Banking Basics

Table of contents Introduction 4

Whatisabank? 6

Howdopeoplestartbanks? 7

Howdidbankingbegin? 8

Whyaretheresomanydifferenttypesofbanks? 11

HowdoIchooseabank? 13

Whattypesofaccountsdobanksoffer? 14

Isitdifficulttoopenabankaccount? 16

Whathappenstomoneyafteryoudepositit? 18

Whathappenswhenyouapplyforaloan? 20

Whatarechecks,andhowdotheywork? 23

Whatiselectronicbanking? 25

Creditcards,debitcards,storedvaluedcards:What’sthedifference? 27

Dobankskeeplargeamountsofgoldandsilverintheirvaults? 30

Whydobanksfail? 31

Doyoulosemoneyifyourbankfails? 34

Doyoulosemoneyifyourbankisrobbed? 35

HowdoestheFederalReservefitintotheU.S.bankingsystem? 36

ResourcesforEveryone 40

IntroductionSomeyoungsaversstashtheircashinshoeboxesorjellyjars.Othersuse“piggybanks,”whichtodaylookmorelikespaceshipsorcartooncharacters.

Inanycase,thesameproblemarises.Soonerorlater,thepiggybankorjellyjarfillsup,andyouhavetomakeadecision:ShouldIspendthemoneyorcontinuetosave?AndifIcontinuetosave,shouldIopenabankaccountorjustfindabiggerjar?

Maybeyou’vehadtofacesuchadecisionyourself.Ifyoudecidetokeepyourmoneyathome,itwilljustsitthereandwon’tearnanyextramoneyforyou.Youalsoruntheriskthataburglar,afire,orsomeotherdisasterwillwipeoutyoursavingsinthewinkofaneye.

Thenagain,ifyouopenabankaccount,youcan’t“visit”yourmoneyaseasilyasyoucanwhenitsitsinyourdresserdrawer.Youcan’tjustwalkintoabankinthemiddleofthenighttocountyourcash.Youcan’trunthecoinsthroughyourfingersortossthebillsintheairandletthemraindownonyourhead.

Openingabankaccountisabigstepbecauseyouareputtingyourmoneyinsomeoneelse’shands.You’recountingonsomeoneelsetohandleyourmoneyresponsibly.Beforeyoudothat,itmightbeagoodideatounderstandhowbanksoperate.

That’sthepurposeofthispamphlet.Itwon’ttellyoueverythingthereistoknowaboutbanksandbanking,butwehopeitwillbeagoodbasicintroduction.

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What is a bank?Abankisabusiness.Butunlikesomebusinesses,banksdon’tmanufactureproductsorextractnaturalresourcesfromtheearth.Bankssellfinancialservicessuchascarloans,homemort-gageloans,businessloans,checkingaccounts,creditcardservices,certificatesofdeposit,andindividualretirementaccounts.

Somepeoplegotobanksinsearchofasafeplacetokeeptheirmoney.Othersareseekingtoborrowmoneytobuyahouseoracar,startabusiness,expandafarm,payforcollege,ordootherthingsthatrequireborrowingmoney.

Wheredobanksgetthemoneytolend?Theygetitfrompeoplewhoopenaccounts.Banksactasgo-betweensforpeoplewhosaveandpeoplewhowanttoborrow.Ifsaversdidn’tputtheirmoneyinbanks,thebankswouldhavelittleornomoneytolend.

Yoursavingsarecombinedwiththesavingsofotherstoformabigpoolofmoney,andthebankusesthatmoneytomakeloans.Themoneydoesn’tbelongtothebank’spresident,boardofdirectors,orstockholders.Itbelongstoyouandtheotherdepositors.That’swhybankershaveaspecialobligationnottotakebigriskswhentheymakeloans.

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How do people start banks?Theprocessofstartingabankvariesfromstatetostate,but,ingeneral,here’showitgoes:

1.Agroupofindividualsdecidestostartabank.Theirfirststepistoapplyforacharterfromtheirstatebankingcommission.*Thechartersetsouttherulesforhowtheymustoperatetheirbank.

2.The banking commission reviews the application to make sure it is complete and thenschedulesahearing.

3.Thecommissionlooksatthefinancialconditionandthecharacteroftheapplicants.

4.Afterthat,thebankingcommissionwilleitherapprovetheapplicationordenyit.

