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Understanding Business, 6/e
William G. Nickels
James M. McHugh
Susan M. McHugh
Chapter 21: Understanding Money and Financial Institutions
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eLearning Session

The PROFILE at the beginning of this chapter focuses on ALAN GREENSPAN, CHAIRMAN OF THE FEDERAL RESERVE, one of the most powerful positions in the country. Greenspan has control over the nation’s money supply.
  1. THE IMPORTANCE OF MONEY.

    2. Explain what money is and how its value is determined.
    1. THE U.S. ECONOMY DEPENDS UPON MONEY: its availability, its value relative to other currencies, and its cost.Power Point Presentation
      1. Money is so important that MANY INSTITUTIONS HAVE EVOLVED TO MANAGE MONEY and to make it available to you when you need it.
      2. The banking system is so complex because the flow of money FROM COUNTRY TO COUNTRY is as free as the flow FROM STATE TO STATE.
      3. What happens to any major country’s economy has an effect on the U.S. economy and vice versa.
        4.
    2. WHAT IS MONEY?
      1. MONEY is anything that people generally accept as payment for goods and services.
      2. BARTER Key Term is the trading of goods and services for other goods and services directly.
        1. Many people today still barter goods and services, but transactions are difficult.
        2. People need some object that’s more portable, divisible, durable, and stable so that they can trade without having to carry the actual goods.
      3. Coins meet all the standards for a more useful money:
        1. PORTABILITY. Coins were easier to take to market than goods.
        2. DIVISIBILITY. Different-sized coins could be made to represent different values.
        3. STABILITY. Everybody agreed on the value of coins so the value of money became relatively stable.
        4. DURABILITY. Coins last for years.
        5. DIFFICULT TO COUNTERFEIT. The government has had to go to extra lengths to make real dollars readily identifiable.
      4. Coins and paper money thus became UNITS OF VALUE and a means of making exchanges easier.
        1. Most countries have their own coins and paper that they use as money.
        2. However, they are not always equally stable—the text uses the example of Russian money.
      5. Electronic cash (e-cash) is the latest form of money.
        1. E-cash can be used to make online bill payments.
        2. You can also e-mail e-cash to anyone.
    3. CHANGING THE CURRENCY IN EUROPE
      1. Commerce among European countries was hindered in the past by the fact that each country had its own currency.
      2. Eleven European countries have created one common currency called the EURO.
      3. The actual coins and notes are expected to go into circulation in 2002.
      4. European bankers hoped that the euro wold compete with the U.S. dollar as an international currency of choice.
      5. However, the new currency’s value fell after introduction.
      6. How the euro performs depends on the strength of the U.S. economy versus the European economy.
    4. WHAT IS THE MONEY SUPPLYKey Term ?
      1. Two important considerations:
        1. Two important considerations:
        2. Why does it need to be controlled?
      2. The MONEY SUPPLY is how much money there is to buy available goods and services.
      3. There are several DEFINITIONS OF MONEY SUPPLY (M-1, M-2, and so on)
        1. M-1 includes CURRENCY (coins and paper bills), money that’s available by writing checks, and money held in traveler’s checks; that is MONEY THAT IS QUICKLY AND EASILY RAISED.
        2. M-2 includes everything in M-1 PLUS MONEY IN SAVINGS ACCOUNTS (time deposits), and money in money market accounts, mutual funds, certificates of deposit, and the like; that is MONEY THAT MAY TAKE A LITTLE MORE TIME TO OBTAIN THAN CURRENCY.
        3. M-2 is the most commonly used definition of money.
    5. WHY DOES THE MONEY SUPPLY NEED TO BE CONTROLLED?
      1. The money supply needs to be controlled because the prices of goods and services can be somewhat managed by controlling the amount of money available in the economy.
      2. If TOO MUCH MONEY is available, prices go up—INFLATION.
      3. If TOO LITTLE MONEY is available, prices would go down resulting in RECESSION.
      4. The money supply tools have an effect on employment and economic growth or decline.
    6. THE GLOBAL EXCHANGE OF MONEY.Concept Check CONCEPT CHECK
      1. FALLING DOLLAR means that the amount of goods and services you can buy with a dollar goes down.
      2. RISING DOLLAR means that the amount of goods and services you can buy with a dollar does up.
      3. What makes the dollar weak or strong is the position of the U.S. economy relative to other economies.
        1. When the economy is strong, people want to buy dollars and the value relative to other economies rises.
        2. When a country’s economy is perceived as weakening, people no longer desire its currency and the currency’s value falls.
  2. CONTROL OF THE MONEY SUPPLY.Power Point Presentation

