Download The Federal Reserve System (cont`d)

Chapter
Nineteen
Understanding
Money, Banking, and
Credit
Learning Objectives
1. Identify the functions and characteristics of
money.
2. Summarize how the Federal Reserve
System regulates the money supply.
3. Describe the organizations involved in the
banking industry.
4. Identify the services provided by financial
institutions.
5. Understand how financial institutions are
changing to meet the needs of domestic and
international customers.
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Learning Objectives (cont’d)
6. Explain how deposit insurance protects
customers.
7. Discuss the importance of credit and credit
management.
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What Is Money?
• Barter system
– A system of exchange in
which goods or services
are traded directly for
other goods or services
• Money
– Anything a society uses to
purchase products,
services, or resources
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The Functions of Money
• Medium of exchange
– Anything accepted as payment for
products, services, and resources
• Measure of value
– A single standard or “yardstick” used to
assign values to, and compare the
values of, products, services, and
resources
• Store of value
– A means of retaining and accumulating
wealth
– The Consumer Price Index measures
the effects of inflation
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The Consumer Price Index and the Purchasing Power of the
Consumer Dollar (Base Period 1982–1984 = 100)
Source: U.S. Bureau of Labor Statistics website, www.bls.gov, January 6, 2003.
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The Consumer Price Index and the Purchasing Power of the
Consumer Dollar (Base Period 1982–1984 = 100)
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Important Characteristics of Money
•
•
•
•
•
Divisibility
Portability
Stability
Durability
Difficulty of counterfeiting
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The Supply of Money: M1 and M2
• Demand deposit
– An amount on deposit in a checking account
• Time deposit
– An amount on deposit in an interest-bearing savings
account
• Three main measures of the supply of money
– M1
• Currency, demand deposits, and travelers checks
– M2
• M1 plus savings accounts, certain money-market
securities and small-denomination time deposits or
certificates of deposit (CDs) of less than $100,000
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The Supply of Money
Source: The Federal Reserve website, www.federalreserve.gov, December 15, 2005.
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The Federal Reserve System
• The central bank of the United States responsible for
regulating the banking industry
– Controlled by a 7-member board of governors who are
appointed by the president and confirmed by the
Senate to serve 14-year terms
– Composed of 12 district banks and 25 branch banks
– District banks are owned by commercial banks that are
members of the Federal Reserve system
– Main function is to regulate the nation’s money supply
by controlling bank reserves requirements, regulating
the discount rate, and running open-market operations
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Federal Reserve System
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The Federal Reserve System (cont’d)
• Regulation of reserve
requirements
– Reserve requirement—the
percentage of its deposits a bank
must retain, either in its own
vault or on deposit with its
Federal Reserve District Bank
– More required reserves = less
money in circulation
– Less required reserves = more
money in circulation to stimulate
the economy
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The Federal Reserve System (cont’d)
• Regulation of the discount rate
– Discount rate—the interest
rate the Federal Reserve
System charges for loans to
its member banks
– Lower loan rates allow banks
to lend more
and stimulate the economy
– Higher rates slow the
economy and check inflation
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The Federal Reserve System (cont’d)
• Open-market operations
– The buying and selling of U.S. government
securities by the Federal Reserve System for
the purpose of controlling the supply of money
– To reduce the money supply, the Fed sells
government securities on the open market to
take money out of circulation
– To increase the money supply, the Fed buys
government securities
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The Federal Reserve System (cont’d)
• Other Fed responsibilities
– Serving as the U.S. government
bank
– Clearing checks and electronic
transfers of
funds between banks
– Inspection and replacement of
worn and unfit currency
– Selective credit controls
• Truth-in-Lending Act enforcement
• Stock purchase margin
requirements
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Controlling the Money Supply and the
Economy
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The American Banking Industry
• Commercial bank
– A profit-making organization that
accepts deposits, makes loans, and
provides related services to its
customers
– National bank: A commercial bank
chartered by the U.S. Comptroller of
the Currency
– State bank: A commercial bank
chartered by the banking authorities
in the state in which it operates
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Seven Largest U.S. Banks
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The American Banking Industry (cont’d)
• Other financial institutions
– Savings and loan associations (S&L)
• A financial institution that offers checking and savings
accounts and certificates of deposit and that invests most
of its assets in home-mortgage loans and other
consumer loans
– Credit unions
• A financial institution that accepts deposits from and
lends money to only those people who are its members
• Members are usually employees of a particular firm,
people in a particular profession, or those who live in a
community served by a a local credit union
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The American Banking Industry (cont’d)
• Other financial institutions
(cont’d)
–
–
–
–
–
–
Mutual savings banks
Insurance companies
Pension funds
Brokerage firms
Finance companies
Investment banking firms
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Careers in Banking
• The 7 largest banks in the U.S. employ
approx. 944,000 people
• The U.S. Department of Labor expects the
number of people employed in banking to
grow more slowly than other jobs in the
economy between now and the year 2012.
