Transcript The Federal Reserve System (cont`d)

Chapter Nineteen
Understanding
Money, Banking,
and Credit
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 Supply of Money: M1, M2, and M3
• 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 certain money-market securities and smalldenomination time deposits or certificates of deposit of
less than $100,000
– M3
• M1 and M2 supplies of money plus time deposits or
certificates of deposit of $100,000 or more
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The Supply of Money
Source: The Federal Reserve website, www.federalreserve.gov, January 8, 2003.
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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 openmarket operations
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Federal Reserve System
Source: Federal Reserve Bulletin, May 2002, pp. A84-86.
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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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Clearing a
Check Through
the Federal
Reserve System
Source: Federal Reserve Bank of New York, The
Story of Checks, 7th ed. New York, 1995, p. 11.
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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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The American Banking Industry (cont’d)
• Other financial institutions
– Savings and loan association (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 union
• 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)
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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. 620,000 people
• The U.S. Department of Labor expects the
number of people employed in banking to
decrease by 2% by 2010
• 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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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
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Mergers and consolidations of banks, S&Ls, credit unions, etc.
Fewer bank branch offices
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
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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 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
• 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 (1971)
• 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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