Banking System Basics

Banking and the Banking System

• There are different vehicles available for keeping money.
• It is possible to maximize your money.
• Banks and credit unions differ.
• There is a way of growing your money.
• The "Fed" plays a key role in the banking system.

Key Terms

• An account is a financial property or obligation held under your name, granting you rights and responsibilities.
• ACH (Automated Clearing House) is an electronic funds transfer system for transactions between banks, businesses, and consumers.
• APR (Annual Percentage Rate) is the total annualized cost of a loan, disclosed by lenders to inform borrowers of borrowing costs.
• APY (Annual Percentage Yield) is the annual yield earned on deposit accounts and helps savers determine the best savings options.
• ATM (Automated Teller Machine) is a location for basic banking transactions like withdrawals, deposits, and balance inquiries.
• Available balance is the amount of money in your bank account that is available for spending or withdrawal.
• Cash equivalents are liquid accounts, such as savings, checking, and money market accounts, that provide immediate access to funds without penalty or risk.
• Certificate of deposit (CD) is a time deposit account, insured by the FDIC or NCUA, where savings earn a yield for a fixed term.
• A check is a financial instrument instructing a bank to make a payment to a specified recipient.
• A checking account is your base for making financial transactions and can be interest-bearing or non-interest-bearing.
• Compound interest is a financial effect where savings grow over time by earning interest on the principal plus accumulated interest.
• Credit refers to your ability to borrow, evidenced by your credit history and credit score.
• Credit history is a record of paying bills and debts on time.
• Credit score is a measure of creditworthiness based on credit history.
• Direct deposit allows paychecks to be automatically deposited into an account, potentially reducing fees.
• Electronic Funds Transfer (EFT) transfers funds between banks, businesses, or individuals via ACH or wire transfers.
• Electronic signatures (e-signatures) have the same legal validity as written signatures under U.S. federal law.
• Endorsement is signing the back of a check to cash or deposit it.
• Federal Deposit Insurance Corporation (FDIC) ensures the stability of the U.S. financial system by protecting bank deposits up to $250,000 per depositor, per ownership category.
• Fraudulent charges are unauthorized transactions, against which banks offer protection.
• Grace period is a period where payments on loans or credit cards can be delayed without penalty or interest.
• A joint account has two or more owners with equal rights and obligations, often used by married couples.
• Maturity date is the expiration date of a financial instrument, such as a CD, after which the funds can be withdrawn.
• A money market account is an FDIC-insured deposit account that pays interest, often with higher minimum balance requirements.
• Online banks operate primarily via the internet.
• Overdraft occurs when a transaction exceeds the available balance in a checking account, often incurring fees.
• A savings account is a basic account for storing savings safely.
• Solvency is when banks have enough money to cover potential losses.
• Wire transfers are a method of electronic funds transfer that typically involves a fee.

Time Value of Money

• The time value of money is the concept that a dollar today is worth more than a dollar in the future.
• Most people prefer to consume now rather than later.
• Money received today starts earning interest sooner, leading to faster growth.
• Starting to save early can significantly increase long-term wealth.
• Saving even a small amount regularly can accumulate a substantial retirement fund.

Federal Reserve System (Fed)

• The Federal Reserve System was created in 1913 by the Federal Reserve Act.
• It serves as the nation's central bank.
• The Board of Governors in Washington, D.C., is an agency of the federal government and reports to Congress.
• The Federal Reserve System is not owned by anyone.
• It was established to provide a stable monetary and banking system after the panic of 1907.
• The Fed oversees the monetary and credit system, supports private banking, and influences interest rates and inflation.
• It is an independent government entity accountable to Congress.
• The Fed consists of 12 district banks, each overseeing a specific geographic area.
• The Fed's responsibilities include monetary policy, credit rules, currency distribution, and check clearing.

