2. Chapter 7 – Financial Institutions ECONOMICS THEORY AND PRACTICE Seventh Edition Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Patrick J. Welch St. Louis University Gerry F. Welch St. Louis Community College at Meramec & PowerPoint Presentation by: Dr. Ray Everett Pima Community College

3. Money & Financial Institutions Contents Money Money Supply Monetary Standards Financial Institutions Federal Reserve System Recent Trends in Financial Institutions

4. Money & Financial Institutions Chapter Objectives To define money and explain the functions of money. To identify the various measures and components of the U.S. money supply and different monetary standards. To introduce the financial institutions that are important for the maintenance and control of the U.S. money supply, and to highlight commercial banks and commercial bank regulation. To explain the role of the Federal Reserve System, its organization, and the functions that Federal Reserve Banks perform. To discuss recent legislative and structural changes in the financial institutions system.

5. Money  Anything that is generally accepted as a medium of exchange. Money 7-1a

6. Value of Money  Measured by the goods, services, and resources that money can purchase. Functions of Money  Medium of Exchange Something that is generally accepted as payment for goods, services, and resources.  Measure of Value Value of every good, service, and resource expressed in terms of an economy’s base unit of money.  Method for Storing Wealth & Delaying Payment Allows for saving, or storing wealth for future use, and permits credit, or delayed payments. Barter System  Goods and services are exchanged for each other rather than for money. Money 7-1b

7. M1  Narrowest definition of the U.S. money supply.  Includes: Coins, paper money in circulation, some traveler’s checks, most demand deposits, and other checkable deposits. Money Supply 7-2a

8. Currency  Coins and paper money. Token Money  Money with a face value greater than the value of the commodity from which it is made. Federal Reserve Notes  Paper money issued by the Federal Reserve Banks. Demand Deposits  Checking account balances kept primarily at commercial banks. Other Checkable Deposits  Interest-bearing accounts similar to demand deposits offered by financial institutions. Money Supply 7-2b

9. Velocity  Average number of times the money supply is turned over in a year in relationship to GDP. Money Supply 7-2c TABLE 7-3 Currency, Traveler’s Checks, Demand Deposits, and Other Checkable Deposits (Billions of Dollars) a

10. M2  Includes M1 and: Savings, small denomination time deposit accounts, money market deposit accounts, and other financial instruments. M3  Includes M2 and: Eurodollar holdings by U.S. residents, $100,000+ time deposit accounts, and other financial instruments. Money Supply 7-2d This table replaces the one on Page 214 that displays amounts as: M1 = $5.5 trillion, M2 = $8.1 trillion.

11. Commodity Monetary Standard  Economy’s money is backed by something of tangible value such as gold or silver. Prior to 1933 the U.S. had a gold-coin standard. –Gold not only backed the money supply but also freely circulated in the hands of the public. From 1934 through 1971 the U.S. had a gold-bullion standard. –Gold backed the money supply but was no longer available to the general public. Paper Monetary Standard  Economy’s money is not backed by anything of tangible value such as gold or silver. Since 1971 the U.S. economy has been on a paper monetary standard. –Occurred after foreign debts were paid off in gold bullion and the U.S. gold reserves were nearly exhausted, no longer allowing the U.S. to back its money with gold. Monetary Standards 7-3

12. Financial Depository Institutions (FDI)  Institutions that accept and maintain deposits, and make loans.  Have the ability to create and destroy money.  Come in many forms: Commercial banks Savings and loan associations Savings banks Credit unions Financial Institutions 7-4a

13. Commercial Banks  Primary financial depository institutions.  Institutions that hold and maintain checking accounts for their customers, make commercial and other loans, and perform other functions.  Must be incorporated or have a corporate charter.  Dual Banking System National banks –Incorporated under a federal charter. State banks –Incorporated under a state charter. Financial Institutions 7-4b

14. Banking Agencies  Charter Authority National banks are regulated by a federal agency, and state banks by a state banking agency.  The Federal Reserve Regulates its own members and imposes some uniform regulations on all commercial banks regardless of membership.  Federal Deposit Insurance Corporation (FDIC) Administers regulations and insures deposits in commercial banks that choose to affiliate with the FDIC. Financial Institutions 7-4c

15. Bank Failure  Occurs when a bank’s assets are no longer sufficient to cover liabilities that must be paid. Usually the result of heavy loan losses and deposit withdrawals.  FDIC will guarantee depositors with accounts of less than a specified amount in this situation. Financial Institutions 7-4d

16. Federal Reserve System  Created in 1913.  Charged with: Overseeing the money supply and adjusting its size to meet the needs of the economy. Coordinating commercial banking operations, and Regulating some aspects of all depository institutions. Federal Reserve System 7-5a

17. Organization of the Federal Reserve System  Board of Governors Develops policies concerning money, banking, etc.  Open Market Committee Oversees the buying and selling of government securities by the Federal Reserve System.  Federal Reserve Bank Twelve banks that deal with commercial banks and other financial institutions. Federal Reserve System 7-5b

18. Functions of the Federal Reserve Banks  Supervise & examine member banks  Maintain reserve accounts  Currency circulation  Check clearing Federal Reserve System 7-5c

19. Functions of the Federal Reserve Banks (cont.) Federal Reserve System 7-5d FIGURE 7-3 Check Clearing through the Federal Reserve System

20. Legislative Changes  Depository Institutions Deregulation & Monetary Control Act Increased the similarity among many financial institutions and increased the control of the Federal Reserve System.  Garn-St. Germain Act Strengthened the deregulatory trend.  Riegle-Neal Interstate Banking & Branching Efficiency Act Allows banking organizations from one state to open or acquire banks, and to open branches, in other states. Interstate Banking  Performance of services in more than one state by a single banking organization. Recent Financial Institution Trends 7-6a

21. Legislative Changes (cont.)  Gramm-Leach-Bliley Act Allows bank holding companies that meet certain standards to become financial holding companies. Also called the Financial Services Modernization Act. Bank Holding Company  Corporation formed for the purpose of owning, or holding, the controlling shares of stock in a bank or banks. Recent Financial Institution Trends 7-6b

22. Structural Changes  Branch Banking Operation of more than one facility by a bank to perform its functions.  Unit Banking Operation of one bank with no branches. Mutual Fund Growth  Banks have begun providing mutual fund services in response to the growing interest by customers. Savings & Loan Crisis  Many savings and loan institutions became insolvent in the late 1980s and early 1990s due to relaxed regulations.  Resolution Trust Corporation (RTC) Federal agency created to reorganize troubled savings and loans or to deal with their affairs if they failed and closed. Recent Financial Institution Trends 7-6c

23. ECONOMICS THEORY AND PRACTICE Seventh Edition Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the expressed written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Chapter 7 – Financial Institutions This is the end of Chapter 7. To return to the contents menu of this chapter, click on the menu graphic to the right of this text. To begin Chapter 8, click on the next chapter icon to the right of this text. Menu Next Chapter