Banking Basics. Wise! Review. What is a Bank?. Banks are a type of financial institution. A financial institution is any organization that provides services related to money. Protect money Lending money Issuing money Sending money from one place to another Keeping track of money
What is a Bank? Banks are a type of financial institution. A financial institution is any organization that provides services related to money. Protect money Lending money Issuing money Sending money from one place to another Keeping track of money Helping customers get more money Helping businesses find money
Types of Banks
What Does a Bank Do? Retail banks – provide services for consumers Deposit accounts Mortgage Auto Personal loans Credit cards Internet banks – lack convenience of in-person service Commercial bank – focus on business customers, providing bank accounts along with specialized services such as foreign exchange, investment services, and capital loans Money center banks – often international banks whose primary customers are business
Where Do Banks Operate? Banks maybe classified by how large of an area in which they operate Unit banks – one location, usually in small towns or rural areas, serve local customers, invest locally, and understand the community Regional banks or interstate banks – branch across state or a few states in the same region, usually specialize in retail banking National banks – offices across the country
Technology’s Transformation of Banking
Automated Teller Machines
Online Banking Online banking, also known as home banking, allows customers to conduct financial transactions on a secure website operated by their bank. Transactional Online Banking – transferring funds between checking and savings accounts, paying bills, applying for loans, and purchasing or selling securities Peer-to-peer payments (P2P) – money to immediately transferred from one person to another.
Non-Transactional Online Banking Ability to review information rather than make a transaction. Viewing checking account balances, viewing recent transactions, downloading bank statements, and seeing and printing images of paid checks.
Banks and the Economy
Economic Functions of Banks There are three basic categories of services offered: Safekeeping services that protect our money Deposit services that let our money grow Loan services that allow us to borrow money By offering these services, borrowers, savers, buyers, and sellers are able to successfully transact their business. Banking expands the economy and provides jobs, income, investment returns, and tax revenues that benefit all.
Keeping Money Safe Banks provide physical security as well as electronic security of our money. In addition, federal deposit insurance protects our money in the event of a bank failure ($250,000 per type of account) Rely on banks to keep accurate records of our money Banks are physically protected with state-of-the-art surveillance equipment and security systems
Financial Intermediary A major economic function of a bank is to act as a financial intermediary. A financial intermediary is an institution that acts as a go-between in financial transactions. As an intermediary, the financial institution facilitates transactions between the savers and borrowers.
Transferring Funds Think of money like a river, if it flows slowly it take a long time to transfer money between individuals, businesses, and governments. If money moves slowly, the economy also slows down. Electronic Funds transfer (EFT) – electronic exchange of money from one account to another (ATM or debit card) Automated clearinghouses (ACHs) – are electronic networks for financial transactions. ACHs process credit and debit transactions and transfer funds from bank to bank
Financial Institutions Financial institutions are businesses that offer financial services Depository institutions – receive money from customers and put the money into a bank account, responsible for most of the money circulating in our economy Banks Credit Unions Savings and Loans
Commercial Banks Transfer Funds – transfer money from yourself to someone else Accept Deposits – such as savings accounts and money market accounts Make Loans – purchase cards, houses, and higher education Other Services – such as safety deposit box, sell securities, and insurances
Savings and Loan Associations (S&Ls) Originally created so people could deposit small amounts, because banks would only take larger deposits. Offer similar services as commercial banks Operate for profit Owned by shareholders, single person, a group of people, or a corporation
Credit Unions Have similar services to banks and S&L’s But owned by their members (cooperative is a business owned by its members) Operated as a not-for-profit – means instead of paying profits to shareholders, money made by the credit union is returned to the members (such as higher interest rates on savings and lower interest rates on loans) Share accounts are savings accounts at credit unions Share draft accounts are checking accounts at credit unions
Federal Deposit Insurance (FDIC) Customers can rest assured their money deposited in a bank is safe. Deposit Insurance covers the deposits of customers. If an institution fails, the depositors are protected. The insured institution pays premiums to deposit insurance fund (DIF). The FDIC is a independent federal agency established in 1933. The FDIC was created to promote public confidence in the banks. As 2008 selected accounts are insured for $250,000 Non-interest bearing accounts Single accounts Joint accounts Certain retirement accounts such as IRA Certain trust accounts Employee-benefit plan accounts Government accounts
National Credit Union Share Insurance Fund (NCUSIF) Established 1970 to insure credit union FDIC and NCUA are virtually identical Both insure up to $250,000 Each receives insurance premiums to cover any future failures Both backed by the US government Both have examiners that determine financial soundness of insured institutions
Non-Depository Institutions Do not accept deposits, although they may make loans. Non-depository institutions accept money from their customer to invest in business deals.
