. All rights reserved. 2–5 Smart Cards • Smart card: A card containing a microprocessor that permits storage of funds via security programming, that can communicate with other computers, and that does not require online authorization for funds transfer to occur. • Open smart-card system: An e-money system in which consumers use smart cards with embedded microprocessors, which may be issued by a number of institutions, to purchase goods and services offered by multiple retailers. Copyright © 2004 South-Western. All rights reserved. 2–6 Digital Cash • Digital cash: Funds contained on computer software, in the form of secure algorithms, that is stored on microchips and other computer devices. • Payment intermediary: An institution that facilitates the transfer of funds between buyer and seller during the course of any purchase of goods, services, or financial assets. Copyright © 2004 South-Western. All rights reserved. 2–7 Digital Encryption and Electronic Payment Security Figure 2–2 Copyright © 2004 South-Western. All rights reserved. 2–8 Digital counterfeiting The Security of Digital Cash Malfunctioning money Swiping digital cash offline and online Could e-money “catch a cold”? Copyright © 2004 South-Western. All rights reserved. 2–9 Bank Fraud: An Old Problem with a New Face • Banknotes: Privately issued paper currency. • Free-banking laws: Laws in force in many U.S. states between 1837 and 1861 that allowed anyone to obtain a charter authorizing banking operations. Copyright © 2004 South-Western. All rights reserved. 2–10 States with Free-Banking Laws, 1837–1860 aMichigan prohibited free banking in 1840 and allowed it again in 1857. bAccording to Rockoff, very little free banking was done under the laws in these states. SOURCE: Reprinted from A.J.Rolnick and W.E.Weber, “Inherent Instability in Banking: The Free Banking Experience,” Cato Journal 5 (Winter 1986). Their source was Hugh Rockoff, The Free Banking Era: A Re-Examination (New York: Arno Press,1975). Copyright © 2004 South-Western. All rights reserved. Table 2–2 2–11 Bank Regulation Goals • Maintaining depository institution liquidity. Illiquidity: A situation in which a banking institution lacks the cash assets required to meet requests for depositor withdrawals. • Assuring bank solvency by limiting failures. Insolvency: A situation in which the value of a bank’s assets falls below the value of its liabilities. • Promoting an efficient financial system. • Protecting consumers. Copyright © 2004 South-Western. All rights reserved. 2–12 The Composition of the Quantity of Money in 1861 Figure 2–3 The Composition of the Quantity of Money in 1866 SOURCE: Richard H.Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago:University of Chicago Press,1993). Copyright © 2004 South-Western. All rights reserved. Figure 2–4 2–13 Notes and Deposits at State and National Banks, 1860–1868 SOURCE: Richard H.Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago:University of Chicago Press,1993). Copyright © 2004 South-Western. All rights reserved. Figure 2–5 2–14 Total U.S.Debit-Card Transactions SOURCE: : Bank for International Settlements and authors’ estimates. Copyright © 2004 South-Western. All rights reserved. Figure 2–6 2–15