5.Ifapproved, thegroupthatappliedtostart thebankwill thenhaveacertainamountoftimetoraisethenecessarycapital,puttogetherafullmanagementteam,andobtainfederaldepositinsurance.

6.Whenthat’sdone, thegroupwillnotify thebankingcommission,whichwill thenreviewthelistofproposedinvestors.Ifthecommissionhasnoobjectiontothelist,ifthebankisinsured,andifanacceptablemanagementteamisinplace,thecommissionwillissueitsfinalapprovalandthebankmayopenforbusiness. * The United States has

a dual banking system. People who want to start a bank can choose to apply for either a state charter or a charter from the federal government.

How did banking begin?ImagineforamomentthatyouareamerchantinancientGreeceorPhoenicia.Youmakeyourlivingbysailingtodistantportswithboatloadsofoliveoilandspices.Ifallgoeswell,youwillbepaidforyourcargowhenyoureachyourdestination,butbeforeyousetsailyouneedmoneytooutfityourship.Andyoufinditbyseekingoutpeoplewhohaveextramoneysittingidle.Theyagreetoputupthemoneyforyourvoyageinexchangeforashareofyourprofitswhenyoureturn...ifyoureturn.

Thepeoplewiththeextramoneyareamongtheworld’sfirstlenders,andyouareamongtheworld’sfirstborrowers.Youcomplainthatthey’redemandingtoolargeashareoftheprofits.Theyreplythatyourvoyageisperilous,andtheyrunariskoflosingtheirentireinvestment.Lendersandborrowershavecarriedonthisdebateeversince.

Today,peopleusuallyborrowfrombanksratherthanwealthyindividuals.Butonethinghasn’tchanged:Lendersdon’tletyouhavetheirmoneyfornothing.

Lendershavenoguaranteethattheywillgettheirmoneyback.Sowhydotheytaketherisk?Becauselendingpresentsanopportunitytomakeevenmoremoney.

Forexample,ifabanklends$50,000toaborrower,itisnotsatisfiedjusttogetits$50,000back.Inordertomakeaprofit,thebankchargesinterestontheloan.Interestisthepricebor-rowerspayforusingsomeoneelse’smoney.Ifaloanseemsrisky,thelenderwillchargemoreinteresttooffsettherisk.(Ifyoutakeabiggerchance,youwantabiggerpay-off.)

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Buttheopportunitytoearnlotsofinterestwon’tcountformuchifaborrowerfailstorepayaloan.That’swhybanksoftenrefusetomakeloansthatseemtoorisky.Beforelendingyoumoney,theylookat: •howmuchandwhattypesofcredityouuse,suchascreditcards,autoloans,orother

consumerloans; •whetherornotyouhaveahistoryofrepayingyourloans,and •howpromptlyyoupayyourbills.

Banksalsouseinteresttoattractsavers.Afterall,ifyouhaveextramoneyyoudon’thavetoputitinthebank.Youhavelotsofotherchoices:

•Youcanburyitinthebackyardorstuffitinamattress.Butifyoudothat,themoneywilljustsitthere.Itwon’tincreaseinvalue,anditwon’tearninterest.

•Youcanbuylandorinvestinrealestate.Butiftherealestatemarketweakens,buildingsandlandcantakealongtimetosell.Andthere’salwaystheriskthatrealestatewilldropinvalue.

•Youcaninvestinthestockmarket.Butlikerealestate,stockscanalsodropinvalue,andthesharepricemightbelowwhenyouneedtosell.

•Youcanbuygoldorinvestincollectiblessuchasbaseballcards,butgoldandcollectiblesfluctuateinvalue.Whoknowswhatthevaluewillbewhenit’stimetosell?(In1980,goldsoldfor$800anounce.By1983,thepricehadsunkbelow$400.)

Oryoucanputthemoneyinabank,whereitwillbesafeandearninterest.Manytypesofbankaccountsalsoofferquickaccesstoyourmoney.

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Interest is the price borrowers pay for using someone else’s money.

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Why are there so many different types of banks?Notallbanksareexactlythesame.Therearecommercialbanks,savingsbanks,savingsandloanassociations(S&Ls),cooperativebanks,andcreditunions.Todaytheyoffermanyofthesameservices,butatonetime,theywereverydifferentfromoneanother.

Commercial banksoriginallyconcentratedonmeetingtheneedsofbusinesses.Theyservedasplaceswhereabusinesscouldsafelydeposititsfundsorborrowmoneywhennecessary.Manycommercialbanksalsomadeloansandofferedaccountstoindividuals,buttheyputmostoftheireffortintoservingbusiness(commercial)customers.

