Forms and Functions of Modern Banking

Economic Definitions

1. Modern Banking
Measures of the Money Supply,
Functions and Types of Financial Institutions,
And
Modern E-Banking

2. Measuring the Money Supply
To understand Modern Banking, an understanding of what constitutes
the Money Supply, the money available in the economy, is needed.
The Money Supply is divided into two distinct categories:
M1 – Assets that can be easily accessed and immediately used to
purchase goods and services. These are referred to as Liquid Assets.
Money deposited in Checking Accounts meets this criteria because
checks represent Demand Deposits, as they are paid “On Demand” for
the cash in the account.
M2 – All of M1 and assets that cannot be used directly as cash but can
easily be converted to cash.
Money Market Mutual Funds are examples of this because they can be
used as collateral against certain types of checks.
Savings accounts also fall into this category.

3. Functions of Financial Institutions
Financial Institutions utilize the Money Supply
to perform many roles including:
Storing Money
Saving Money
Loans
Mortgages
Credit Cards
Conveying Interest (Simple and Compound)
Earning a Profit

4. Storing Money
One of the basic
functions of a bank is to
provide a safe, and
convenient, storage
location for valuables,
chiefly money.
Vaults are generally
fireproof and nearly
impenetrable.
Banks are insured
against losses due to
theft.

5. Saving Money
Banks offer a variety of
means of saving money
such as:
Savings Accounts
Checking Accounts
Money Market Accounts
Certificates of Deposit
Banks generally pay interest,
an amount paid for the use
of your money, on these
accounts.

6. Loans
Banks offer loans, money
given out for a period of time
in exchange for fees and
interest charges.
Banks are limited in the total
amount of loans that they
issue because of the
Fractional Reserve System.
This is the idea that
banks must keep a
certain percentage of the
value of loans that they
issue on hand in the form
of deposits.

7. Mortgages
Mortgages are specific types
of loans used to buy real
estate.
They generally come in term
lengths of 15, 25, or 30
years.
A key determining factor in
determining the interest rate
and the term on the
mortgage is the borrowers
Creditworthiness.
That is a reflection of the
likelihood that the
borrower will be able to
repay the loan and not
default, or fail to repay
the loan.

8. Credit Cards
Credit Cards are cards that
allow their holders to make
purchases of goods and
services in exchange for the
credit card’s provider
immediately paying for the
good or service, and the
card holder promising to pay
back the amount of the
purchase to the card
provider over a period of
time, and with interest.
The amount of credit
available to a card holder is
often a reflection of their
creditworthiness.

9. Simple and Compound Interest
Banks earn income through the
interest that they charge on their
lending.
As we have already established,
Interest is the price paid to use
borrowed money.
In can take two forms:
Simple – Interest paid on an
annualized basis as a
percentage of the value of
the loan or deposit – know
as the Principal.
Compound – Interest paid
annually on the total
principal, and the
accumulated interest from
previous time periods.

10. Earning a Profit
Banks exist to earn
money the same as any
other business.
They do this through
charging interest on
their lending and
through charging
various fees for their
services.

11. Modern E-Commerce
Modern Banks utilize electronic formats to
complete many of their functions.
These electronic formats can include:
Automated Teller Machines (ATMs)
Debit Cards
Home Banking
Automatic Clearing Houses (ACHs)
Stored Value Cards

12. ATMs
ATMs replace human bank
tellers in performing basic
banking functions such as:
Deposits
Withdrawals
Account Inquiries
Key advantages of ATMs
include:
24 hour availability.
Elimination of labor
costs.
Convenience of location.

13. Debit Cards
Debit cards are used to
electronically withdraw
funds directly from the
cardholders accounts.
Most debit cards require
a Personal Identification
Number (PIN) to be
used to verify the
transaction.

14. Home Banking
Home banking is the process
of completing financial
transactions from your own
home as opposed to utilizing
a branch of a bank.
Actions can include:
Make Account Inquiries
Transfer Money
Pay Bills
Apply for Loans
Direct Deposit

15. Automatic Clearing Houses (ACHs)
ACHs facilitate the payment
of bills without the need to
write a check.
An ACH can be used to
create automatic monthly bill
payments so that the payer
does not have to initiate the
payment of the bill.
Benefits Include:
Postal Savings
No Forgotten Payments
Time Savings

16. Stored Value Cards
Stored Value Cards are used
in a manner very similar to a
Debit Card.
The card is Loaded, or
credited, with a set value.
That value can then be used
to make purchases.
Examples of this concept
include:
Prepaid Calling Cards
Store Gift Cards
ACCESS Cards