MONEY AND BANKING

[Music] oh [Music] in our complex economy making a living is a process of getting and spending money we get our income in money and we spend that money for the things we want the money itself has virtually no intrinsic worth and is merely a measure of value medium of exchange for the payment of debts and for purchases of goods and services only about 20 percent of the money in the united states is in currency and coin the other 80 percent is checkbook money and that checkbook money is in the form of deposits in our commercial banking system commercial banks are the only private financial institutions in america that provide means of payment by check commercial banking in the united states is part of the private enterprise system and just as auto mechanics offer services for a fee and grocery stores buy for the consumer's dollars commercial banks must compete with many other financial institutions to attract checking and savings accounts which provide them with the money they need to make loans that is why the banks are open and their signs out to sell their services to the public most banks have deposits insured up to the sum of fifteen thousand dollars by the federal deposit insurance corporation state and federal governments have enacted regulatory legislation to further protect people who do business with banks [Music] commercial banks provide their customers with a wide variety of like to make a payment services our car mr dowd in reviewing your estate our trust department feels that a little more liquidity is desirable and they suggest converting the real estate property on olympic boulevard into government bonds are you agreeable to them yes i am free of them you are sir you're seriously bond we have all the information we need in order to close the escrow on your new home i'd like to run a safety deposit box yes sir do you know what size you'd be interested in well i have some securities and some jewelry and some other stocks and bonds i'd like to keep in it one two three four five six seven eight hundred francs thank you all right sir that'll be five twenty dollar traveler's checks one two three four five you just sign on the top line okay here's your money order for 25 would you sign right here please thank you i want to deposit a hundred dollars in my savings the two most sought after services at banks are time deposits which are called savings accounts i'd like to deposit this in my checking and demand deposits better known as checking accounts the single most active department in any commercial bank has to do with checks a check states how much money is to be paid to whom from whom and through what account in what bank with enough money in the bank an individual can write a check in any amount and send it safely by regular mail thus averting the need to ship large amounts of cash from one concern or individual to another [Music] there is little danger of loss or theft since payment can be stopped on a check and a check cannot be cashed or deposited until it has been endorsed by the named payee a check that has been endorsed and paid serves as an automatic receipt of payment cancelled checks are returned by the bank to the depositor usually every month accompanied by a statement of the account balance checks are used to pay nine out of every ten dollars we spend and some 16 billion checkbook dollars move around the united states every day john drake like many young men his age has already learned the usefulness of a checking account enrolled in a west coast college john uses checks as a simple way to pay his bills and to keep track of his expenses you very much [Music] he receives some money from home and also holds a part-time job [Music] today john and his girlfriend are about to consider a major purchase for the coming summer months before they got some great boards johnny look at that one oh johnny i like this red one so how about yellow or maybe look it over here look this would match the car we don't want something to look at the surf on i know but it should match something what we're looking for is something that i can ride you know for my weight and yet she can still learn how to surf on you weigh about what about 150 pounds right but it has to be just right for me too because well most important it has to be just right for him no most important has to be right from my wallet his choice made john writes his check there you go 145 do you have any identification driver's license that'll be fine shows proper identification and the board is his it's that simple banking time for chris hanson owner of the surfboard shop hello how are you today mr hanson very good how's your surfing business picking up thank you that's nice as the proprietor of a neighborhood business chris is well known at his local bank today he will deposit the weekend's receipts some cash but mostly checks including john drake's few people realize the effort that goes into the handling of checks in a modern bank when chris hansen's bank gets john drake's check it and all other checks received that day are sent to their own check processing center here the amount of john drake's check is added to chris hanson's account even though hanson's bank has received no money from drake's bank the dollar amounts of all checks drawn on drake's bank and deposited during the day are added together to make a grand total at the same time drake's bank adds up the dollar amounts of all the checks it received which were drawn on hanson's bank these two groups of checks together with their dollar totals then go to a local clearing house the clearinghouse compares the dollar totals of the checks