This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER FIFTEEN
Understanding Money and Financial Institutions
CHAPTER SUMMARY
Because financial institutions connect people with money, this chapter begins with a
discussion of money, its characteristics and functions, and the components of the U.S.
money supply. Money is anything that is acceptable as payment for goods and services.
It affects our lives in many ways. Businesses and government use money in similar ways.
Both require money to finance their operations. By controlling the amount of money in
circulation, the federal government can promote economic growth and stability.
For money to be a suitable means of exchange, it should be scarce, durable, portable,
and divisible. Money functions as a medium of exchange, a standard of value, and a
store of value. The U.S. money supply consists of currency (coins and paper money),
demand deposits (checking accounts), and time deposits (interest-bearing deposits that
cannot be withdrawn on demand).
The Federal Reserve System(commonly called the Fed) is the central bank of the United
States. The Fed’s primary mission is to oversee the nation’s monetary and credit system
and to support the ongoing operation of America’s private-banking system. The three
tools it uses in managing the money supply are open market operations, reserve
requirements, and the discount rate. The Federal Reserve also distributes the coins
minted and the paper money printed by the U.S. Treasury to banks. Another important
activity of the Federal Reserve is processing and clearing checks between financial
institutions.
Financial institutions can be divided into two main groups: depository institutions and
nondepository institutions. Depository institutions include commercial banks, thrift
institutions, and credit unions. Nondepository institutions include insurance companies,
pension funds, brokerage firms, and finance companies.
The Federal Deposit Insurance Corporation insures deposits in commercial banks
through the Bank Insurance Fund and deposits in thrift institutions through the Savings
Association Insurance Fund. The ceiling for all FDIC-member banks is $250,000 per account.
Deposits in credit unions are insured by the national Credit Union Share Insurance Fund,
which is administered by the national Credit Union Administration. The FDIC also sets
banking policies and practices and reviews banks annually to ensure that they operate
fairly and profitably.
, The financial marketplace spans the globe, with money routinely flowing across
international borders. U.S. banks play an important role in global business by providing
loans to foreign governments and businesses. Multinational corporations need many
special banking services, such as foreign-currency exchange and funding for overseas
investments. U.S. banks also offer trade-related services, such as global cash
management, that help firms manage their cash flows, improve their payment
efficiency, and reduce their exposure to operational risks. Political and economic
uncertainty in other countries can make international banking a high-risk venture.
The banking industry continues to change. Several trends are influencing the future of
the financial industry; including a continued focus on regulatory and compliance issues
as well as on operational efficiency and technological advances. Financial technology (or
“fintech” services) will continue to disrupt the banking industry and provide
opportunities for banks and other institutions to work closely with fintech companies
that can help them innovate and streamline their business practices. Banks will continue
to tackle customer engagement and technology initiatives over the next few years.
Mobile financial apps will continue to be a strategic advantage that separates traditional
banking approaches from innovative companies that can offer their clients a connected,
digital experience when it comes to their money and investments. Finally, the next few
years will see branch banking become less prevalent as online and mobile services
become more popular.
LEARNING OUTCOMES
1. What is money, what are its characteristics and functions, and what are the
three parts of the U.S. money supply?
Money is anything accepted as payment for goods and services. For money to be
a suitable means of exchange, it should be scarce, durable, portable, and
divisible. Money functions as a medium of exchange, a standard of value, and a
store of value. The U.S. money supply consists of currency (coins and paper
money), demand deposits (checking accounts), and time deposits (interest-
bearing deposits that cannot be withdrawn on demand).
2. How does the Federal Reserve manage the money supply?
The Federal Reserve System (the Fed) is an independent government agency that
performs four main functions: carrying out monetary policy, setting rules on
credit, distributing currency, and making check clearing easier. The three tools it
uses in managing the money supply are open market operations, reserve
requirements, and the discount rate. The Fed played a major role in keeping the
U.S. financial system solvent during the financial crisis of 2007–2009 by making
more than $9 trillion available in loans to major banks and other financial firms,
September 17, 2018 2
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER FIFTEEN
Understanding Money and Financial Institutions
CHAPTER SUMMARY
Because financial institutions connect people with money, this chapter begins with a
discussion of money, its characteristics and functions, and the components of the U.S.
money supply. Money is anything that is acceptable as payment for goods and services.