    3. Describe how the Federal Reserve controls the money supply.
    1. It is important to have an organization that controls the money supply to try to keep the U.S. economy from growing too fast or too slowly.
      1. The FEDERAL RESERVE SYSTEM (THE FED) is the organization in charge of monetary policy.
      2. The head of the Federal Reserve, Alan Greenspan, is one of the most influential people in the world.
    2. BASICS ABOUT THE FEDERAL RESERVE.
      1. The Federal Reserve System consists of five major parts:
        1. The BOARD OF GOVERNORS administers and supervises the 12 Federal Reserve System banks.
          1. There are seven members who are appointed by the President.
          2. The primary function is to set monetary policy.
        2. The FEDERAL OPEN MARKET COMMITTEE has 12 voting members and is the policy-making body.
        3. The 12 FEDERAL RESERVE BANKS.
        4. THREE ADVISORY COUNCILS.
          1. The advisory councils offer suggestions to the board and the FOMC.
          2. The councils represent the various banking districts, consumers, and member institutions.
        5. The MEMBER BANKS of the system.
      2. The Federal Reserve:
        1. Buys and sells foreign currencies.
        2. Regulates various types of credit.
        3. Supervises banks.
        4. Collects data on the money supply and other economic activities.
      3. The tools used to regulate the money supply include: reserve requirements, open-market operations, and the discount rate.
    3. THE RESERVE REQUIREMENT.
      4.
      1. The RESERVE REQUIREMENT is a percentage of commercial bank’s checking and savings accounts that must be physically kept in this bank (for example, as cash in the vault) or a non-interest-bearing deposit at the local Federal Reserve district bank.
        2.
      2. Changing the reserve requirement is the Fed’s most powerful tool.Concept Check CONCEPT CHECK
      3. When the Fed INCREASES THE RESERVE REQUIREMENT, banks have LESS MONEY FOR LOANS and make fewer loans, which tends to reduce inflation.
      4. When the Fed DECREASES THE RESERVE REQUIREMENT, banks have MORE MONEY AVAILABLE FOR LOANS and make more loans, which tends to stimulate the economy RISKING INFLATION.
      5. Because this tool is so potent, and can cause such major changes in the U.S. economy, it is rarely used.
        6.
    4. OPEN-MARKET OPERATIONS.
      1. OPEN-MARKET OPERATIONS (the most commonly used tool) involves the buying and selling of U.S. government securities by the Fed with the goal of regulating the money supply.
      2. When the fed wants to DECREASE THE MONEY SUPPLY, it SELLS GOVERNMENT SECURITIES.
      3. When the fed wants to INCREASE THE MONEY SUPPLY, it BUYS GOVERNMENT SECURITIES from individuals, corporations, or organizations willing to sell.
    5. THE DISCOUNT RATE. Key Term
      1. The Fed is called the BANKER’S BANK.
      2. Member banks can borrow money from the Fed and then pass it on to their customers.
      3. The DISCOUNT RATE is the interest rate that Fed charges for loans to member banks.
      4. INCREASING THE DISCOUNT RATE discourages banks from borrowing and consequently reduces the number of available loans, resulting in a DECREASE IN THE MONEY SUPPLY.
      5. DECREASING THE DISCOUNT RATE encourages banks borrowing and increases the amount of funds available for loans, resulting in an INCREASE IN THE MONEY SUPPLY.
        6.
    6. THE FEDERAL RESERVE’S CHECK-CLEARING ROLE.
      1. One of the functions of the Federal Reserve System is to help process your checks.
      2. When a check is presented at another bank, a complicated process, shown in Figure 21.3, transfers funds from one’s home bank.
    7. The whole banking industry is affected by actions taken by the Federal Reserve System.
      8.
  3. THE HISTORY OF BANKING AND THE NEED FOR THE FEDERAL RESERVE

