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PRIDE HUGHES KAPOOR INTRODUCTION TO BUSINESS ELEVENTH EDITION. Chapter Eighteen. Understanding Money, Banking, and Credit . 18 | 1. Learning Objectives. Identify the functions and characteristics of money.

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chapter eighteen

PRIDE HUGHES KAPOOR

INTRODUCTION TO

BUSINESS

ELEVENTH EDITION

Chapter Eighteen

Understanding Money, Banking, and Credit

18 | 1

learning objectives
Learning Objectives
  • Identify the functions and characteristics of money.
  • Summarize how the Federal Reserve System regulates the money supply in order to maintain a healthy economy.
  • Describe the organizations involved in the banking industry.
  • Identify the services provided by financial institutions.

18 | 2

learning objectives cont d
Learning Objectives (cont’d)
  • Understand how financial institutions are changing to meet the needs of domestic and international customers.
  • Explain how deposit insurance protects customers.
  • Discuss the importance of credit and credit management.

18 | 3

introduction
Introduction
  • The economic crisis
    • Described by many experts as the worst since the Great Depression
      • Many people lost their homes because they couldn’t pay their loans
      • Many people and businesses filed for bankruptcy because they couldn’t pay their loans
      • Many people and businesses found it harder or impossible to borrow money

18 | 4

what is money
What Is Money?
  • Barter system
    • A system of exchange in which goods or services are traded directly for other goods or services
  • Money
    • Anything a society uses to purchase products, services, or resources

18 | 5

the functions of money
The Functions of Money
  • Medium of exchange
    • Anything accepted as payment for products, services, and resources
  • Measure of value
    • A single standard or “yardstick” used to assign values to and compare the values of products, services, and resources
  • Store of value
    • A means of retaining and accumulating wealth
    • The consumer price index measures the effects of inflation

18 | 6

the consumer price index and the purchasing power of the consumer dollar base period 1982 1984 100
The Consumer Price Index and the Purchasing Power of the Consumer Dollar (Base Period 1982–1984 = 100)

Figure 18.1

Source:The U.S. Bureau of Labor Statistics website, www.bls.gov, June 16, 2010.

18 | 7

the consumer price index and the purchasing power of the consumer dollar base period 1982 1984 1001
The Consumer Price Index and the Purchasing Power of the Consumer Dollar (Base Period 1982–1984 = 100)

Figure 18.1

Source:The U.S. Bureau of Labor Statistics website, www.bls.gov, June 16, 2010.

18 | 8

important characteristics of money
Important Characteristics of Money
  • Divisibility
  • Portability
  • Stability
  • Durability
  • Difficulty of counterfeiting

18 | 9

the supply of money m1 and m2
The Supply of Money: M1 and M2
  • Demand deposit
    • An amount on deposit in a checking account
  • Time deposit
    • An amount on deposit in an interest-bearing savings account
  • Two main measures of the supply of money
    • M1
      • Currency, demand deposits, and travelers checks
    • M2
      • M1 plus savings accounts, certain money-market securities and small-denomination time deposits or certificates of deposit (CDs) of less than $100,000

18 | 10

the supply of money
The Supply of Money

Figure 18.2

Source:The Federal Reserve website, www.federalreserve.gov, accessed June 15, 2010.

18 | 11

the federal reserve system
The Federal Reserve System
  • The central bank of the United States responsible for regulating the banking industry
    • Controlled by a seven-member board of governors who are appointed by the president and confirmed by the Senate to serve a fourteen-year term
    • Composed of twelve district banks and twenty-four branch banks
    • District banks are owned by commercial banks that are members of the Federal Reserve system
    • Main function is to regulate the banking system and maintain a healthy economy

18 | 12

the federal reserve system cont d
The Federal Reserve System (cont’d)

Figure 18.3

Source: “91st Annual Report, 2004,” The Federal Reserve Board website, www.federalreserve.gov, accessed June 18, 2010.