• Traits of successful bankers
–
–
–
–
Honesty
Ability to interact with people
Strong background in accounting
Appreciation for the banking-finance
relationship
– Basic computer skills
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Traditional Services Provided by
Financial Institutions
• Checking accounts
– Check—a written order for a bank or other financial institution to pay
a stated dollar amount to the business or person indicated on the
check
– NOW account—an interest-bearing checking account
• Savings accounts
– Passbook savings account
– Certificate of deposit (CD)—a document stating that a bank will pay
the depositor a guaranteed interest rate for money left on deposit for
a specified period of time
• Short- and long-term loans
– Line of credit—a short-term loan that is approved before the money
is actually needed
– Revolving credit agreement—a guaranteed line of credit
– Collateral—real estate or property pledged as security for a loan
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Traditional Services Provided by
Financial Institutions (cont’d)
• Credit card and debit card transactions
– Banks and other financial institutions
charge merchants fees (a percentage of
each credit card transaction) for
handling the transactions for the
merchant
– Banks impose monthly finance charges
on the unpaid balances (essentially, a
line of consumer credit) of cardholders
– Debit card—a card that electronically
subtracts the amount of a purchase from
the cardholder’s bank account at the
moment the purchase is made
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Typical Services Provided by Banks
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Recent Changes in the Banking Industry
• Financial Services Modernization Banking Act (1999)
– Allows banks to establish one-stop financial supermarkets
where customers can get a variety of financial services,
including banking, buying and selling securities, and
purchasing insurance
– Competition will increase and consumers will have more
choice
• Anticipated changes
– Mergers and consolidations of banks, S&Ls, credit unions,
etc.
– Globalization of banking
– Importance of customer service as a way to keep customers
– Increased use of credit and debit cards; decrease in use of
checks
– Increased competition from nonbank competitors
– Growth in online banking
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Online Banking
• Advantages
–
–
–
–
–
Convenience of electronic deposits
Ability to obtain current account balances
Convenience of transferring funds
Ability to pay bills
Convenience of seeing which checks have
cleared
– Easy access to current interest rates
– Simplified loan application procedures
– For banks—lower processing costs
• Disadvantages
– Not being able to discuss financial matters with
a personal banker
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Online Banking (cont’d)
• Electronic fund transfer (EFT)
system
– A means of performing financial
transactions through a computer
terminal or telephone hookup
– Changing how banks do business
• Automated teller machines (ATMs)
• Automated clearinghouses (ACHs)
• Point-of-sale terminals
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International Banking
• Popular methods of paying for import and
export transactions
– Letter of credit
• A legal document issued by a
bank or other financial institution
guaranteeing to pay a seller a stated amount
for a specified period of time
– Banker’s acceptance
• A written order for the bank to pay a third party
a stated amount of money on a specific date
• Currency exchange
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The FDIC, SAIF, BIF, NCUA
• Federal Deposit Insurance Corporation (FDIC)
– As a result of the Depression, to restore public confidence in
the banking industry, the FDIC was created to insure
deposits against bank failures
• FDIC reorganized into the Banking Insurance Fund (BIF) and
Savings Association Insurance Fund (SAIF)
– As a result of S&L failures
• FDIC provides deposit insurance of $100,000 per account
• All Federal Reserve System member banks must belong to the
FDIC; nonmembers and S&Ls may join if they qualify
• National Credit Union Association (NCUA)
– Insures the deposits of credit union members for up to
$100,000 per account
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How Do You Get Money from
a Bank or Lender?
• For individuals
– Shop around for low
interest rates, but you
have a better chance at
an institution where you
already have an account
– Fill out a loan application
– Describe how you will
use the money and how
you will repay it
– Prepare for an interview
– If rejected, ask the loan
officer why
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• For businesses
– Develop a relationship
with your banker
– Apply for a preapproved
line of credit or revolving
credit agreement even if
you do not need the
money
– Supply financial
statements and tax
documents
– Prepare a convincing
cover letter
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Effective Credit Management
• Credit
– Immediate purchasing power that is exchanged for a
promise to repay borrowed money, with or without
interest, at a later date.
• The five Cs of credit management
– Character—the borrower’s attitude toward credit
obligations
– Capacity—the borrower’s financial ability to meet credit
obligations
– Capital—the extent of the borrower’s assets or net
worth
– Collateral—borrower assets that can be pledged as
security for the loaned amount
– Conditions—general economic conditions that can
affect a borrower’s ability to repay the loan
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Effective Credit Management (cont’d)
• Checking credit information
– Credit information sources regarding businesses
•
•
•
•
Global credit-reporting agencies
Local credit-reporting agencies
Industry associations
Other firms that have given
the firm credit
– Credit information concerning individuals
• Experian
• Trans Union
• Equifax
– Fair Credit Reporting Act
• Consumers have a right to know what information is in their
credit bureau files
• Consumers have a right to request that information in their files
be verified, and they can file an explanation of their side of a
dispute
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Effective Credit Management (cont’d)
• Sound collection procedures
– Firm
– Fair, allowing for compromise
– Not harassing
• Techniques
–
–
–
–
Subtle reminders
Telephone calls
Personal visits
Legal action
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