Savings banks, S&Ls, cooperative banks,andcredit unionsareclassifiedasthriftinstitu-tionsor“thrifts,”ratherthanbanks.Originally,theyconcentratedonservingpeoplewhosebankingneedswereignoredorunmetbycommercialbanks.

Thefirstsavings bankswerefoundedintheearly1800stogiveblue-collarworkers,clerks,anddomesticworkersasecureplacetosavefora“rainyday.”Theywerestartedbypublic-spiritedcitizenswhowantedtoencourageeffortsatsavingamongpeoplewhodidnotearnmuchmoney.

Savings and loan associationsandcooperative bankswereestablishedduringthe1800stohelpfactoryworkersandotherwageearnersbecomehomeowners.S&Lsacceptedsavingsdepositsandusedthemoneytomakeloanstohomebuyers.Mostoftheloanswenttopeoplewhodidnotmakeenoughmoneytobewelcomeattraditionalbanks.

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Credit unions began as a 19th-century solution to the emergency needs of people whowereunabletoborrowmoneyfromtraditionallenders.Beforetheopeningofcreditunions,ordinary citizens had no place to turnwhen they faced unexpected home repairs,medicalexpenses,orotheremergencies.Creditunionswerestartedbypeoplewhosharedacommonbondsuchasworkinginthesamefactory,belongingtothesamehouseofworship,orfarminginthesamecommunity.Memberspooledtheirsavingsandusedthemoneytomakesmallloanstooneanother.

Althoughtherearestilldifferencesbetweenbanksandthrifts,theynowoffermanyofthesamebankingservicestotheircustomers.Mostcommercialbanksnowcompetetomakecarloans.Manythriftinstitutionshavebeguntomakecommercialloans,andsomecreditunionsmakeloanstohomebuyers.

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Credit unions were started by people who shared a common bond. Members pooled their savings and used the money to make small loans to one another.

How do I choose a bank?Backinthe1950s,banksoftengaveawaytoasterstonewdepositors,andthatmadechoosingabanksimpler.Youwenttotheonethatgaveawaythebesttoaster.

Todaybanksrarelygiveawaytoasters,andchoosingabankisalittlemorecomplicated.Forstarters,youshouldshoparoundtofindoutwhichbanksofferthebestservicesandthelow-estfees.Somebankschargeamonthlyfeeifyouraccountfallsbelowacertainlevel,andthatfeecanbehigherthantheinterestyouraccountearns.Otherbanksmaychargefeesformanytypesoftransactions.Youdon’twantthat.

Incertainstates,suchasMassachusetts,thelawprohibitsbanksfromchargingfeesonsavingsaccountsheldbypeopleundertheageof18orovertheageof65.Findoutifyourstatehassuchalaw.

Otherthingsyoumightwanttoconsider:

1.Doesyourbankpaydepositorsacompetitiveinterestrate?

2.Isthebankinaconvenientlocationandareitsbusinesshoursconvenientforyou?

3.IsyourdepositinsuredbytheFDIC(FederalDepositInsuranceCorporation)?

4.Isthebankagoodcorporatecitizen?Doesitinvestinyourneighborhood?

5.Andlast,butcertainlynotleast,doesyourbankprovidecourteousandefficientservice?

Beforeyouopenanaccount,askafewpeopleiftheyarehappywiththeirbank.Anddosomecomparisonshoppingbecauseallbanksarenotthesame.

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What types of accounts do banks offer?People use banks for different purposes. Some have extra money to save; others need toborrow.Someneedtomanagetheirhouseholdfinances;othersneedtomanageabusiness.Bankshelptheircustomersmeetthoseneedsbyofferingavarietyofaccounts.

Savings accounts are forpeoplewhowant tokeeptheirmoney inasafeplaceandearninterestatthesametime.Youdon’tneedalotofmoneytoopenasavingsaccount,andyoucanwithdrawyourmoneyeasily.

Certificates of deposit(CDs)aresavingsdepositsthatrequireyoutokeepacertainamountofmoneyinthebankforafixedperiodoftime(example:$1,000fortwoyears).Asarule,youearnahigherrateofinterestifyouagreetokeepyourmoneyondepositlonger,andthereisusuallyapenaltyifyouwithdrawyourmoneyearly.