drawn on the two banks and records which of the two banks owes the other money each group of checks is given to the bank on which it was drawn at drake's bank the amount of his check is deducted from drake's account if there's any disagreement on the amounts owed between banks computers in check processing centers quickly verify the day's check transactions to correct any errors that might have been made banks together with clearinghouses and the federal reserve system make possible the daily payment of billions of dollars of checkbook money however banks seldom earn much of a profit on handling checks many make no profit at all a bank's major income is earned through charging interest for their services of lending money to borrowers [Music] today a high percentage of the more expensive items we buy are purchased with borrowed money with consumer loans yes sir may we help you today i'm kind of interested in this car that's fine car it has air conditioner deluxe interior it says 4 100 on the glass there what can i get it for well it all depends on what you would want on it what you have to trade but we go inside and talk that fine all right mr wilson i think you'll find that all in order there well that's uh white side wall tires power steering air conditioning and you're allowing me 700 on my car that's right mr wilson now we also offer a fine financing plan through our company if you wish to finance through us well i'd like to talk this over with my banker they've been doing all my other financing i just got my real estate license and i've been offered a job by one of the top realty firms now one of the requirements is that i have to have a late model car i like this one i looked at today so i'd like to see what kind of financing we can work out on it now what do you expect to be earning in the new job 400 a month draw plus commissions those who have been working for the company for six months or longer are getting a minimum of a thousand dollars a month fine now i noticed by the dealer's purchase order here that you got 700 for your trade-in how much do you intend to put down in addition to that 700 down that'll leave a balance of 27 38.65 to be financed now while i'm looking up interest charges and ways to approach this why don't you fill out our loan application if you will yes sir to establish his credit rating tom wilson states in writing where he works how long he's been employed where his new job is how much he'll earn there how much money he has in savings and other items of value how much he owes and to whom he owes it i guess that's just about it mr caldwell every loan is carefully scrutinized on the basis of the borrower's ability to keep up his payments in tom wilson's case he's borrowed money from this bank before and has a good reputation for paying his monthly charge accounts on time liberty here while you were filling out the form of looking in the book and uh making a suggestion for you i think the best answer for this loan is our straight auto loan how much interest will that be in dollars over a three year period 36 months at six percent our existing rate was 551 dollars and three cents what will the monthly payments be the monthly payment over 36 months is 91.38 cents a month now this includes a nominal charge for life insurance to protect the loan which i think is to your advantage well that's just fine in fact it's less than i expected to pay good well there's nothing further to do then for us to prepare the draft which we will have done i should think by noon tomorrow and if you can come back at that time we will hand you the draft and we have ourselves a deal and you have yourself a car tom wilson gets a new car and the bank puts dollars out on loan to earn a profit [Music] the auto loan was based on what is known as an add-on interest rate of six percent multiplying six percent interest times the amount borrowed times the three-year loan period gives a total interest charge of 492.96 for the 36-month loan dividing the interest charge of 492.96 by 36 months gives a monthly interest payment of 13.69 for 36 months there is a monthly cost of a dollar and 62 cents for the loan insurance this cost plus the 13.69 interest charge plus the repayment of 76.7 cents on the principal add up to 91.38 to reduce the balance owed by that amount every month [Music] by the 24th month the balance due would be reduced to dollars and 1096.50 six cents however the interest charge remains the same as it was the first month when the amount owed was three thousand two hundred eighty nine dollars and sixty eight cents [Music] thus by paying the same interest every month for 36 months on a declining loan balance the borrower is actually paying approximately 11 simple annual interest on the money he borrowed at 6 add-on interest banks also earn profits on commercial loans this president and treasurer of a medium-sized corporation are seeking a two million dollar loan from their local bank mr johnson here's the most recent appraisal of our equipment machinery and real estate worth four million dollars most of it as you can see is free and clear we intend to use it as collateral for the loan i presume you've studied the report on our company over the past five years yes we have mrs andrews and the projected sales plan over the next five if we get the loan we were wondering why you have to take on such a big obligation to keep your share of the market well frankly we don't have any choice production is already at capacity and if we don't expand the competition can run us right out of the market you're figuring a increase of 500 000 a year in net profit if you get the loan is that right