Understanding Money and Banking

1
CHAPTER 19

• Understanding Money and Banking

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What Is Money?

• Characteristics of Money
• Portable
• Divisible
• Durable
• Stable

• The Functions of Money
• Medium of Exchange
• Store of Value
• Unit of Account

3
The Spendable Money Supply M-1

• M-1 Measure of the money supply that includes
  only the most liquid (spendable) forms of money
• Currency Government-issued paper money and metal
  coins
• Check Demand deposit order instructing a bank to
  pay a given sum to a specified payee
• Demand Deposit Bank account funds that may be
  withdrawn at any time

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M-1 plus the Convertible Money Supply M-2

• M-2 Measure of the money supply that includes
  all the components of M-1 plus the forms of money
  that can be easily converted into spendable form
• Time Deposit Bank funds that cannot be withdrawn
  without notice or transferred by check
• Money Market Mutual Fund Fund of short-term,
  low-risk financial securities purchased with the
  assets of investor-owners pooled by a nonbank
  institution
• Savings Deposits
• Credit Cards

5
The U.S. Financial System

• Many forms of money, especially demand deposits
  and time deposits, depend on the existence of
  financial institutions to provide a broad
  spectrum of services to both individuals and
  businesses.

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• The only way banks can compete is to transform
  themselves into successful retailers of financial
  services, which involves dramatic, not
  incremental changes.
• Thomas Brown
• Banking Analyst

19 - 6
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Financial Institutions

• Commercial Bank Federal- or state-chartered
  financial institution accepting deposits that it
  uses to make loans and earn profits

State Bank Commercial bank chartered by an
individual state

• National Bank Commercial bank chartered by the
  federal government
• Diversification Mergers
• Commercial Interest Rates

Prime Rate Interest rate available to a banks
most creditworthy customers
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Financial Institutions

• Savings and Loan Association (SL)
• Financial institution accepting deposits and
  making loans primarily for home mortgages These
  are getting harder to find
• Mutual Savings Bank
• Financial institution whose depositors are owners
  sharing in its profits
• Credit Union
• Financial institution that accepts deposits from,
  and makes loans to, only its members, usually
  employees of a particular organization

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Nondeposit Institution

• Pension Fund
• Nondeposit pool of funds managed to provide
  retirement income for its members
• Insurance Company
• Nondeposit institution that invests funds
  collected as premiums charged for insurance
  coverage
• Finance Company
• Nondeposit institution that specializes in making
  loans to businesses and consumers
• Securities Investment Dealer (broker)
• Nondeposit institution that buys and sells stocks
  and bonds both for investors and for its own
  accounts

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Special Financial Services

• Pension Services
• Individual Retirement Account (IRA) Tax-deferred
  pension fund with which wage earners supplement
  other retirement funds
• Keogh Plan Tax-deferred pension plan for the
  self-employed
• Trust Services Bank management of an
  individuals investments, payments, or estate

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Special Financial Services

• International Services
• Currency Exchange
• Letter of Credit Bank promise, issued for a
  buyer, to pay a designated firm a certain amount
  of money if specified conditions are met
• Bankers Acceptance Bank promise, issued for a
  buyer, to pay a designated firm a specified
  amount at a future date
• Financial Advice Brokerage Services

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Special Financial Services

• Automated Teller Machine (ATM)
• Electronic machine that allows customers to
  conduct account-related activities 24 hours a
  day, 7 days a week
• Electronic Funds Transfer (EFT)
• Communication of fund-transfer information over
  wire, cable, or microwave

13
Banks as Creators of Money

• By taking in deposits and making loans, banks
  expand the money supply.

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How Banks Create Money
100.00 10.00 90.00 190.00
90.00 9.00 81.00 271.00
81.00 8.10 72.90 343.90
72.90 7.29 65.61 409.51
65.61 6.56 59.05 468.56
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Regulation of Commercial Banking

• Federal Deposit Insurance Corporation (FDIC)
• Federal agency that guarantees the safety of all
  deposits up to 100,000 in the financial
  institutions that it insures

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The Federal Reserve System

• The Fed is the Central bank of the United
  States, which acts as the governments bank,
  serves member commercial banks, and controls the
  nations money supply

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The Structure of the Fed

• The Board of Governors
• Reserve Banks
• Member Banks

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The Functions of the Fed

• The Governments Bank
• The Bankers Bank
• Check Clearing

Float Total amount of checks written but not yet
cleared through the Federal Reserve
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The Functions of the Fed

• Overseeing the Banking Community
• Controlling the Money Supply

Monetary Policy  Policies by which the Federal
Reserve manages the nations money supply and
interest rates
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The Tools of the Fed

• Reserve Requirement 
• Percentage of its deposits that a bank must hold
  in cash or on deposit with the Federal Reserve
• Discount Rate 
• Interest rate at which member banks can borrow
  money from the Federal Reserve
• Open-Market Operations 
• The Federal Reserves sales and purchases of
  securities in the open market
• Selective Credit Controls 
• Federal Reserve authority to set both margin
  requirements for consumer stock purchases and
  credit rules for other consumer purchases

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The Changing Money Banking System

• Deregulation
• The Depository Institutions Deregulation and
  Monetary Control Act (DIDMCA) of 1980 brought
  many changes to the banking industry.
• Interstate Banking
• The Interstate Banking Efficiency Act of
  September 1994 allowed banks to gradually enter
  into interstate banking.

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The Impact of Electronic Technologies

• Debit Card Plastic card that allows an
  individual to transfer money between accounts
• Point-of-Sale (POS) Terminal Electronic device
  that allows customers to pay for retail purchases
  with debit cards
• Smart Card Credit-card-size computer programmed
  with electronic money
• E-Cash Electronic money that moves among
  consumers and businesses via digital electronic
  transmissions

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International Banking Finance

• International Banking at U.S. Banks
• Exchange Rates and International Trade

The Law of One Price the principle that
identical products should sell for the same price
in all countries.

• Government Influences on Exchange Rates

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The International Payment Process
19 - 24
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International Bank Structure

• There is no worldwide banking system that is
  comparable, in terms of policy-making and
  regulatory power, to the system of any
  industrialized nation. Rather, worldwide banking
  stability relies on a loose structure of
  agreements among individual countries or groups
  of countries.

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The World Bank and the IMF

• World Bank (technically the International Bank
  for Reconstruction and Development) provides only
  a very limited scope of services.
• The International Monetary Fund (IMF) a group of
  some 150 nations that have combined resources to
• promote the stability of exchange rates
• provide temporary, short-term loans to member
  countries
• encourage members to cooperate on international
  monetary issues
• encourage development of a system for
  international payments