18 | 13

the federal reserve system cont d1
The Federal Reserve System (cont’d)
  • Economic crisis and the Fed’s response
    • Provided liquidity
    • Supported troubled financial markets
    • Supported important financial institution
    • Conducted stress tests of major banks

18 | 14

the federal reserve system cont d2
The Federal Reserve System (cont’d)
  • Regulation of reserve requirements
    • Reserve requirement—the percentage of its deposits a bank must retain, either in its own vault or on deposit with its Federal Reserve District Bank
    • More required reserves = less money in circulation
    • Less required reserves = more money in circulation to stimulate the economy

18 | 15

the federal reserve system cont d3
The Federal Reserve System (cont’d)
  • Regulation of the discount rate
    • Discount rate—the interest rate the Federal Reserve System charges for loans to member banks
    • Lower loan rates allow banks to lend more and stimulate the economy
    • Higher rates slow the economy

18 | 16

the federal reserve system cont d4
The Federal Reserve System (cont’d)
  • Open-market operations
    • The buying and selling of U.S. government securities by the Federal Reserve System for the purpose of controlling the supply of money
    • To reduce the money supply, the Fed sells government securities to take money out of circulation
    • To increase the money supply, the Fed buys government securities

18 | 17

the federal reserve system cont d5
The Federal Reserve System (cont’d)
  • Other Fed responsibilities
    • Serving as the U.S. government bank
    • Clearing checks and electronic transfers of funds between banks
    • Inspection and replacement of worn and unfit currency
    • Selective credit controls
      • Truth-in-Lending Act enforcement
      • Stock purchase margin requirements

18 | 19

the american banking industry
The American Banking Industry
  • Banking and financial reform: New regulations
    • Goals are
      • Protection from unfair, abusive financial and banking practices
      • Close gaps that allowed large banks and financial firms to avoid strong, comprehensive federal oversight
      • Curb high-risk investment strategies
      • Require banks and financial firms to pay back bailout funds
      • Provide a foundation for stable economic growth

18 | 20

the american banking industry cont d
The American Banking Industry (cont’d)
  • Commercial bank
    • A profit-making organization that accepts deposits, makes loans, and provides related services to its customers
      • National bank: chartered by the U.S. Comptroller of the Currency
      • State bank: chartered by the banking authorities in the state in which it operates

18 | 21

the seven largest u s banks ranked by total revenues
The Seven Largest U.S. Banks,Ranked by Total Revenues

Table 18.2

Source:The Fortune website, www.fortune.com, accessed June 20, 2010.

18 | 22

the american banking industry cont d1
The American Banking Industry (cont’d)
  • Other financial institutions
    • Savings and loan associations (S&L)
      • A financial institution that offers checking and savings accounts and CDs and that invests most of its assets in home mortgage loans and other consumer loans
    • Credit unions
      • A financial institution that accepts deposits from and lends money to only those people who are its members
      • Members are usually employees of a particular firm, people in a particular profession, or those who live in a community served by a local credit union

18 | 23

the american banking industry cont d2
The American Banking Industry (cont’d)
  • Other financial institutions (cont’d)
    • Organizations that perform banking functions
      • Mutual savings banks
      • Insurance companies
      • Pension funds
      • Brokerage firms
      • Finance companies
      • Investment banking firms

18 | 24

careers in banking
Careers in Banking
  • The seven largest banks in the U.S. employ approximately 1,200,000 people
  • The U.S. Department of Labor expects the number of people employed in banking to grow more slowly than other jobs in the economy between now and the year 2018
  • Traits of successful bankers
    • Honesty
    • Ability to interact with people
    • Strong background in accounting
    • Appreciation for the banking-finance relationship
    • Basic computer skills

18 | 25

traditional services provided by financial institutions
Traditional Services Provided by Financial Institutions
  • Checking accounts
    • Check—a written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the check
    • NOW account—an interest-bearing checking account
  • Savings accounts
    • Passbook savings account
    • Certificate of deposit (CD)—a document stating that the bank will pay the depositor a guaranteed interest rate for money left on deposit for a specified period of time
  • Short- and long-term loans
    • Line of credit—a loan that is approved before the money is actually needed
    • Revolving credit agreement—a guaranteed line of credit
    • Collateral—real estate or property pledged as security for a loan

18 | 26

traditional services provided by financial institutions cont d
Traditional Services Provided by Financial Institutions (cont’d)
  • Credit-card and debit card transactions
    • Banks and other financial institutions charge merchants fees (a percentage of each credit card transaction) for handling the transactions for the merchant
    • Debit card—a card that electronically subtracts the amount of a purchase from the cardholder’s bank account at the moment the purchase is made

18 | 27

innovative banking services
Innovative Banking Services
  • Changes in the banking industry
    • Anticipated changes
      • More emphasis on evaluating the creditworthiness of loan applicants as a result of the recent economic crisis
      • An increase in government regulation of the industry
      • A reduction in the number of banks, S&Ls, credit unions, and financial institutions because of consolidation and mergers
      • Globalization of the banking industry

