Chapter 12: Money and Financial Institutions

Money and Banking

The Purpose of Money

• Money enables people and businesses to buy and sell goods and services more easily around the world.
  • Money is a standard of value and a means of exchange or payment.
• Modern society uses coins, currency, checks, and debit cards as part of the monetary system.
• Goods and services are directly exchanged using money.
• Without money, people would be forced to barter, or trade goods or services directly for other goods or services.
• Money has three basic functions:
  • It is a medium of exchange
  • Money functions as a standard of value.
  • Money functions as a store of value.
• Characteristics of money:
  • Money must be stable in value.
  • To be used as money, an item must be scarce
  • Money must be accepted
  • Money also has to be portable and durable
  • Finally, it must be hard to counterfeit.
  • To counterfeit means to make a copy of something in order to defraud or deceive people.

The Functions of Banks

• A financial institution is a firm that manages money.
  • Banks are the main types of financial institutions.
• One of the main services banks provide is storing money in bank accounts.
  • To store money means to place or leave it for preservation or later use.
• A bank account is a record of the amount of money a customer has deposited into or withdrawn from a bank.
• The money put in a bank account is called a deposit.
• The money taken out is called a withdrawal.
• The two main types of bank accounts are checking accounts and savings accounts.
  • Checking accounts are used for storing money in the short term.
  • Banks usually charge a fee for checking accounts.
  • Savings accounts are used for storing money over a longer period of time.
  • An advantage of a savings account is that it earns more interest than most checking accounts.
• Interest is a rate that the bank pays customers for keeping their money.
• Banks use checks and electronic funds transfers to move money.
• Checks are primarily used to transfer money from one party to another.
• Electronic funds transfer (EFT) allows money to be transferred from one bank account to another through a network of computers.
• Direct deposit is the electronic transfer of a payment directly from the payer’s bank account to that of the party being paid.
• Most bank loans require some form of collateral.
  • Collateral is property or goods pledged by a borrower to use as security against a loan if it is not repaid.
• There are four main types of loans that banks offer to businesses and individuals:
  • A mortgage loan is a loan used to buy real estate, such as a house or an office building.
  • A mortgage is an agreement in which a borrower gives a lender the right to take the property if the loan is not repaid.
  • A commercial loan is a loan made to businesses to buy supplies and equipment.
  • An individual loan is a loan made to an individual to pay for personal items, such as a car, home repairs, or a vacation.
  • A line of credit is a credit arrangement in which a financial institution agrees to lend a specific amount of money to be used at any time for any purpose.
• Many provide financial advice on managing and investing money.
• A safe-deposit box is a secure box in a bank’s vault used for the safe storage of a customer’s valuables.
• As another service, many banks offer debit cards and credit cards, such as MasterCard® or Visa®.
• Banks also have trust departments that manage money for individuals and organizations.

Types of Financial Institutions

Financial Institutions

• In the United States, there are three main types of banks.
  • They are commercial banks, savings and loan associations, and credit unions.
• Most of the banks in the United States are commercial banks.
• Commercial banks offer the entire range of banking services, such as checking and savings accounts, loans, and financial advice.
  • They are often called full-service banks
• Savings and loan associations are financial institutions that hold customers’ funds in interest-bearing accounts and invest mainly in mortgage loans.
• Credit unions are not-for-profit banks set up by organizations for their customers to use.
  • Credit union customers are also called members.
• There are other financial institutions that offer some of the same services as banks.
  • Mortgage companies provide loans specifically for buying a home or business.
  • Finance companies offer short-term loans to businesses and consumers, but at much higher interest rates than banks charge.
  • Insurance companies not only provide protection against problems such as fire and theft, but they also offer loans to businesses and consumers.
  • Brokerage firms that sell stocks and bonds may also offer a wide range of financial services to their customers.

The Federal Reserve System

• The Federal Reserve System (or Federal Reserve) is the central bank of the United States.
• Also known as “The Fed,” the Federal Reserve is the banker’s bank.
• It monitors the money supply.
• The Federal Reserve has six functions:
  • Clearing Checks: Funds are transferred from one bank to another when someone writes or deposits a check.
  • Acting as the Federal Government’s Fiscal Agent: The Federal Reserve distributes money to Federal Reserve member banks and commercial banks.
  • It also tracks the deposits and holds a checking account for the U.S. Treasury.
  • Supervising Member Banks: The Fed regulates banks that are members of the Federal Reserve System.
  • Regulating the Money Supply: The primary responsibility of the Federal Reserve is to determine the amount of money in circulation and either increase or decrease it.
  • Setting Reserve Requirements: Member banks must keep a certain percentage of deposits as reserves.
  • Reserves are funds set aside for emergencies, such as a rush of withdrawals.
  • Supplying Paper Currency: The Federal Reserve is responsible for printing and maintaining U.S. paper currency.