Transcript Chapter Eighteen

Chapter Eighteen
Understanding Money,
Banking, and Credit
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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: The U.S. Bureau of Labor Statistics website, www.bls.gov, September 30, 2008.
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The Consumer Price Index and the Purchasing Power of the
Consumer Dollar (Base Period 1982–1984 = 100)
Source: The U.S. Bureau of Labor Statistics website, www.bls.gov, September 30, 2008.
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Important Characteristics of Money
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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
• Two 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, accessed September 30, 2008.
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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
Source: The Fortune website, www.fortune.com, accessed September 30, 2008.
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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 local credit union
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The American Banking Industry (cont’d)
• Other financial institutions
(cont’d)
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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.
1,132,000 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
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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
– More emphasis on evaluating the creditworthiness of
loan applicants as a result of the recent financial crisis
– An increase in government regulation of the industry
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Recent Changes in the Banking Industry
• Anticipated changes (continued)
– A reduction in the number of banks, S&Ls, credit unions,
and financial institutions because of consolidation and
mergers
– Globalization of the banking industry
– The importance of customer service as a way to keep
customers from switching to competitors
– Increased use of credit and debit cards and a decrease
in the number of written checks
– Continued growth in online banking
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Online Banking
• Advantages
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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 funds 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
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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
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Subtle reminders
Telephone calls
Personal visits
Legal action
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