Chapter 20 Money, Financial Institutions, and the Federal Reserve McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Twenty LEARNING GOALS 1. Explain what money is and what makes money useful. 2. Describe how the Federal Reserve controls the money supply. 3. Trace the history of banking and the Federal Reserve System. 4. Classify the various institutions in the U.S. banking system. 20-2 Chapter Twenty LEARNING GOALS 5. Briefly trace the causes of the banking crisis starting in 2008 and explain how the government protects your funds during such crises. 6. Describe how technology helps make banking more efficient. 7. Evaluate the role and importance of international banking, the World Bank, and the International Monetary Fund. 20-3 Profile BEN BERNANKE Federal Reserve • Bernanke is a former Princeton economics professor. • Former President George W. Bush appointed Bernanke Chairman of the Federal Reserve in 2006. • Almost every factor related to the economy is influenced by the decisions he makes. 20-4 What is Money? WHAT’S MONEY? LG1 • Money -- Anything people generally accept as payment for goods and services. • Barter -- The direct trading of goods or services for other goods or services. 20-5 What is Money? LG1 STANDARDS for a USEFUL FORM of MONEY • Portability • Divisibility • Stability • Durability • Uniqueness 20-6 What is the Money Supply? The MONEY SUPPLY LG2 • Money Supply -- The amount of money the Federal Reserve makes available for people. The money supply is referred to as: - M1 -- Money that can be accessed quickly (coins, paper money, travelers’ checks, etc.). - M2 -- M1 + money that may take a little time to obtain (savings accounts, mutual funds, etc.). - M3 -- M2 + big deposits like institutional money market funds. 20-7 What is the Money Supply? LG2 MONEY FACTS What You Might Not Know About What’s in Your Wallet • In 2009, the U.S. printed 26,000,000 bills a day! • Each penny costs 1.6¢ and each nickel costs 6¢ to make. • The most-tracked bill on WheresGeorge.com has travelled over 7,600 miles in 4 years! • 2/3 of all U.S. $100 bills are outside the U.S. • 90% of paper money has traces of cocaine! Source: Fast Company, February 2011. 20-8 The Global Exchange of Money EXCHANGING MONEY GLOBALLY LG2 • Falling dollar value: The amount of goods and services you can buy with a dollar decreases. • Rising dollar value: The amount of goods and services you can buy with a dollar increases. • What makes the dollar fall or rise is the position of the U.S. economy relative to other global economies. 20-9 The Global Exchange of Money LG2 The IMPACT of a FALLING DOLLAR • Overseas demand for U.S. products rise. • A favorable exchange rate for U.S. companies increases profits in foreign markets. • U.S. tourism increases which is good for hotels, resorts, theme parks, and retailers that serve international travelers. 20-10 Basics About the Federal Reserve LG2 FIVE MAJOR PARTS of the FEDERAL RESERVE SYSTEM 1. The Board of Governors 2. The Federal Open Market Committee 3. 12 Federal Reserve Banks 4. 3 Advisory Councils 5. The member banks of the system 20-11 Basics About the Federal Reserve MANAGING the MONEY SUPPLY LG2 • The Fed uses three basic tools: 1. Reserve Requirement -- A percentage of commercial banks’ checking and savings accounts they must keep in the bank or in non-interest-bearing deposits at the local Federal Reserve district bank. 2. Open-Market Operations -- The buying and selling of government bonds. 3. Discount Rate -- The interest rate the Fed charges for loans to member banks. 20-12 The Federal Reserve’s CheckClearing Role LG2 CHECK-CLEARING PROCESS THROUGH the FEDERAL RESERVE 20-13 The History of Banking and the Need for the Fed LG3 The ESTABLISHMENT of the FEDERAL RESERVE SYSTEM • A cash shortage problem in 1907 led to the creation of the Federal Reserve System. • Under the Federal Reserve Act of 1913, all federally chartered banks had to join the Federal Reserve. 20-14 The History of Banking and the Need for the Fed LARGEST BANK FAILURES LG3 Bank Year Assets Washington Mutual Bank 2008 $307 Billion Continental Illinois NB&T 1984 $67 Billion First Republic Bank Corp 1986 $49 Billion American Savings & Loan Assn 1988 $45 Billion IndyMac Bank 2008 $32 Billion Colonial Bank 2009 $25 Billion Source: http://www.FDIC.gov, accessed July 2011. 