Individual retirement accounts(IRAs)aresavingsdepositsthatofferanexcellentwaytosaveforyourlateryears.Youdon’thavetopaytaxonthemoneyyoudepositinyourIRAuntilyouwithdrawit.Butthereisoftenasignificantpenaltyifyouwithdrawyourfundsbeforeyoureachaspecifiedage(usually59orolder).

Checking accountsoffersafetyandconvenience.Youkeepyourmoneyintheaccountandwriteacheckwhenyouwanttopayabillortransfersomeofyourmoneytosomeoneelse.Ifyourcheckbookislostorstolen,allyouneedtodoiscloseyouraccountandopenanewonesothatnobodycanuseyouroldchecks.(Whencashislostorstolen,yourarelyseeitagain.)Anotherattractivefeatureofacheckingaccountisthatyourbanksendsyouamonthlyrecordofthechecksyouhavewritten,andyoucanusethatrecordifeverneedtoprovethatyou’vemadeapayment.Bankssometimeschargeafeeforcheckingaccounts,becausecheckprocessingiscostly.

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Manybanksalsoofferno-feecheckingandcheckingaccountsthatearninterestifyouagreetokeepacertainamountofmoney—aminimumbalance—intheaccount.Buttheseaccountsarelimitedtonon-businesscustomers.Bankinglawsalmostalwaysrequirebusinessestouseregularcheckingaccountsthatdonotpayinterest.

Money market deposit accountsaresimilartocheckingaccountsthatearninterest,exceptthat theyusuallypayahigherrateof interestandrequireahigherminimumbalance (often$2,500ormore).Theyalsolimitthenumberofchecksyoucanwritepermonth.

Finally,banksdonotalwayscalltheiraccountsbythesamenames.Often,theychoosedistinc-tivenamesinhopesofattractingcustomers.Buttherecanbearealdifferencebetweenonebank’saccountsandanother’s,soshoparound.

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Banks sometimes charge a fee for checking accounts, because check processing is costly.

Is it difficult to open a bank account?You’vefinallydecidedtotaketheplunge.Withyourcashtuckeddeepinyourpocket,youwalkintothebankandasktoopenasavingsaccount.

The bank’s receptionist directs you to a desk where a customer service representativewillhelpyouwiththepaperwork.Toyoursurprise,theonly formyouneedtofillout isasignature card, which requires you to sign your name and then print your name, address,telephonenumber,dateofbirth,socialsecuritynumber,andyourmother’smaidenname(asameansoffurtheridentification).Afteryoucompletethesignaturecard,youreceiveabankbook(sometimescalledapassbook)thatlistsyouraccountbalance(thetotalamountofmoneyinyouraccount).

Whenever you make a deposit (put money in) or a withdrawal (take money out), thetransactionisrecordedinyourbankbook.Itisveryimportantforyoutokeeptrackoftheactivityinyouraccount.

Youdon’tneedlotsofmoneytostartasavingsaccount.Somebanksletyouopenonewithaslittleas$20.Nordoyouneedtowaituntilyouare18yearsold.Inmostcases,youcanopenasavingsaccountassoonasyouareoldenoughtosignyourname,orevenearlierthanthatifyouopentheaccountwithaparentorguardian.

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What happens to money after you deposit it?Whathappenstoa$10billafteryoudeposititinyoursavingsaccount?Doesthebanktellertakeittoavaultandputitintoaseparatecompartmentorcubbyholemarkedwithyournameandaccountnumber?No.

Thebankbeginsbyadding$10totheamountthatisalreadyinyouraccount(yourexistingbalance).Your$10depositandyournewbalancearethenrecordedinyourbankbookandinthebank’scomputersystem.The$10billyoudepositedismixedinwithalltheothercashyourbankreceivesthatday.

Whenyouandothercustomersdepositmoneyinabank,thebank“putsmostofittowork.”Partofthemoneyissetasideandheldinreserve,butmuchoftherestisloanedtopeoplewhoneedtoborrowmoneyinordertobuyahouseoracar,expandabusiness,buyfarmequipment,ordoanyoftheotherthingsthatrequirepeopletoborrowmoney.

Ofcourse,banksdonot lendmoney just toprovideaservice.Theydo it tomakemoney.Here’showitworks.

Whenyoukeepyoursavingsinabank,thebankpaysyouextramoney,whichiscalledinterest.Theinterestisaddedtoyouraccountonaregularbasis,usuallyonceamonth.

