© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter Eighteen Understanding Money, Banking, and Credit 18 | 1 PRIDE HUGHES KAPOOR INTRODUCTION TO BUSINESS ELEVENTH EDITION

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives 1. Identify the functions and characteristics of money. 2. Summarize how the Federal Reserve System regulates the money supply in order to maintain a healthy economy. 3. Describe the organizations involved in the banking industry. 4. Identify the services provided by financial institutions. 18 | 2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives (cont’d) 5. Understand how financial institutions are changing to meet the needs of domestic and international customers. 6. Explain how deposit insurance protects customers. 7. Discuss the importance of credit and credit management. 18 | 3

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Introduction  The economic crisis Described by many experts as the worst since the Great Depression -Many people lost their homes because they couldn’t pay their loans -Many people and businesses filed for bankruptcy because they couldn’t pay their loans -Many people and businesses found it harder or impossible to borrow money 18 | 4

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. What Is Money?  Barter system A system of exchange in which goods or services are traded directly for other goods or services  Money Anything a society uses to purchase products, services, or resources 18 | 5

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Functions of Money  Medium of exchange Anything accepted as payment for products, services, and resources  Measure of value A single standard or “yardstick” used to assign values to and compare the values of products, services, and resources  Store of value A means of retaining and accumulating wealth The consumer price index measures the effects of inflation 18 | 6

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Consumer Price Index and the Purchasing Power of the Consumer Dollar (Base Period 1982–1984 = 100) Source: The U.S. Bureau of Labor Statistics website, June 16, | 7 Figure 18.1

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Consumer Price Index and the Purchasing Power of the Consumer Dollar (Base Period 1982–1984 = 100) Source: The U.S. Bureau of Labor Statistics website, June 16, | 8 Figure 18.1

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Important Characteristics of Money  Divisibility  Portability  Stability  Durability  Difficulty of counterfeiting 18 | 9

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Supply of Money: M1 and M2  Demand deposit An amount on deposit in a checking account  Time deposit An amount on deposit in an interest-bearing savings account  Two main measures of the supply of money M1 -Currency, demand deposits, and travelers checks M2 -M1 plus savings accounts, certain money-market securities and small-denomination time deposits or certificates of deposit (CDs) of less than $100, | 10

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Supply of Money Source: The Federal Reserve website, accessed June 15, | 11 Figure 18.2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System  The central bank of the United States responsible for regulating the banking industry Controlled by a seven-member board of governors who are appointed by the president and confirmed by the Senate to serve a fourteen-year term Composed of twelve district banks and twenty-four branch banks District banks are owned by commercial banks that are members of the Federal Reserve system Main function is to regulate the banking system and maintain a healthy economy 18 | 12

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d) Source: “91st Annual Report, 2004,” The Federal Reserve Board website, accessed June 18, | 13 Figure 18.3

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d)  Economic crisis and the Fed’s response Provided liquidity Supported troubled financial markets Supported important financial institution Conducted stress tests of major banks 18 | 14

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d)  Regulation of reserve requirements Reserve requirement—the percentage of its deposits a bank must retain, either in its own vault or on deposit with its Federal Reserve District Bank More required reserves = less money in circulation Less required reserves = more money in circulation to stimulate the economy 18 | 15

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d)  Regulation of the discount rate Discount rate—the interest rate the Federal Reserve System charges for loans to member banks Lower loan rates allow banks to lend more and stimulate the economy Higher rates slow the economy 18 | 16

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d)  Open-market operations The buying and selling of U.S. government securities by the Federal Reserve System for the purpose of controlling the supply of money To reduce the money supply, the Fed sells government securities to take money out of circulation To increase the money supply, the Fed buys government securities 18 | 17

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Controlling the Money Supply and the Economy 18 | 18 Table 18.1

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Federal Reserve System (cont’d)  Other Fed responsibilities Serving as the U.S. government bank Clearing checks and electronic transfers of funds between banks Inspection and replacement of worn and unfit currency Selective credit controls -Truth-in-Lending Act enforcement -Stock purchase margin requirements 18 | 19

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The American Banking Industry  Banking and financial reform: New regulations Goals are -Protection from unfair, abusive financial and banking practices -Close gaps that allowed large banks and financial firms to avoid strong, comprehensive federal oversight -Curb high-risk investment strategies -Require banks and financial firms to pay back bailout funds -Provide a foundation for stable economic growth 18 | 20

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The American Banking Industry (cont’d)  Commercial bank A profit-making organization that accepts deposits, makes loans, and provides related services to its customers -National bank: chartered by the U.S. Comptroller of the Currency -State bank: chartered by the banking authorities in the state in which it operates 18 | 21

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Seven Largest U.S. Banks, Ranked by Total Revenues Source: The Fortune website, accessed June 20, | 22 Table 18.2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The American Banking Industry (cont’d)  Other financial institutions Savings and loan associations (S&L) -A financial institution that offers checking and savings accounts and CDs and that invests most of its assets in home mortgage loans and other consumer loans Credit unions -A financial institution that accepts deposits from and lends money to only those people who are its members -Members are usually employees of a particular firm, people in a particular profession, or those who live in a community served by a local credit union 18 | 23

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The American Banking Industry (cont’d)  Other financial institutions (cont’d) Organizations that perform banking functions -Mutual savings banks -Insurance companies -Pension funds -Brokerage firms -Finance companies -Investment banking firms 18 | 24

