Understanding Money and Banking

business essentials -- part 14 -- summary

Money

Any item that is portable, divisible, durable, and stable satisfies the four basic characteristics of money. The money also serves three functions: it is a medium of exchange, a store of value, and a unit of account. The nation's money supply is often determined by two measures. M-1 includes liquid (or spendable) forms of money: currency (bills and coins), demand deposits,and other checkable deposits (such as ATM account balances and NOW accounts). M-2 includes M-1 plus items that cannot be directly spent but can be converted easily into spendable forms: time deposits, money market funds, and savings deposits. Credit must also be considered as a factor in the money supply.

Financial institutions

The U.S. financial system includes federal and state chartered commercial banks, savings and loan associations, mutual savings banks, credit unions, and non deposit institutions such as pension funds and insurance companies. Commercial banks accept deposits that they used to make loans and earn profits. Savings and loan associations also accept deposits and make loans, primarily for home mortgages. In mutual savings banks, all depositors are owners of the bank, and all profits are divided proportionately among them. In credit unions, deposits are excepted only from members.

Numerous other organizations called non deposit institutions -- pension funds, insurance companies, finance companies, and securities investment dealers -- take in money, provide interest or other services, and make loans. In the competitive finance business, most commercial banks offer a wide range of special services: (1) pension and trust services, (2) international services, (3) financial advice and brokerage services, and (4) automated teller machines (ATMs).

Creating Money

The money supply expands because banks can loan out most (although not all) of the money they take in from deposits. Out of a deposit of $100, the Bank may hold $10 in reserve and loan 90% to borrowers. There will still be $100 on deposit, and borrowers will also deposit the $90 loan in their banks. Now the borrowers banks have $81 (90% of $90) available for new loans. Banks, therefore, have turned the original $100 into $271 ($100 + $90 + $81).

The government regulates commercial banks to ensure a sound financial system. The Federal Deposit Insurance Corporation (FDIC) insures deposit and guarantees, through its Bank Insurance Fund (BIF), the safety of all deposits up to the current maximum of $100,000. It also examines the activities and accounts of all member banks.

The Federal Reserve System

The Federal Reserve System (or the Fed) is the nation's central bank. As the governments bank and, the Fed produces currency and lends money to the government. As the bankers bank of, it lends money (at interest) to member banks, stores required reserve funds for banks, and clears checks for them. The Fed is empowered to audit member banks and sets U.S. monetary policy by controlling the country's money supply. To control the money supply, the Fed specifies reserve requirements (the percentage of its deposits databank must hold with the Fed). It sets the discount rate at which it lends money to banks and conducts open market operations to buy and sell securities. It also exerts influence through selective credit controls (such as margin requirements governing the credit granted to buyers by securities brokers).

Changes in the financial industry

Deregulation
the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and subsequent laws promote competition by eliminating many restrictions on banking services.

Interstate banking
The Interstate Banking Efficiency Act (1994) allows banks to operate across state lines.

Electronic technologies
Banks are increasingly investing in technology as a way to improve efficiency and customer service: (1) debit cards allow the transfer of money between accounts and can be used to make retail purchases at point-of-sale (POS) terminals, which relate purchase information directly to the banks computer system for automatic transfer to the stores account. (2) the smartcard can be programmed with electronic money at ATM machines. (3) E-cash is money that moves along multiple channels via digital electronic transmissions. It is outside the established network of banks, checks, and paper currency overseen by the Fed. Traditional currency is used to buy electronic funds, which are downloaded over phone lines, cable, or satellite into a PC or a portable "electronic wallet" that can store and transmit e-cash. The online shopper pays by sending digital money into the sellers e-cash funds, which are instantaneously updated.

International banking

Electronic technologies now permits the global financial transactions to support the growing importance of international finance. The country to country transactions are conducted according to an international payment process that moves money between buyers and sellers in different nations. The payment process recognizes the current exchange rates of currencies for all countries involved in an international exchange.

Two United Nations agencies help to finance international trade: (1) the World Bank funds national improvements by making loans to build roads, schools, and so forth. The improvements enable borrowers to increasing productive capacity and international trade. (2) to the in the International Monetary Fund (IMF), some 150 nations have combined resources for the following purposes: (a) to promote the stability of exchange rates; (b) to provide temporary, short-term loans to member countries; (c) to encourage cooperation on international monetary issues; and (d) to encourage development of a system for international payments.