that's right as you can see with what we're earning now we'd be able to meet our obligation if you can give us a five-year payoff well what kind of interest were you planning on paying with four million collateral six percent well i'd like to but i can't we're almost loaned up and we've just raised the interest on our savings account we have to pay more for our money so we have to charge you more well what are your best terms six and a half percent well that's a going rate anywhere around here now charlie what do you think it's still a very good loan mr johnson you've got a deal good now here's a resolution passed by the board of directors of our company authorizing charlie and me to negotiate the loan i think you'll find everything's in order how much time will you need before you can give us a firm commitment our loan committee meets every day we can let you know right after the next meeting fine the corporation's 2 million loan for a five-year term at six and a half percent simple annual interest amounts to a monthly payment of thirty nine thousand one hundred forty dollars this payment includes principal and interest multiplying two million dollars by six and a half percent gives a simple annual interest cost of one hundred thirty thousand dollars [Music] dividing this by twelve months the first month's interest payment is ten thousand eight hundred thirty three dollars [Music] twenty eight thousand three hundred seven dollars payment on the principal reduces the loan by that amount [Music] by the 31st month interest on the declining balance is five thousand eight hundred fifty three dollars thirty three thousand two hundred eighty seven dollars is paid on the principal by this monthly reduction in interest charges on a declining balance of money owed the borrower pays six and a half percent simple annual interest [Music] today's commercial banks list on their records over 200 billion dollars in outstanding consumer and commercial loans to individuals and businesses in addition banks also make public loans they lend more than 100 billion dollars a year to the united states government to states school districts cities and other public organizations and most of these 300 billion dollars of loanable funds are obtained from checking and savings accounts that millions of people keep on deposit in the nation's commercial banks over the years bankers have learned that they have to keep in reserve for normal day-to-day customer demands only a fraction of the amount of money they have on deposit in checking and savings accounts and the rest can be made available to qualified borrowers [Music] the federal reserve system is the official agency that directly influences the volume of money and credit provided to our financial system the country is divided into 12 federal reserve districts each with its own federal reserve bank the federal reserve system is directly responsible to congress the activities and policies of the reserve banks and all subscribing member banks of the system are coordinated by a sinman board of governors appointed by the president of the united states this federal reserve board of seven governors plus five representatives of the twelve reserve districts make up the federal open market committee that formulates policies and actions today some five thousand nationally chartered banks are members of the federal reserve system and most of the larger state chartered banks are also members [Music] although member banks represent only 45 percent of the banks in the country they hold more than 80 percent of all the nation's checking deposits the federal reserve system requires that member banks hold reserves in the form of deposits at a federal reserve bank or as cash in vault equal to a fraction of the bank's demand deposit liabilities to their depositors at present this required fractional reserve is about one-seventh for mathematical simplicity let's say that these reserves are 20 or one-fifth of the bank's assets and the remaining all the banks deposits support the bank's loans and investments this fractional reserve policy enables commercial banks to expand the supply of credit available to borrowers for example let's suppose a depositor places one thousand dollars in his account by regulation the bank must put twenty percent two hundred dollars in reserves at the regional federal reserve bank or keep it in ready till cash now the bank can loan the remaining eight hundred dollars to a worthy company or individual the bank thus creates an eight hundred dollar deposit for a borrower who will write checks against it for whatever purpose the loan was acquired these checks will more often than not find their way into another bank thus transferring eight hundred dollars of money to a second bank the first bank still shows one thousand dollars deposited on its books where there was one thousand dollars credited to one account now there is one thousand eight hundred dollars credited to two accounts [Music] the second bank by regulation must place twenty percent of the eight hundred dollars on deposit at the federal reserve bank then it is free to put the remaining six hundred forty dollars out to work perhaps a loan to some enterprising woman to help her buy a business of her a third bank upon receipt of the 640 deposit places 128 dollars or twenty percent with the federal reserve and perhaps invests the remaining five hundred twelve dollars in local state or federal securities to earn interest thus in three steps the original one thousand dollars has become two thousand four hundred forty dollars one thousand at the first bank plus eight hundred at the second bank plus six