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Careers in Banking  The seven largest banks in the U.S. employ approximately 1,200,000 people  The U.S. Department of Labor expects the number of people employed in banking to grow more slowly than other jobs in the economy between now and the year 2018  Traits of successful bankers Honesty Ability to interact with people Strong background in accounting Appreciation for the banking-finance relationship Basic computer skills 18 | 25

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Services Provided by Financial Institutions  Checking accounts Check—a written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the check NOW account—an interest-bearing checking account  Savings accounts Passbook savings account Certificate of deposit (CD)—a document stating that the bank will pay the depositor a guaranteed interest rate for money left on deposit for a specified period of time  Short- and long-term loans Line of credit—a loan that is approved before the money is actually needed Revolving credit agreement—a guaranteed line of credit Collateral—real estate or property pledged as security for a loan 18 | 26

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Services Provided by Financial Institutions (cont’d)  Credit-card and debit card transactions Banks and other financial institutions charge merchants fees (a percentage of each credit card transaction) for handling the transactions for the merchant Debit card—a card that electronically subtracts the amount of a purchase from the cardholder’s bank account at the moment the purchase is made 18 | 27

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Typical Services Provided by Banks 18 | 28 Figure 18.4

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Innovative Banking Services  Changes in the banking industry Anticipated changes -More emphasis on evaluating the creditworthiness of loan applicants as a result of the recent economic crisis -An increase in government regulation of the industry -A reduction in the number of banks, S&Ls, credit unions, and financial institutions because of consolidation and mergers -Globalization of the banking industry 18 | 29

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Innovative Banking Services (cont’d)  Changes in the banking industry (cont’d) Anticipated changes (cont’d) -The importance of customer service as a way to keep customers from switching to competitors -Increased use of credit and debit cards and a decrease in the number of written checks -Increased competition from nonbank competitors that provide many of the same services as banks (S&Ls, credit unions) -Continued growth in online banking 18 | 30

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Online Banking  Advantages Easy access to account regardless of time or location Ability to obtain current account balances Convenience of transferring funds Ability to pay bills Convenience of seeing which checks have cleared Easy access to current interest rates Simplified loan application procedures For banks—lower processing costs  Disadvantages Not being able to discuss financial matters with a personal banker 18 | 31

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Online Banking (cont’d)  Electronic funds transfer (EFT) system A means of performing financial transactions through a computer terminal or telephone hookup Changing how banks do business -Automated teller machines (ATMs) -Automated clearinghouses (ACHs) -Point-of-sale (POS) terminals -Electronic check conversion (ECC) 18 | 32

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. International Banking  Popular methods of paying for import and export transactions Letter of credit -A legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time Banker’s acceptance -A written order for the bank to pay a third party a stated amount of money on a specific date  Currency exchange 18 | 33

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The FDIC and NCUA  Federal Deposit Insurance Corporation (FDIC) Created as a result of the Depression, to restore public confidence in the banking industry to insure deposits against bank failures  FDIC provides deposit insurance of $250,000 per account  National Credit Union Association (NCUA) Insures the deposits of credit union members for up to $250,000 per account 18 | 34

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Effective Credit Management  Credit Immediate purchasing power that is exchanged for a promise to repay borrowed money, with or without interest, at a later date  Borrower Person or business wishing to make a purchase  Lender Bank or firm selling merchandise or service on credit Interest charged for the loan is profit 18 | 35

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Getting Money from a Bank or Lender After a Credit Crisis For individuals Fill out a loan application Describe how you will use the money and how you will repay it Prepare for an interview If rejected, ask the loan officer why For businesses Develop a relationship with your banker Apply for a preapproved line of credit or revolving credit agreement even if you do not need the money Supply financial statements and tax documents Update your business plan Prepare a convincing cover letter 18 | 36

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The Five C’s of Credit Management  The five Cs of credit management Character—the borrower’s attitude toward credit obligations Capacity—the borrower’s financial ability to meet credit obligations Capital—the extent of the borrower’s assets or net worth Collateral—borrower assets that can be pledged as security for a loan Conditions—general economic conditions that can affect a borrower’s ability to repay the loan 18 | 37

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Credit Application Form 18 | 38 Figure 18.5

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Checking Credit Information  Credit information sources regarding businesses Global credit-reporting agencies Local credit-reporting agencies Industry associations Other firms that have given the firm credit  Credit information concerning individuals Experian Trans Union Equifax  Fair Credit Reporting Act Consumers have a right to know what information is in their credit bureau files Consumers have a right to request that information in their files be verified, and they can file an explanation of their side of a dispute 18 | 39

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. New Protection for Consumers: The Credit Card Act of 2009  Designed to level the playing field between credit card customers and financial institutions that issue credit cards Disclosures regarding due dates, late fees, time required to pay off balances written in plain language Protection against arbitrary rate increases, requires 45-day notice Increased protection for students and people under 21 Standardized billing dates Requires fees to be reasonable in relation to a credit agreement violation New measures of accountability such as posting contract on the Internet review by Federal Reserve Board Increases penalties for companies that violate the Truth in Lending Act for credit card customers 18 | 40

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sound Collection Procedures  Techniques Subtle reminders Telephone calls Personal visits Legal action  Sound collection procedures Firm Fair, allowing for compromise Not harassing 18 | 41