It affects our lives in many ways. Businesses and government use money in similar ways.
Both require money to finance their operations. By controlling the amount of money in
circulation, the federal government can promote economic growth and stability.
For money to be a suitable means of exchange, it should be scarce, durable, portable,
and divisible. Money functions as a medium of exchange, a standard of value, and a
store of value. The U.S. money supply consists of currency (coins and paper money),
demand deposits (checking accounts), and time deposits (interest-bearing deposits that
cannot be withdrawn on demand).
The Federal Reserve System(commonly called the Fed) is the central bank of the United
States. The Fed’s primary mission is to oversee the nation’s monetary and credit system
and to support the ongoing operation of America’s private-banking system. The three
tools it uses in managing the money supply are open market operations, reserve
requirements, and the discount rate. The Federal Reserve also distributes the coins
minted and the paper money printed by the U.S. Treasury to banks. Another important
activity of the Federal Reserve is processing and clearing checks between financial
institutions.
Financial institutions can be divided into two main groups: depository institutions and
nondepository institutions. Depository institutions include commercial banks, thrift
institutions, and credit unions. Nondepository institutions include insurance companies,
pension funds, brokerage firms, and finance companies.
The Federal Deposit Insurance Corporation insures deposits in commercial banks
through the Bank Insurance Fund and deposits in thrift institutions through the Savings
Association Insurance Fund. The ceiling for all FDIC-member banks is $250,000 per account.
Deposits in credit unions are insured by the national Credit Union Share Insurance Fund,
which is administered by the national Credit Union Administration. The FDIC also sets
banking policies and practices and reviews banks annually to ensure that they operate
fairly and profitably.
, The financial marketplace spans the globe, with money routinely flowing across
international borders. U.S. banks play an important role in global business by providing
loans to foreign governments and businesses. Multinational corporations need many
special banking services, such as foreign-currency exchange and funding for overseas
investments. U.S. banks also offer trade-related services, such as global cash
management, that help firms manage their cash flows, improve their payment
efficiency, and reduce their exposure to operational risks. Political and economic
uncertainty in other countries can make international banking a high-risk venture.
The banking industry continues to change. Several trends are influencing the future of
the financial industry; including a continued focus on regulatory and compliance issues
as well as on operational efficiency and technological advances. Financial technology (or
“fintech” services) will continue to disrupt the banking industry and provide
opportunities for banks and other institutions to work closely with fintech companies
that can help them innovate and streamline their business practices. Banks will continue
to tackle customer engagement and technology initiatives over the next few years.
Mobile financial apps will continue to be a strategic advantage that separates traditional
banking approaches from innovative companies that can offer their clients a connected,
digital experience when it comes to their money and investments. Finally, the next few
years will see branch banking become less prevalent as online and mobile services
become more popular.
LEARNING OUTCOMES
1. What is money, what are its characteristics and functions, and what are the
three parts of the U.S. money supply?
Money is anything accepted as payment for goods and services. For money to be
a suitable means of exchange, it should be scarce, durable, portable, and
divisible. Money functions as a medium of exchange, a standard of value, and a
store of value. The U.S. money supply consists of currency (coins and paper
money), demand deposits (checking accounts), and time deposits (interest-
bearing deposits that cannot be withdrawn on demand).
2. How does the Federal Reserve manage the money supply?
The Federal Reserve System (the Fed) is an independent government agency that
performs four main functions: carrying out monetary policy, setting rules on
credit, distributing currency, and making check clearing easier. The three tools it
uses in managing the money supply are open market operations, reserve
requirements, and the discount rate. The Fed played a major role in keeping the
U.S. financial system solvent during the financial crisis of 2007–2009 by making
more than $9 trillion available in loans to major banks and other financial firms,
September 17, 2018 2
