PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 2 Banking in the New Cyberworld

Copyright © 2004 South-Western. All rights reserved.2–2 Fundamental Issues 1.What is the difference between stored-value cards and smart cards? 2.Is digital cash less secure than physical cash? 3.What are the rationales for regulating cyberbanking? 4.Does e-money matter for monetary policy?

Copyright © 2004 South-Western. All rights reserved.2–3 Stored-Value and Debit-Card Systems Closed stored-value system:  An e-money system in which consumers use cards containing prestored funds to buy specific goods and services offered by a single issuer of the cards. Open stored-value system:  An e-money system in which consumers buy goods and services using cards containing prestored funds that are offered by multiple card issuers and accepted by multiple retailers.

Copyright © 2004 South-Western. All rights reserved.2–4 Card Systems (cont’d) Debit card:  A plastic card that allows the bearer to transfer funds to a merchant’s account, provided that the bearer authorizes the transfer by providing personal identification.

Copyright © 2004 South-Western. All rights reserved.2–5 A Debit-Card System Figure 2–1

Copyright © 2004 South-Western. All rights reserved.2–6 Smart Cards Smart card:  A card containing a microprocessor that permits storage of funds via security programming, that can communicate with other computers, and that does not require online authorization for funds transfer to occur. Open smart-card system:  An e-money system in which consumers use smart cards with embedded microprocessors, which may be issued by a number of institutions, to purchase goods and services offered by multiple retailers.

Copyright © 2004 South-Western. All rights reserved.2–7 Digital Cash Digital cash:  Funds contained on computer software, in the form of secure algorithms, that is stored on microchips and other computer devices. Payment intermediary:  An institution that facilitates the transfer of funds between buyer and seller during the course of any purchase of goods, services, or financial assets.

Copyright © 2004 South-Western. All rights reserved.2–8 Digital Encryption and Electronic Payment Security Figure 2–2

Copyright © 2004 South-Western. All rights reserved.2–9 Could e-money “catch a cold”? Malfunctioning money Swiping digital cash offline and online Digital counterfeiting The Security of Digital Cash

Copyright © 2004 South-Western. All rights reserved.2–10 Bank Fraud: An Old Problem with a New Face Banknotes:  Privately issued paper currency. Free-banking laws:  Laws in force in many U.S. states between 1837 and 1861 that allowed anyone to obtain a charter authorizing banking operations.

Copyright © 2004 South-Western. All rights reserved.2–11 States with Free-Banking Laws, 1837–1860 Table 2–2 SOURCE: Reprinted from A.J.Rolnick and W.E.Weber, “Inherent Instability in Banking: The Free Banking Experience,” Cato Journal 5 (Winter 1986). Their source was Hugh Rockoff, The Free Banking Era: A Re-Examination (New York: Arno Press,1975). a Michigan prohibited free banking in 1840 and allowed it again in b According to Rockoff, very little free banking was done under the laws in these states.

Copyright © 2004 South-Western. All rights reserved.2–12 Bank Regulation Goals Maintaining depository institution liquidity.  Illiquidity: A situation in which a banking institution lacks the cash assets required to meet requests for depositor withdrawals. Assuring bank solvency by limiting failures.  Insolvency: A situation in which the value of a bank’s assets falls below the value of its liabilities. Promoting an efficient financial system. Protecting consumers.

Copyright © 2004 South-Western. All rights reserved.2–13 The Composition of the Quantity of Money in 1861 Figure 2–3 SOURCE: Richard H.Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago:University of Chicago Press,1993). Figure 2–4 The Composition of the Quantity of Money in 1866

Copyright © 2004 South-Western. All rights reserved.2–14 Notes and Deposits at State and National Banks, 1860–1868 Figure 2–5 SOURCE: Richard H.Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago:University of Chicago Press,1993).

Copyright © 2004 South-Western. All rights reserved.2–15 Total U.S.Debit-Card Transactions Figure 2–6 SOURCE: : Bank for International Settlements and authors’ estimates.