THE BUSINESS OF BANKING 6/15/2018 THE BUSINESS OF BANKING 1 1.1 Introduction to Banking 1.2 Role of Banks in the Economy 1.3 How the Banking System Works 1.4 Other Financial Institutions Chapter 1

1.1 INTRODUCTION TO BANKING 6/15/2018 1.1 INTRODUCTION TO BANKING GOALS Define the business of banking. Identify trends in modern banking. Chapter 1

TERMS Medium of exchange Financial intermediary Commercial bank Retail bank Central banks

What is a Bank? A Unique Business Medium of exchange An agreed upon system for measuring the value of goods and services Financial intermediary Safeguards, transfers, exchanges, or lends money

Types of Banks Commercial banks Conduct about 60 percent of deposit and loan business Provide familiar services Checking and savings accounts Credit cards Investment services

Retail banks Institutions that help individuals not served by commercial banks Mutual savings banks Savings and loans Credit unions

Central banks Government banks that manage, regulate, and protect the money supply Protect banks Serve as the government’s banker Issue currency Conduct monetary policy

checkpoint List four functions that define a bank.

Banking Today Mergers When one or more banks join or acquire another bank or banks

Operations have been automated TECHNOLOGY Operations have been automated Accounting Auditing Examining functions Instantaneous transactions Funds transfer Record keeping Financial analyses

Competition As government regulations have changed, competition between banks has become fiercer. Banks compete with each other and with other businesses that sell financial services.

checkpoint What three factors in modern banking have changed the industry?

1.2 ROLE OF BANKS IN THE ECONOMY Banking 6/15/2018 1.2 ROLE OF BANKS IN THE ECONOMY GOALS List banking activities that contribute to economic stability. Explain how banking expands the economy. Chapter 1

TERMS Identity theft Creditworthy

BANKS AND ECONOMICS Money Medium of exchange Basis of modern economy

KEEPING YOUR MONEY SAFE Record keeping Identity theft When someone achieves financial gain by using another person’s personal information to unlawfully assume the identity of the other person Enforcement Transfer security Sound business practices Examinations by federal or state bank authorities

checkpoint Name six ways that banks safeguard your money.

SPREADING THE WEALTH Banks Transfer money to provide growth Stabilize the monetary supply Bank lending makes money available to consumers and businesses to make purchases they might not otherwise be able to make.

TRANSFERRING Between Banks Banks and individual customers Banks and industry Banks and governments Governments

Lending is a primary component of a bank’s business. Types of loans provided are: Automotive Home Business Government Credit card

HEALTHY, RATIONAL LOANS Matching appropriate loans to qualified consumers is essential for a stable economy. The mortgage crisis occurred because unqualified buyers were granted loans they could not reasonably be expected to pay back in a timely fashion.

The ripple effect of the mortgage crisis included: Devastating the personal financial standing of affected homeowners Reduced demand and defaulted payments to suppliers of the housing industry Municipalities that had to bear the cost of maintaining abandoned properties

A creditworthy customer has CREDITWORTHINESS A creditworthy customer has A good credit rating Sufficient collateral for loans An ongoing income sufficient to make timely loan payments Banking policies and regulations help guarantee a secure financial environment. Creditworthiness Ratio of loans to deposits

GUARENTEEING THE MONEY Banks and the government work together to form the banking system. They make sure the money supply is: Adequate Appropriate Trustworthy The Federal Reserve is part of the guarantee process. Banks guarantee their own policies.

THE SUBSTANCE OF SOCIETY A great part of the economic system is psychological. Banks are at the heart of our financial system, and their effect on your life cannot be calculated.

checkpoint How does lending stimulate the economy?

1.3 HOW THE BANKING SYSTEM WORKS 6/15/2018 1.3 HOW THE BANKING SYSTEM WORKS GOALS Explain how banks acquire money to do business. Identify new services that banks offer to stay competitive. Chapter 1

TERMS Depositor Spread Profit Asset Liquid asset Liability

TERMS Return on assets (ROA) Return on equity (ROE) Equity Niche market Deregulation

Most of banks’ revenues come from interest income. MONEY AT WORK Most of banks’ revenues come from interest income. Bank loans help people Buy products and services Manufacture products Start businesses

Spread (net interest income) THE SPREAD Depositors People who put money into banks Interest A percentage of revenue earned on the principal over a period of time Spread (net interest income) The difference between what a bank pays in interest and what it receives in interest

PROFIT Profit (net income) What’s left of revenue after costs are deducted

Additional sources of bank income include: OTHER FUNDS Additional sources of bank income include: Credit-card interest Fee income Safe-deposit rental Checking account maintenance Online bill payment ATM transactions Stockholder investments

ASSETS AND LIABILITIES Anything of value Money Liquid asset Anything that can readily be exchanged Cash Liability A cash obligation

TWO PRINCIPLES OF BANKING A bank’s liabilities exceed its reserves. A bank’s liabilities are more liquid than its assets.

FAULTY INVESTMENT STRATEGIES Late 1990s Asian banking crisis Summer of 2007 and beyond U.S. mortgage lending crisis First quarter, 2008 Fraudulent investments by a trader at a French bank resulted in a massive sell-off of faulty investments. Impacted international financial markets

TESTS OF BANK PROFITABILITY Return on assets (ROA) Net income  Total assets  Return on assets Return on equity (ROE) Net income  Total equity  Return on equity Equity Total assets – Total liabilities = Equity

checkpoint Name three sources of bank income. What is a bank’s spread?

Large regional banks have huge resources. Niche markets BANKS WORKING FOR YOU Large regional banks have huge resources. Niche markets Particular customers in defined locations Particular customers using distinct services Deregulation Loosening of government control Changed the banking environment in the U.S.

CHANGES IN TRADITIONAL SERVICES Drive-up windows Extended hours Branch locations Variety of checking accounts Savings options Personal service

NEW SERVICES Credit cards Innovative lending Technology tools Automated teller machines (ATMs) Smart cards Payroll cards Online banking Mobile banking

checkpoint What changes have deregulation and competition brought to modern banking?

1.4 OTHER FINANCIAL INSTITUTIONS Banking 6/15/2018 1.4 OTHER FINANCIAL INSTITUTIONS GOALS Define depository financial institutions. Explain nondepository financial institutions. Chapter 1

TERMS Depository intermediaries Nondepository intermediaries Wholesale bank

DEPOSITORY INTERMEDIARIES Two primary types of financial institutions Depository intermediaries Obtain funds from the public Use funds to finance the financial institution’s business Nondepository intermediaries Do not take or hold deposits Generate revenue by selling specific services or policies

COMMERCIAL BANKS Commercial banks are owned by stockholders who expect a profit on their investments. Wholesale banks Commercial banks that specialize only in business banking

SAVINGS AND LOAN ASSOCIATIONS Receive most of their deposits from individuals Focus on real-estate lending Chartered by either state or federal government Owned by depositors Depositors receive shares of the company

Receive most of their deposits from individuals MUTUAL SAVINGS BANKS Receive most of their deposits from individuals Focus on real-estate lending State-chartered Owned by depositors

Membership is based on some type of association Not-for-profit CREDIT UNIONS Users must be members Membership is based on some type of association Not-for-profit Exist to benefit members

checkpoint What is a wholesale bank? What is the primary difference between credit unions and other depositor-owned financial institutions?

NONDEPOSITORY INTERMEDIARIES Insurance companies Trusts companies/pension funds Brokerage houses Loan companies Payday loans Currency exchanges

checkpoint Why is an insurance company considered a financial intermediary? What is the primary difference between depository institutions and most nondepository institutions?