Competency 4.02 Understand the Banking System

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Competency 4.02Understand the Banking System
4.0 Understand the Role of Finance in Business

• Objective 4.02-A
• Analyze the roles/responsibilities of the Federal
  Reserve.

http//www.federalreserveeducation.org/, go to
website, learn more about Fed, visit Richmond,
visit the bank, tour virtual money museum.
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The Federal Reserve System

• What is the Federal Reserve System?
• Why does it exist?
• Who participates?
• How is it organized?

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The Federal Reserve (The Fed)A Centralized
Banking System

• Federal Reserve Act signed into law by President
  Woodrow Wilson
• Organized by the Federal Government in 1913
• Why have The Fed ? Purpose
• To establish and maintain confidence in the US
  monetary system
• To ensure and safe, healthy and stable economy
• To supervise and regulate member banks and help
  serve the public efficiently.
• Prior to the Federal Reserve Act anyone could
  issue currency or coin money

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Who Participates in Federal Reserve?

• All National Banks are required to be part of the
  Fed
• Optional for state banks
• Divisions are called DISTRICTS
• There are 12 DISTRICTS in the United States
• Every state comes under a district
• Each Federal Reserve Bank is a corporation, owned
  by its member banks

NC is in District 5, the Richmond District.
Charlotte has a regional office.
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The Federal Reserve

• What are the two arms of The Fed?
• Board of Governors
• Represents the government (public) sector
• District Federal Reserve Banks
• Represents the business (private) sector

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Board of Governors

• Usually meet about twice a week, ordinarily on
  Mondays and Wednesdays
• Public is invited to look into the meetings of
  the Board of Governors
• Usually discuss monetary policy such as lowering
  and raising interest rates

The Board Room at the Federal Reserve in
Washington, DC
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Members of the Board of Governors

• Ben S. Bernanke, Current Chairman
• Alan Greenspan, Retired Chairman  
• Chairman is appointed by President and confirmed
  by Senate
• Similar to procedure for Supreme Court Justices

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Purpose of Federal Reserve

• Established to supervise and regulate banks
• Known as the Banks bank
• The central bank of the United States
• Assists banks with serving the public more
  efficiently
• All national banks are required to join the
  Federal Reserve System
• State banks have the option of joining the system

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The Federal Reserve System Services

1. Supervision of banks
2. Agent for the federal government
3. Regulates monetary policy
4. Lends money to member banks
5. Acting as a clearinghouse
6. Participation in open market activities
7. Sets loan limits standards
8. Supplies currency

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1. Fed Supervision Set Reserve Requirements

• Member banks are required to keep a certain
  percentage (10 for many years) of all deposits
  in the banks vault or on deposit with the
  district federal reserve bank
• Reserves funds set aside for emergencies
• Example a rush of withdrawals by customers
• Purpose to reduce risk of bank panics and
  protect depositors money

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1. Fed Supervision Audits Member Banks

• Inspects banks by auditing financial records
• Audit -an inspection of records to verify the
• 1. accuracy of books (records) of the bank
• 2. bank is complying with banking laws
• Similar to Individuals/corporations who are
  audited by the IRS to review the accuracy of a
  tax return.

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1. FED Supervision Approves Bank Mergers

• Q Why do banks merge?
• To be more competitive
• -to offer customers more locations (local,
  regional, national, international)
• -to offer a variety of services more efficiently
• -to compete with a growing array of other
  financial service companies such as
• money market and other mutual funds
• mortgage companies
• credit unions and
• credit arms of industrial firms (General
  Electric and Ford Motor)
• Here are some recent bank mergers approved by
  The Fed in 2007-2008
• Bank of New York bought Mellon Financial
  Corporation for 18.3 Billion
• JPMorgan Chase bought Bear Stearns for 1.1
  Billion
• Bank of America bought Merrill Lynch Bank of
  America for 50 Billion
• Wells Fargo bought Wachovia for 15.1 Billion

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2. Fed Acts as Agent for Federal Government