Other Financial Institutions Investment Banks – they do NOT accept deposits, but help businesses raise capital. Securities is one way, through giving part ownership in a business (bonds, stocks, dividends) Securities Firm (brokerage firms, stockbrokers, or bond brokers)– are financial institutions involved in the trading of securities in financial markets. Full-servicebrokerage firms advise customers on which securities to buy Discount brokers place orders for customers, commissions are usually less than full-service brokers.
Finance Companies Make profits by issuing loans to both individuals and businesses. They are also known as loan companies. Customer finance companies – personal loans to individuals An new type of customer finance company - Payday lenders Business finance companies – provide loans for business, such as a retail store. Captive finance company – formed by manufacturer to provide loans so the manufacturer can easily sell its goods.
Insurance Companies Are for-profit businesses that primarily sell insurance. Consumer buys an insurance policy by making periodic payments, known as premiums. The person or thing covered by the policy is called the insured.
Business of Banking
Income from Traditional Bank Services Interest on Loans – when banks make loans they charge a fee called interest. Loans are the banks largest asset and produce the larges amount of income (interest rates based on completion; market rates, and the borrower’s creditworthiness) Interest on Securities – banks invest their money, typically bonds and treasury bills (long and short-term) Treasury Securities – pay interest to investor with maturities of up to 30 years
Income from Fees Fees are a large source of income for banks
Income from Nontraditional Services
Insurance Products Life Insurance – protects people from financial loss in the event of death Credit Life Insurance – will pay off a loan if the insured dies Mortgage Life Insurance – pays off the loan balance on your home on your death Property and Casualty Insurance and Liability Insurance – Covers things Health Insurance – pays some or all medical bills
Trust Service Estate Planning – is preparing for the transfer of assets after a client’s death Estate Settlement – Trustee settles the estate Paying any debts of the estate Managing the assets until the estate is completely settled Preparing and filing tax returns
Banking Income & Expenses
Savings Products Types of Savings Accounts Passbook Savings Accounts – when the account owner comes into the bank to make a deposit or withdrawal, the transaction is recorded in the passbook. Online Savings Accounts –is opened and used without visiting a physical location, everything done electronically Custodial Accounts – managed by an adult for a minor who is younger than 18 or 21 Money Market Accounts – is a savings account that pays higher interest rate than a traditional savings account
Savings Account Features Certificates of Deposit (CD) – long-term money held on deposit for a specific amount of time (also known as a time deposit or a fixed deposit) Interest rates are higher Insured by FDIC Length of deposit is fixed A specific amount is needed to purchase A fee is charged if a withdrawal is made before the date of maturity Terms, Amounts and Interest Rates – based on the amount deposited, length of time, and competitors’ interest rates Jumbo CDs – is a CD for a large amount of money, usually $100,000 or more.
Comparing Savings Accounts and CDs
Retirement Accounts Expectations – life expectance in 2011 is 78 years Historical Solutions – Social Security Individual Retirement Accounts (IRA) – is a savings account in which income taxes are deferred on some deposits and all interest until all or part of the balance is withdrawn at retirement age. Roth IRA – Contributions are NOT deducted from your income, the money is taxed when it is earned Retirement Accounts Provided by Employers Simplified Employee Pension (SEP) – a retirement plan established by a business for its employees or owners. Simple IRA Plans – is an IRA-base plan that gives small employers a simplified method to make contributions toward their employees’ retirement Traditional 401K Plan – enables employees to make tax-deferred or taxed contributions through payroll deductions
Opening and Maintaining an Account Complete an Application Personal information Social Security number Driver’s license or state-issued IDContact information An opening deposit Security Information (Ex. mothers maiden name) Depositing an Opening Amount – show them the money
Loans Characteristics – is money temporarily transferred to a borrower in exchange for repayment and interest Policy – lending institution’s risk tolerance is balanced with the need to make loans that will help the bank generate money through the interest charged. Consumer and Commercial – who borrows the money (you or a business) Open-ended loan – is a loan that does not have to be paid in full by a specific date (credit card) Closed-end loan – must be paid in full on a specific date (such as your mortgage) Secured – is backed by the borrower’s property Unsecured – is less safe for the bank because it is not backed by collateral
Financial Assistance to Businesses Small Business Administration (SBA)- help Americans start and grow businesses Export-Import Bank of the United States – to help businesses export American goods and services to foreign countries Farm Service Agency – provides financial and logistical support to commercial farms and is part of the US Department of Agriculture (USDA) World Bank Group – was created to help rebuild countries after WWII, now days its mission is to ease poverty around the world