18 | 29

innovative banking services cont d
Innovative Banking Services (cont’d)
  • Changes in the banking industry (cont’d)
    • Anticipated changes (cont’d)
      • The importance of customer service as a way to keep customers from switching to competitors
      • Increased use of credit and debit cards and a decrease in the number of written checks
      • Increased competition from nonbank competitors that provide many of the same services as banks (S&Ls, credit unions)
      • Continued growth in online banking

18 | 30

online banking
Online Banking
  • Advantages
    • Easy access to account regardless of time or location
    • Ability to obtain current account balances
    • Convenience of transferring funds
    • Ability to pay bills
    • Convenience of seeing which checks have cleared
    • Easy access to current interest rates
    • Simplified loan application procedures
    • For banks—lower processing costs
  • Disadvantages
    • Not being able to discuss financial matters with a personal banker

18 | 31

online banking cont d
Online Banking (cont’d)
  • Electronic funds transfer (EFT) system
    • A means of performing financial transactions through a computer terminal or telephone hookup
    • Changing how banks do business
      • Automated teller machines (ATMs)
      • Automated clearinghouses (ACHs)
      • Point-of-sale (POS) terminals
      • Electronic check conversion (ECC)

18 | 32

international banking
International Banking
  • Popular methods of paying for import and export transactions
    • Letter of credit
      • A legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time
    • Banker’s acceptance
      • A written order for the bank to pay a third party a stated amount of money on a specific date
  • Currency exchange

18 | 33

the fdic and ncua
The FDIC and NCUA
  • Federal Deposit Insurance Corporation (FDIC)
    • Created as a result of the Depression, to restore public confidence in the banking industry to insure deposits against bank failures
  • FDIC provides deposit insurance of $250,000 per account
  • National Credit Union Association (NCUA)
    • Insures the deposits of credit union members for up to $250,000 per account

18 | 34

effective credit management
Effective Credit Management
  • Credit
    • Immediate purchasing power that is exchanged for a promise to repay borrowed money, with or without interest, at a later date
  • Borrower
    • Person or business wishing to make a purchase
  • Lender
    • Bank or firm selling merchandise or service on credit
    • Interest charged for the loan is profit

18 | 35

getting money from a bank or lender after a credit crisis

For businesses

Develop a relationship with your banker

Apply for a preapproved line of credit or revolving credit agreement even if you do not need the money

Supply financial statements and tax documents

Update your business plan

Prepare a convincing cover letter

Getting Money from a Bank or Lender After a Credit Crisis

For individuals

  • Fill out a loan application
  • Describe how you will use the money and how you will repay it
  • Prepare for an interview
  • If rejected, ask the loan officer why

18 | 36

the five c s of credit management
The Five C’s of Credit Management
  • The five Cs of credit management
    • Character—the borrower’s attitude toward credit obligations
    • Capacity—the borrower’s financial ability to meet credit obligations
    • Capital—the extent of the borrower’s assets or net worth
    • Collateral—borrower assets that can be pledged as security for a loan
    • Conditions—general economic conditions that can affect a borrower’s ability to repay the loan

18 | 37

credit application form
Credit Application Form

Figure 18.5

18 | 38

checking credit information
Checking Credit Information
  • Credit information sources regarding businesses
    • Global credit-reporting agencies
    • Local credit-reporting agencies
    • Industry associations
    • Other firms that have given the firm credit
  • Credit information concerning individuals
    • Experian
    • Trans Union
    • Equifax
  • Fair Credit Reporting Act
    • Consumers have a right to know what information is in their credit bureau files
    • Consumers have a right to request that information in their files be verified, and they can file an explanation of their side of a dispute

18 | 39

new protection for consumers the credit card act of 2009
New Protection for Consumers: The Credit Card Act of 2009
  • Designed to level the playing field between credit card customers and financial institutions that issue credit cards
    • Disclosures regarding due dates, late fees, time required to pay off balances written in plain language
    • Protection against arbitrary rate increases, requires 45-day notice
    • Increased protection for students and people under 21
    • Standardized billing dates
    • Requires fees to be reasonable in relation to a credit agreement violation
    • New measures of accountability such as posting contract on the Internet review by Federal Reserve Board
    • Increases penalties for companies that violate the Truth in Lending Act for credit card customers

18 | 40

sound collection procedures
Sound Collection Procedures
  • Techniques
    • Subtle reminders
    • Telephone calls
    • Personal visits
    • Legal action
  • Sound collection procedures
    • Firm
    • Fair, allowing for compromise
    • Not harassing

18 | 41