hundred forty dollars at the third bank and by the time this bank to bank creation of funds reaches the 25th generation bank five thousand dollars has been created within the banking system while one thousand dollars the equivalent of the original deposit has remained on reserve at the federal reserve bank and four thousand dollars has been made available for loans and investments through research departments federal reserve banks keep a watchful eye on the overall national economic look by constantly monitoring a wide range of indicators [Music] if it appears that the economy is expanding too fast and inflation threatens the federal reserve system can reduce the volume of money available for loans by changing the legal reserve requirements of member banks to tighten credit rapidly the federal reserve requirements for member banks could be raised from say 12 and a half percent or 1 8 to 20 percent or one-fifth thus ten thousand dollars in deposits would require two thousand dollars in reserve the bank must sell some of its bonds or call in some of its loans to meet reserve requirements buyers of these bonds and borrowers repaying loans use their demand deposits to meet their obligations this reduces the deposits to six thousand two hundred fifty dollars in meeting the new reserve requirement of twenty percent the supply of money available to borrowers has been reduced to five thousand dollars thus tightening credit if indicators suggest a business session is in the wind the federal reserve system can increase bank credit by reducing member bank reserve requirements suppose the federal reserve reduced reserve requirements from twenty percent or one-fifth to twelve and a half percent or one-eighth all the member banks now would have excess reserves for every ten thousand dollars on deposit the lowered reserve requirements would mean another 750 dollars in loanable funds these excess reserves would stimulate banks to expand their loans and create more deposit money thus increasing the supply of money available to borrowers the federal open market committee can also tighten or expand bank credit by selling or buying government securities to tighten bank credit available to borrowers the reserve bank sells governments the federal reserve bank presents the check it receives from the buyer of government securities to a commercial bank for payment and deducts the amount of the check from the commercial bank's reserve account this sale of government securities automatically reduces member banks reserves and their ability to make loans and investments to expand bank credit the federal reserve buys government securities the seller takes the check drawn on a reserve bank and deposits it in his commercial bank the commercial bank presents the check to a federal reserve bank that pays the check by crediting the reserve account of the commercial bank on the books of the reserve in this way the commercial bank gets more reserves and can make more loans and investments which means more money available to the public [Music] to tighten or expand credit the federal reserve can also change its discount rate that is the rate of interest member banks pay when they borrow from the reserve banks subject to approval of the federal reserve board each of the federal reserve district banks may raise or lower the discount rate for its district raising the discount rate makes it more expensive for banks to get reserves by borrowing from the federal reserve bank this discourages member banks from expanding their loans and deposits thereby reducing the supply of money available to borrowers lowering the discount rate makes it cheaper for member banks to borrow reserves from the federal reserve bank this encourages member banks to make loans and create deposits which increases the supply of money available for bank credit all lending institutions study any change in federal reserve discount rates which serve as a kind of pace setter for the interest rates that banks charge their borrowers thus by changing legal reserve requirements of member banks or by using the powers of the federal open market committee to buy or sell government securities or by changing the discount rate the federal reserve system can add money to the nation's banking system if a recession looms ahead or withhold money if inflation threatens the stability of the economy as for their part the commercial banks provide the unique service of a means of payment by check and they also use their ability under fractional reserve banking policies to make an adequate supply of credit available to qualified borrowers to a man like tom wilson the test of an adequate supply of credit is whether he can borrow enough money at a cost and on repayment terms that will permit him to buy what he wants or needs to a businessman like the corporation president the test of an adequate supply of credit is whether he can borrow enough dollars at an interest rate and on repayment terms he can afford to finance his expansion program to increase sales and profit in a dynamic and growing economy such as ours enough bank credit helps to maintain high and steadily rising levels of employment production and consumption this raises some serious questions how can government taxing borrowing and spending policies keep enough but not too much credit available to borrowers how can business and labor maintain wage and price levels that keep the value of the dollar stable and perhaps most important of all how can you learn enough about our complicated economy to support monetary and fiscal policies that will keep our dollars strong and our country prosperous speaking [Music] you