Mortgage Loans Government-Backed Mortgage Programs – Federal Housing Administration (FHA) Nature of Mortgage loans - Consumer and Commercial – you or a business Mortgage interest rates – rates based on time loan to be repaid, rates offered by competitive banks, etc. Adjustable-rate mortgage (ARM) the interest rate may change over the life of the loan Terms (years) and Fees (interest rate and any additional fees) Applying for a Mortgage – finances must be in order Mortgage-Related Laws – Truth in Lending Act (TILA) requires lenders to plainly show the true cost of any loan
Equity Loans Characteristics – similar to mortgage loans, called a second mortgage Consumer and Commercial – you or a business Interest Rates – higher than a mortgage loan, but less than a credit card Terms and Fees – 5 to 30 years
Five C’s of Credit Character – is a loan applicant’s honesty and integrity as shown by how he or she handles debt Capacity – is a loan applicant’s ability to pay debts as shown by cash flow Capital – is a loan applicant’s money, property, and other valuables Collateral – is used to back up a loan Conditions – involve the overall environment in which the loan will be given
Credit-Application Process Applying – customer completes the application Documenting – provide income tax returns Submitting – bank verifies the information you provided Underwriting – when lenders analyze risk and set conditions on the loan Approving – underwriter approves the applicant Closing – customer meets with the bank to review and sign the loan agreement Funding – borrow receives the amount of the loan by check or direct deposit
Profits and Loses Interest Rates Nominal annual rate identifies a loan’s annual interest rate without the cost of fees or compound interest Annual percentage rate (APR) is the annual cost of a loan, including all interest Periodic interest rate is the interest rate the lender applies to a loan’s outstanding balance to calculate the finance charge each billing period Calculating Finance Charges Average Daily Balance Method – is a way to calculate finance charges by using the card’s beginning daily balance (most common used) Previous Balance Method – is a way to calculate finance charges by using the amount the amount the customer owed at eh end of the pervious billing period Adjusted Method – using the balance from the previous month and subtracting payments made during the current period
Loans in Default Bankruptcy – is the legal procedure that enables individuals or companies to eliminate or repay some or all debt under the guidance of federal bankruptcy courts Liquidation – the process of converting property into cash to pay bills (Chapter 7 bankruptcy) Reorganization – is the process of creating a repayment plan to repay debts without liquidating property Chapter 11 bankruptcy – can make arrangements for repayment while restructure to prevent future problems Chapter 13 bankruptcy – enables an individual to make agreements with his or her lenders to repay loans without liquidating property.
Payments Negotiable Instrument – is a transferrable, signed document that represents the promise to pay a specific amount of money in the future or on demand (Ex. Check) Authorized signature – signed by the person who has authority Specific amount – the value plus interest Unconditional promise to pay – no conditions to payments Payment date Payee
Types of Negotiable Instruments Drafts – is a negotiable instrument that orders the payment to be made Checks – current date Bills of Exchange – has a future date Notes – is a negotiable instrument that promises payment, but does not order that the payment be made Promissory Note – commercial IOU Certificate of Deposit – the bank promise to repay your deposit
Using Checks Checking Accounts Checks – contains info on the drawer, drawee, payee, and how the check is processed Endorsements - is a signature used to legally transfer the value of the check Blank Endorsement –payee’s signature, without restrictions Restrictive Endorsement – limits what can be done with a check when it is presented to the bank Third-Party Endorsement – transfers the payee’s claim o the check’s value to a third party
Life Cycle of a Check Honoring a Check Date – older than 6 months banks will NOT honor it Signature – legible? Matches signature on original bank documents or your drivers license Address – permanent street address not PO box Identity of payee – legal identification required to cash check Amount – numbers match number words written out Check number – look closer at 101 thru 150 ABA routing number – correct to the financial institution Appearance – does it look right
Legal Influences Federal Reserve Check processing Electronic transfers Uniform Commercial Code – uniformity to banking Expedited Funds Availability Act – speedy access to funds Check 21- allows for electronic checks (take a picture with your phone)
Other Payment Systems Electronic Funds Transfer (EFT) – is any transfer of funds started by electronic means (ATM, Direct deposits, wire transfers, automatic payments, and bill-payments services) Automated Teller Machine (ATM) – is a computerized machine that allows a customer to perform basic banking actives Direct Deposit – funds are added directly into a bank account by electronic means instead of a check being cut Wire Transfer – transfer of funds form one location to another Automated Payments – are preauthorized electronic funds sent form a customer’s account to a vendor’s account Bill-Payment Services – customer must request transfer of funds to vendors account Credit Cards and charge cards – open ended loans that do not need to be paid off each month Debit cards – money is immediately take out of the users account