    4. Trace the history of banking and the Federal Reserve System.

    1. EARLY BANKING HISTORY.
      1. There were NO BANKS IN EARLY COLONIAL AMERICA.
        1. Strict laws limited the number of coins that could be brought to the colonies.
        2. Colonists were forced to barter for goods.
      2. MASSACHUSETTS issued its OWN PAPER MONEY in 1690 and soon other colonies did as well.
        1. LAND BANKS made loans to farmers.
        2. England stopped these practices by 1741.
        3. Colonies rebelled against these restrictions.
      3. ALEXANDER HAMILTON convinced Congress to form a CENTRAL BANK in 1791.
        1. The bank had so much OPPOSITION that it CLOSED in 1811.
        2. An attempt to replace the bank in 1816 failed again by 1836.
      4. By the time of the CIVIL WAR, BANKING WAS A MESS.
        1. Different banks issued different currency.
        2. Often the coins were worth more as gold or silver than as coins.
        3. Many people became nervous about their money and caused runs on banks; trust in banking declined.
      5. The chaos reached a climax in 1907 when many BANKS FAILED.
      6. People withdrew their funds from the bank until there was no cash left and money could no longer be given to depositors.
      7. To avoid another cash shortage, the FEDERAL RESERVE SYSTEM was formed.
        1. All Federally chartered banks must join; state chartered banks may join.
        2. The Federal Reserve became the BANKERS’ BANK.
    2. THE GREAT DEPRESSION.
      1. The STOCK MARKET CRASH OF 1929 led to bank failures in the early 1930s.
      2. In 1933 and 1935, the federal government passed LAWS to strengthen the banking system.
      3. One move established FEDERAL DEPOSIT INSURANCE (discussed later in the chapter.)
    3. One move established FEDERAL DEPOSIT INSURANCE (discussed later in the chapter.)
      1. The Fed is frequently featured in the news.
        1. In the early 1990s the Fed pumped up the money supply and lowered interest rates to get the economy moving.
        2. The Fed increased short-term interest rates in the mid 1990s, threatening the stock market.
        3. Some applauded hiking the interest rates saying it would cut inflation and let the economy grow slowly.
        4. Others said there was no threat of inflation and higher interest rates would slow the economy to the point of recession.
        5. Because of the complicated process, banks take many measures to lessen the use of checks.
      2. Businesses are concerned because higher bank rates mean a higher cost of borrowing.
      3. STAGFLATION, the combination of slow growth and inflation, is possible.
  4. THE AMERICAN BANKING SYSTEM. Power Point Presentation