20-15 The U.S. Banking System The U.S. BANKING SYSTEM LG4 • Commercial banks • Savings and loan associations • Credit unions • Nonbanks 20-16 Commercial Banks COMMERCIAL BANKS LG4 • Commercial Bank -- A profit-seeking organization that receives deposits from individuals and corporations in the form of checking and savings accounts and uses those funds to make loans. • A commercial bank has two types of customers: 1. Depositors 2. Borrowers 20-17 Services Provided by Commercial Banks LG4 COMMERICAL BANKS’ SERVICES • Demand Deposit -- The technical name for a checking account; money is available on demand from the depositor. • Time Deposit -- A savings account; a bank can require a prior notice before you make a withdrawal. • Certificate of Deposit -- A savings account that earns interest, to be delivered on the certificate’s maturity date. 20-18 BANKING on SOCIAL MEDIA (Social Media in Business) • Banks are using the Internet and social media to communicate with Gen Y customers. • Today 29 million Bank of America customers use online banking. • 6.5 million customers use smartphones for mobile banking. • Banks are following other companies leads and embracing social media. 20-19 WHAT to TELL the TELLER (Making Ethical Decisions) • The bank teller mistakenly gives you $320 instead of the $300 you asked for. • You bring the error to her attention, but she disagrees she miscounted the money. • You wonder whether to just keep the extra $20 even though you know her accounts will not balance at the end of the day. • What are your alternatives? What do you do? 20-20 Savings and Loan Associations LG4 SAVINGS and LOAN ASSOCIATIONS • Savings and Loan Associations (S&Ls) -- A financial institution that accepts both savings and checking deposits and provides home mortgage loans. • Often known as thrift institutions because their original purpose was to promote customer thrift and home ownership. 20-21 Credit Unions CREDIT UNIONS LG4 • Credit Unions -Nonprofit, member-owned financial cooperatives that offer the full variety of banking services to their members. • As nonprofits, credit unions enjoy an exemption from federal income taxes. 20-22 Other Financial Institutions NONBANKS LG4 • Nonbanks -- Financial institutions that accept no deposits, but offer many of the services provided by regular banks. Nonbanks include: - Life insurance companies - Pension funds - Brokerage firms - Commercial finance companies - Corporate financial services 20-23 The RISE of the NONBANK (Spotlight on Small Business) • About ¼ of American households don’t have a bank account. • Mango Store is a bank-like facility in Austin, Texas. Clients pay a one-time $10 fee that lets them cash as many checks as they want by putting the money onto debit cards. • Mango hopes its customers will increase their earning power and remain customers over time. 20-24 Other Financial Institutions LG4 WHAT ATTRACTS CUSTOMERS to ONLINE BANKING • Free identity theft protection • Free credit score monitoring • Personal financial management • Instant messaging service • Bank’s blog Source: comScore, www.comscore.com, accessed September 2010. 20-25 Protecting Your Funds LG5 PROTECTING DEPOSITORS’ MONEY • The Federal Deposit Insurance Corporation (FDIC) -- An independent agency of the U.S. government that insures bank deposits up to $250,000. • The Savings Association Insurance Fund (SAIF) -- Insures holders of accounts in savings and loan associations. • The National Credit Union Administration (NCUA) -- Provides up to $250,000 coverage per individual depositor per institution. 20-26 Using Technology to Make Banking More Efficient LG6 TECHNOLOGICAL ADVANCEMENTS in BANKING • Electronic Funds Transfer System - Messages about a transaction are sent from one computer to another so funds can be transferred quickly and more economically. • Debit Card -- Serves the same function as a check; it withdrawals funds from a checking account. • Smart Card -- A combination of a credit card, debit card, phone card, driver’s license, and more. 20-27 International Banking and Banking Services LG7 MAKING TRANSACTIONS in OTHER COUNTRIES • Letter of Credit -- A promise by the bank to pay the seller a given amount if certain conditions are met. • Banker’s Acceptance -- A promise the bank will pay some specified amount at a particular time. • Money exchange allows companies to go to a bank and exchange currencies to use in a particular country (i.e. dollars for euros). 20-28 The World Bank and the International Monetary Fund LG7 LEADING INSTITUTIONS in INTERNATIONAL BANKING • World Bank -- Lends most of its money to less-developed nations to improve their productivity and help raise standards of living and quality of life. • International Monetary Fund (IMF) -- Fosters cooperative monetary policies that stabilize the exchange of one national currency for another. About 185 countries are a part of the IMF. 20-29 NEW ISSUES FACING the WORLD BANK and the IMF (Reaching Beyond Our Borders) • A debt crisis in Europe (Greece); Japan trying to recover from its earthquake and tsunami; major disruptions in the Middle East; China and Brazil are having problems with high inflation; and rising food prices are happening all over the planet. • Poorer nations are having a particularly hard time because of the high food prices. • The IMF and the World Bank are both trying to come up with answers to the global issues that have become very serious. 20-30