• The Fed holds a checking account for the US
  Treasury
• Disburses social security benefits and other
  transfer payments using the direct deposit system
  
• Accepts some types of federal tax money
• Example Federal tax depositories
• Payroll taxes - federal income tax, FUTA, and
  social security taxes are deposited using federal
  deposit coupon into a national bank

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3. FED Regulates Monetary Policy

• What is Monetary Policy? When the Federal
  Reserve influences money and credit conditions in
  the economy to achieve economic goals
• How? The Fed determines amount of money in
  circulation and available for loans, then either
  increases or decreases to stabilize/stimulate the
  economy
• Tight money- policy when less money is available
  at higher interest rates, slows (stabilizes)
  economy
• Loose money- policy when more money is available
  at lower interest rates, increases (stimulates)
  economy

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4. FED Lends Money to Member Banks

• Monitors the discount rate of interest - rate
  used by the Fed to loan money to member banks
• Compare banks to intermediaries (go-betweens)
  trading in money at wholesale prices
• The Fed changing interest rates affect borrowers
  (member banks) who pass rates to consumers
• Raising rate - discourages borrowing
• Reducing rate - encourages borrowing
• Note the Federal Reserve does not loan money to
  individuals or businesses (only member banks)
  HOWEVER, rates the Fed charges member banks
  trickle down and affect the interest rates for
  consumers

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5. FED Acts as Clearing House

• Clears/Processes/Settles checks for member banks
• Federal Reserve uses the Automated Clearing House
  (ACH) to electronically complete fund transfers
  (check settlements) between banks
• Interdistrict Settlement Fund in Washington, DC
  used for between district transfers
• Checks/deposit slips have MICR coding
• Magnetic Ink Character Recognition
• Scanners read MICR on checks to electronically
  process data accurately and rapidly through the
  ACH and Interdistrict Settlement Fund

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6. FED Participates in Open Market

• Participates in open market operations by buying
  and selling government securities
• Q What are government securities?
• A Treasury bills and bonds loans to government
  in various denominations (amounts) and for
  various time periods
• Advantages and Disadvantages
• offer a fixed rate of interest over a fixed
  period of time
• attractive because not subject to income taxes
• - cannot be easily transferred and are
  non-negotiable

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Open Market Operations

• Government securities are sold at a discount
  (from face value), but are redeemed (cashed in)
  for face value on the maturity (due) date
• Examples
• Purchase treasury note for 7500 (discount
  price), redeem at maturity date for 10,000 (face
  value)
• Purchase Series EE savings bond for 25, redeem
  in 7 years at maturity for 50

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Government Securities

• Savings bonds - Example Series EE-
• Denomination minimum 25
• Payable after 6 months
• Earns interest up to 30 years
• Short-term obligation of the U.S. Treasury
  Treasury bill maturity in one year or less
• Issued to mature in 13 weeks, 26 weeks, 52 weeks
• Long-term obligation of the U.S. Treasury
• Treasury note maturity at 1 to 10 years,
  minimum 1000
• Treasury bond - maturity at 10 years

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Open Market Operations

• Bank discount rates encourages borrowing by
  member banks, and therefore encourages borrowing
  by consumers
• Purpose of open market operations
• Regulate money supply
• Most frequent method of controlling the economy
• Who controls open market operations?
• Federal Open Market Committee (FOMC)-
• A committee within the Federal Reserve

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7. The FED Sets Lending Standards

• Sets standards for consumer legislation dealing
  with lending and credit
• Sets limits for loans and investments by member
  banks
• News Federal Reserve revised bank lending rules
  since banking crisis
• Ex Lower of total loans for land/acreage

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8. The Fed Supplies Currency

• Money defined
• a medium of exchange for value
• US money currency and coins
• Federal Reserve supplies paper currency
• Legal Tender for all debts, public and private
• Paper currency supplied is Federal Reserve
  Notes
• Printing currency (paper money, bills)
• Bureau of Printing and Engraving
• Counterfeiting - federal crime
• Coinage
• Minting supplied and regulated by the Department
  of Treasury, US Mint