    5. Classify the various institutions in the U.S. banking system.
    1. THE BANKING SYSTEM.
      1. The AMERICAN BANKING SYSTEM consists of commercial banks, savings and loan associations, credit unions, mutual savings banks, and nonbanks.
      2. NONBANKS are financial organizations that accept no deposits but offer many of the services provided by regular banks.
        3.
    2. COMMERCIAL BANKS.
      1. A COMMERCIAL BANK Key Term is a profit-making organization that receives deposits from individuals and corporations in the form of checking and savings accounts and uses some of these funds to make loans.
      2. Commercial banks have two types of customers: DEPOSITORS and BORROWERS.
      3. Commercial banks make a profit if the revenue generated by loans exceeds the interest paid to depositors.
    3. SERVICES PROVIDED BY COMMERCIAL BANKS.
      1. A DEMAND DEPOSIT is the technical name for a checking account.
        1. The money can be withdrawn on demand at any time by the owner.
        2. Banks impose a service charge for check-writing, and may also charge a handling fee.
      2. In the past, checking accounts paid no interest, but interest-bearing checking accounts (NOW and SUPER NOW accounts) have grown in recent years.
      3. A NOW (NEGOTIABLE ORDER OF WITHDRAWAL) ACCOUNT pays an annual interest rate, but imposes a minimum balance.
      4. A SUPER NOW account pays higher interest and requires a large minimum balance.
      5. A TIME DEPOSIT is the technical name for a SAVINGS ACCOUNT for which the bank requires prior notice before withdrawal.
        1. A CERTIFICATE OF DEPOSIT a time-deposit (savings) account that earns interest to be delivered at the end of the certificate’s maturity date.
        2. The CD cannot be withdrawn without penalty until the maturity date.
        3. The interest rate depends on the length of the period, the economic conditions, and the prime rate at the time of deposit.
      6. AUTOMATED TELLER MACHINES (ATMs) give customers the convenience of 24-hour banking.
      7. Commercial banks may also offer credit cards, brokerage services, financial counseling, automatic payment of bills, safe deposit boxes, tax-deferred IRAs, travelers’ checks, and overdraft privileges.
    4. SERVICES TO BORROWERS.Concept Check CONCEPT CHECK
      1. Banks screen loan applicants carefully to ensure that the loan plus interest will be paid back on tie.
      2. Small businesses and minority businesses often search out banks that cater to their needs.
        3.
    5. SAVINGS AND LOAN ASSOCIATIONS.
      1. SAVINGS AND LOAN ASSOCIATIONS are financial institutions that accept both savings and checking deposits and provide home mortgage loans.
        1. S&Ls are often known as thrift institutions since their original purpose was to promote consumer thrift and home ownership.
        2. Thrifts were permitted to offer slightly higher interest rates to attract funds.
        3. These funds were then used to offer long-term fixed rate mortgages.
      2. In the early 1980s S&Ls ran into trouble.
        1. To help relieve the pressure, the federal government permitted S&LS to offer NOW and SUPER NOW ACCOUNTS, to allocate up to 10% of their funds to COMMERCIAL LOANS, and to offer mortgage loans with ADJUSTABLE INTEREST RATES.
        2. S&Ls became similar to commercial banks.
    6. CREDIT UNIONS.
      1. CREDIT UNIONS are nonprofit, member-owned financial cooperatives that offer basic banking service.
      2. Credit unions offer members interest-bearing checking accounts at relatively high rates, short-term loans at relatively low rates, financial counseling, life insurance, and home mortgage loans.
      3. As not-for-profit institutions, credit unions enjoy an exemption from federal income taxes.
    7. OTHER FINANCIAL INSTITUTIONS (NONBANKS).
      1. NONBANKS are financial organizations that accept no deposits, but offer many of the services provided by other banks.
        1. NONBANKS INCLUDE life insurance companies, pension funds, brokerage firms, and commercial finance companies.
        2. The diversity of financial services offered by nonbanks has caused banks to expand their services.
      2. LIFE INSURANCE COMPANIES provide financial protection for policyholders who periodically pay premiums.
      3. PENSION FUNDS are amounts of money designated by corporations, nonprofit organizations, or unions to cover part of the financial needs of members when they retire.
        1. Pension funds typically invest in low-return but safe corporate stocks or government securities.
        2. Many large pension funds are becoming a force in U.S. financial markets.
      4. BROKERAGE FIRMS are organizations that buy and sell securities for their clients and provide other financial services.
      5. COMMERCIAL AND CONSUMER FINANCE COMPANIES are institutions that offer short-term loans to individuals at higher interest rates than commercial banks.
        1. The primary customers are new businesses and individuals with no credit history.
        2. One should be careful when borrowing from such institutions because the interest rates can be quite high.
      6. CORPORATE FINANCIAL SYSTEMS are financial services offered to customers of major corporations such as GE, Sears, and GM.
  5. HOW THE GOVERNMENT PROTECTS YOUR FUNDS.

    6. Explain the importance of the Federal Deposit Insurance Corporation and other organizations that guarantee funds.

    1. As a result of the depression of the 1930s, several organizations evolved to protect your money.
      1. The three major sources of financial protection are the FDIC, the SAIF, and the NCUA.
      2. All three insure deposits in individual accounts up to $100,000.
    2. THE FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC) is an independent government agency that insures accounts in banks against bank failures (up to a limit of $100,000 per account).
      1. If a bank were to fail, the FDIC would arrange to have its accounts transferred to another bank.
      2. The idea is to maintain confidence in banks so that others don’t fail if one falls.
    3. THE SAVINGS ASSOCIATION INSURANCE FUND (SAIF) (Formerly Federal Savings and Loan Insurance Corporation)
      1. SAIF insures holders of accounts in savings and loan associations.
      2. During the great depression, some 1,700 bank and thrift institutions failed and people were losing faith in them.
      3. The FDIC and FSLIC were designed to create more confidence in banking institutions.
    4. NATIONAL CREDIT UNION ADMINISTRATION (NCUA).
      1. The NCUA provides up to $100,000 coverage per depositor.
      2. Additional protection can be obtained by holding accounts jointly or in trust.
  6. THE FUTURE OF BANKINGPower Point Presentation