Carrying Out Monetary Policy

• The most important function of the Federal Reserve System is carrying out monetary policy.
• The Federal Open Market Committee (FOMC) makes monetary policy decisions.
• Tools used include open market operations, reserve requirements, and the discount rate.
• Open market operations involve buying or selling U.S. government bonds. Buying bonds increases the money supply and lowers interest rates, stimulating economic activity.
• Reserve requirements are the percentage of deposits banks must hold in cash. Raising requirements decreases lending, increases interest rates, and slows down economic activity.
• The discount rate is the interest rate the Federal Reserve charges member banks for loans. Lowering the rate stimulates growth, while raising it slows growth.

Setting Rules on Credit

• The Federal Reserve sets rules on credit, including consumer credit rules and margin requirements.
• Consumer credit rules dictate minimum down payments and maximum repayment periods for consumer loans.
• Margin requirements specify the minimum cash amount an investor must provide to buy securities. Lowering margin requirements stimulates securities trading.

Distributing Currency

• The Federal Reserve distributes coins and paper money, mostly in the form of Federal Reserve notes.
• Each note indicates which Federal Reserve Bank issued it.

Making Check Clearing Easier

• Check clearing involves processing checks between financial institutions.
• The Federal Reserve established maximum check-clearing times in 1988.
• The use of checks is declining as electronic payments become more popular.

Managing the 2007–2009 Financial Crisis

• The Fed's intervention prevented the U.S. economy from slipping into a deeper financial depression.
• Banks approved consumers for mortgages they couldn't afford, then packaged mortgages into high-risk financial products.
• The U.S. housing bubble burst in late 2007, causing real estate values to plummet and leading to widespread foreclosures and bankruptcies.
• The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 to regulate the financial industry and prevent future collapses.
• It created an oversight council, requires banks to increase cash reserves, prohibits banks from certain investments, and established a whistle-blower program.
• Major U.S. banks must undergo annual stress tests by the Federal Reserve to ensure they can survive economic turbulence.

Prime Rate

• The prime rate helps financial institutions determine interest rates for consumers.
• The Federal Reserve's Federal Open Market Committee (FOMC) meets every six weeks to evaluate the economy and potentially adjust the federal funds rate.
• The prime rate is based on the federal funds rate and is typically about 3% higher.
• Changes in the prime rate can affect home equity lines of credit, adjustable-rate mortgages, small business loans, and small business credit cards.
• Fixed-rate loans, rates set by the bank, or rates tied to SOFR (Secured Overnight Financing Rate) won't change due to prime rate changes.

Banks and Credit Unions

• Banks are owned by investors and operate as for-profit institutions, while credit unions are not-for-profit and owned by their members.
• Anyone can open an account at a bank, but credit unions require membership based on specific criteria.
• Banks offer personal and commercial banking products, while credit unions offer fewer commercial banking products.
• Credit unions tend to have lower fees and better interest rates on savings accounts and loans.
• Banks invest more in technology, leading to more advanced online services.
• Credit unions emphasize customer service.
• Accounts in banks and credit unions are insured up to $250,000 by the FDIC and NCUA, respectively.
• Larger banks may have poor customer service due to inflexible rules, while credit unions tend to show more flexibility, influenced by member votes.
• Banks have more locations, but credit unions have formed the CO-OP Shared Branch network to offset this.

Federal Deposit Insurance Corporation (FDIC)

• The FDIC was created in 1933 to insure deposits in commercial banks.
• It protects depositors' funds and ensure the stability of the banking system
• The Banking Act of 1933 empowered the Federal Reserve System to regulate banks.
• The FDIC insures all member banks in the Federal Reserve System, up to $250,000 per account.
• The FDIC sets guidelines for banks and reviews their financial records.
• It can take actions such as lending money, recommending mergers, or requiring new management practices.

International Banking

• International banks promote a competitive U.S. economy and are a key source of capital.
• U.S. banks provide loans to foreign governments and businesses and offer trade-related services.
• Political and economic uncertainty in other countries can make international banking risky.
• Some governments protect their banks against foreign competition.
• International banks operating in the U.S. contribute to the economy through job creation, capital expenditures, and taxes.
• The United States has five banks listed in the top 10 world’s biggest banks.