Understanding Money and Financial Institutions Chapter 15

Chapter 15 Learning Goals What is money, what are its characteristics and functions, and what are the three parts of the U.S. money supply? What are the basic functions of the Federal Reserve System, and what tools does it use to manage the money supply? What are the key financial institutions, and what role do they play in the process of financial intermediation?

Chapter 15 Learning Goals (cont’d.) How does the Federal Deposit Insurance Corporation protect depositors’ funds? What trends are reshaping the banking industry?

Learning Goal 1 What is money, what are its characteristics and functions, and what are the three parts of the U.S. money supply? –Money Anything accepted as payment for goods and services –Characteristics Scarce, durable, portable, and divisible –Functions Medium of exchange Standard and store of value –U.S. money supply CurrencyCurrency (coins and paper money) Demand depositsDemand deposits (checking accounts) Time depositsTime deposits (interest-bearing deposits that cannot be withdrawn on demand)

Money: Anything that is acceptable as payment for goods and services

Characteristics of Money Scarcity Durability –US paper money does wear out; 95% of the new money printed in 1990 was to replace ‘unfit notes’ & 5% was for economic growth (Source: Federal Reserve Bank San Francisco, Portability Divisibility

Functions of Money medium of exchange standard of value store of value

Learning Goal 2 What are the basic functions of the Federal Reserve System, and what tools does it use to manage the money supply? –Four major functions of the Federal Reserve System (the Fed) Carrying out monetary policy Setting rules on credit Distributing currency Making check clearing easier –Three money-managing tools of the Fed Open market operations Reserve requirements Discount rate

The Federal Reserve System Carrying out monetary policy –open market operations, reserve requirement, discount rate Setting rules on credit –selective credit controls, consumer credit rules, margin requirements Distributing currency Making check clearing easier

Distributing Currency $150 billion$150 billion in cash typically exists at the Federal Reserve & at banks extra $70 billionAnticipating a high demand for cash prior to Y2K, the Federal Reserve printed an extra $70 billion –the extra money was distributed to banks –this was enough for every US citizen (including children) to have $255

Federal Monetary Tools Money InterestEconomic Action supplyratesactivity buy bonds   sell bonds   raise reserve   lower reserve   raise discount rate   lower discount rate  

Financial Intermediation Process Demanders of funds: businesses, governments Financial intermediaries: banks, life insurance companies, pension funds Suppliers of funds: households $$

Learning Goal 3 What are the key financial institutions, and what role do they play in the process of financial intermediation? –Depository institutions Commercial banks Thrift institutions Credit unions –Nondepository institutions Insurance and finance companies Pension funds Brokerage firms –Financial institutions Ease the transfer of funds between suppliers and demanders

The US Financial System Depository financial institutions –commercial banks, thrift institutions, credit unions Nondepository financial institutions –insurance companies, pension funds, brokerage firms, finance companies

Learning Goal 4 How does the Federal Deposit Insurance Corporation protect depositors’ funds? –Federal Deposit Insurance Corporation (FDIC) Insures deposits in commercial banks through the Bank Insurance Fund Deposits in thrift institutions through the Savings Association Insurance Fund Sets banking policies and practices Reviews banks annually to ensure that they operate fairly and profitably

Insuring Bank Deposits Federal Deposit Insurance Corporation (FDIC) –protection for bank failure –insures deposits up to $100,000 per account –backed by the credit of the US government –all banks in the Federal Reserve must have insurance

Learning Goal 5 What trends are reshaping the banking industry? –Banks are delivering more online services –Bank mergers and acquisitions are: Consolidating the banking industry Helping banks to improve their operating efficiency Reducing costs Extending their geographic reach –Passage of bank reform legislation Allows banks to market securities and insurance products Helps banks compete with nondepository institutions

Trends in Banking  Online banking  Consolidation  one expert predicts that 12 finance companies will hold 85% of the world’s private-sector financial assets by 2020 (Source: Eugene Ludwig in The Arizona Republic, Jan. 3, 2000, p. D1)

Trends in Banking  Integration of banking, brokerage, & insurance services –Congress passed the Gramm-Leach-Bliley Act of 1999 allowing companies in these areas to offer each other’s services –The legislation is expected to lead to healthy competition & lower prices for consumers (Source: Georgia Bankers Association, –This will likely lead to cross-industry mergers (Source: The Arizona Republic, Jan. 3, 2000, p. D1)