    7. Discuss the future of the U.S. banking system.
    1. Banking in the future is likely to change.
      1. One change is the repeal of the Glass-Steagall Act of 1992, which prohibited banks from owning brokerages.
      2. The Gramm-Leach-Bliley Act of 1999 allows banks, insurers, and securities firms to combine and sell each other’s services.
      3. As companies compete for business, the total cost of banking is likely to go down.
      4. Online banking is also poised for future growth.
    2. ELECTRONIC BANKING ON THE INTERNET
      1. All of the nation’s top 25 retail banks now allow customers access to their accounts online.
        1. You can transfer funds from one account to another, pay your bills, and apply for a car loan or mortgage.
        2. Buying and selling stocks and bonds is also easy.
      2. New Internet banks have been created that offer online banking only.
        1. These banks offer better interest rates and lower fees because they don’t have the costs of a brick-and-mortar presence.
        2. Not all consumers are entirely happy with online banking, and many worry about privacy, security, and lack of one-on-one help.
      3. The future seems to be with traditional banks that offer both online services and brick-and-mortar facilities.
      4. In the future, online banking will be combined with ATMs to provide new services.
        5.
    3. USING TECHNOLOGY TO MAKE BANKING MORE EFFICIENT.
      1. Banks have long looked for ways to make the system more efficient.
        1. Credit cards reduce the flow of checks but have their own costs.
        2. ELECTRONIC FUNDS TRANSFER SYSTEM (EFTS) is a computerized system that electronically performs financial transactions such as making purchases, paying bills, and receiving paychecks.
        3. ELECTRONIC CHECK CONVERSION (ECC) converts paper checks into an electronic transaction at the cash register, called a POINT-OF-SALE TERMINAL.
        4. ECC saves time and money while reducing the risks of bounced checks.
      2. Debit cards eliminate the paper-handling costs of using checks.
        1. A DEBIT CARD serves the same function as checks, but withdraws the funds directly from ones’ account.
        2. You can spend no more than is in your account.
      3. SMART CARDS Key Term are a combination of credit cards, debit cards, hone cards, drivers license cards, and more.
        1. They replace the magnetic strip on a credit card with a microprocessor.
        2. The card can store a variety of information, including the bank balance.
        3. Some smart cards have embedded radio-frequency antennae.
      4. New debit cards for teenagers let parents give teens funds and monitor their children’s transactions.
      5. Automatic transfers.
        1. A DIRECT DEPOSIT is a credit made directly to a checking or savings account.
        2. A DIRECT PAYMENT is a preauthorized electronic payment.
  7. INTERNATIONAL BANKING AND BANKING SERVICES. Power Point Presentation

    8. Evaluate the role and importance of international banking and the role of the World Bank and the International Monetary Fund.
    1. Banks help businesses conduct business in other countries by providing three services.
      1. A LETTER OF CREDIT is a promise by the bank to pay the seller a given amount if certain conditions are met.
      2. A BANKER’ ACCEPTANCE promises that the bank will pay some specified amount at a particular time.
      3. CURRENCY EXCHANGE is the exchange of one country’s currency for another country’s currency.
    2. LEADERS IN INTERNATIONAL BANKING.
      3.
      1. In the future, many crucial financial issues will be international in scope.
      2. Today’s money markets are GLOBAL MARKETS.
        1. American firms must compete for funds with firms all over the world.
        2. The success of American business is tied to the success of businesses throughout the world.
      3. Banking is no longer a domestic issue.
        4.
      4. What has evolved is a world economy financed by international banks.
    3. THE WORLD BANK AND THE INTERNATIONAL MONETARY FUND (IMF).
      4.
      1. The World Bank and the IMF are twin pillars that support the structure of the world’s banking community.
      2. The WORLD BANK is responsible for financing economic developing.
        1. It is also known as the International Bank for Reconstruction and Development.
        2. Today, most of the money is lent to poor nations to raise productivity and raise the standard of living.
      3. Recently the World Bank has received considerable criticism with protests taking place across the nation.
      4. The World Bank is trying to focus more on the poor and do less to damage the environment. Concept Check CONCEPT CHECK
      5. The INTERNATIONAL MONETARY FUND (IMF) was established to assist the smooth flow of money among nations.
        1. It requires members to allow their currency to be exchanged for foreign currencies freely and keep the IMF informed about changes in monetary policy.
        2. The IMF is not primarily a lending institution, rather an overseer of member countries monetary and exchange rate policies.
      6. The IMF’s goal is to maintain a global monetary system that works best for all nations.
      7. Members of the IMF contribute funds that are available to countries when they get into financial difficulty.
      8. The IMF has also been criticized lately because it was lending money to nations whose currencies have fallen dramatically.
        9.




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