Let’ssayabankpaysitsdepositorsinterestof3percentayearontheirsavings.Insimpleterms,thatmeans ifyoukeep$100inyoursavingsaccount,thebankwilladd$3toyouraccountbalanceduringthecourseofayear.

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But,thereisanothersidetointerest.Whensomeoneborrowsmoneyfromabank,thebankchargesinterest,anditchargesborrowersahigherratethanitpayssavers.Forexample, itmightpaysavers3percentandchargeborrowers8percent.Thedifference,8percentminus3percent,goestothebank.Charginginterestonloansisoneofthemainwaysforabanktomakemoney.

Therateofinterestabankchargesdependslargelyontwothings:•howmanypeoplewanttoborrowmoney,and•howmuchmoneybankshaveavailabletolend.

Ifabankhasplentyofmoneytolend,andthedemandtoborrowmoneyisnotparticularlystrong,interestrateswilltendtobelowinordertoattractborrowers.Butwhenbankshaveasmalleramountofmoneytolend,andthedemandtoborrowisfairlystrong,interestrateswillrise.Asadepositor,youwantinterestratestobehigh,butasaborrower,youwantthemtobelow.

When it comes to paying interest on savings deposits, there usually isn’t a big differencebetween banks. They pay just enough to stay competitive with one another and attractdepositors. So, if one bank is offering a much better (higher) rate than most other banks,trytofindoutwhy.Andremembertheoldsaying: If something sounds too good to be true, it probably is.

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As a depositor, you want interest rates to be high, but as a borrower, you want them to be low.

What happens when you apply for a loan?Lastweekyourmechanicadvisedyounottospendanymoremoneyonthefaithfuloldcarthathascarriedyouovermanymilesofhighway.Thetimehascometoshoparoundforanewone.Butcarswerealotcheaperwhenyoulastboughtone.Thistimeyou’llhavetotakeoutabigloan.

Youdon’tnecessarilyhavetoborrowfromthebankwhereyouhaveanaccount.Youshouldshoparoundforalenderthatoffersthebestdeal,includingthelowestinterestrate.Sometimescarcompaniesofferlow-interest,orevenno-interestloans.Anddon’tforgettheinternet.Youcanresearchawealthofonlineresourcesfromthecomfortofyourhomeoroffice.

Yourfirststepistofigureouthowmuchyoucanaffordtoborrow.Youwillnotknowifyoucanaffordthenewcar—orifalenderwillletyouborrowtheamountwant—untilafteryoucompletea loanapplication. Inadditiontoroutinepersonal informationsuchasyourname,address,telephonenumber,andSocialSecuritynumber,aloanapplicationalsoasksforinfor-mationonhowmuchmoneyyouearn,howlongyouhaveworkedatyourcurrentjob,andhowmuchmoneyyoualreadyoweoncreditcardbillsandotherdebts.

Thenextstepisforthelendertoevaluateyourapplicationanddecideifyouarea“goodrisk.”Beforetheylendyoumoney,lenderswanttobeascertainaspossiblethatyouwillbeabletopaythemback.Doyouearnenoughmoneytokeepupwithyourloanpayments?Doyouhaveahistoryofpayingyourdebtsontime?Toanswerthesequestions,lendersrelyheavilyoncreditbureausandcreditreports.Thereareapproximately1200localandregionalcreditbureausintheUnitedStates.Allareprivatecompanies(notgovernmentagencies),andmostarelinkedbycomputertothreenationwidecreditbureaus.Theyprovidemuchoftheinforma-tionthatlendersneedtoevaluateloanapplications.

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Whenyouapplyforaloan,yourbankcontactsacreditbureauandasksforacopyofyourcreditreport,whichisbasicallyasummaryofyourpaymenthabits—informationaboutloans,chargeaccounts,creditcardaccounts,bankruptcies,andcourtjudgmentsthatmightrequireapotentialborrowertopayalargesumofmoneyasasettlement.Howtheinformationgetsintoyourcreditreportisnomystery.Whenyouapplyforanewchargeaccountorcreditcard,clerkstransferinformationfromyourapplicationtoelectronicrecordsthatareforwardedtooneormoreofthenationwidecreditbureaus.Ifyouarelateinpayingyourbills,orifyoumissapayment,theinformationgoesintoyourcreditreport.Lendersthenevaluateyourreportandtrytodecideifyouarea“goodrisk.”

Afterweighingalltheinformation,yourbankwilleitherapproveordenyyourloanrequest.Ifyourrequest isdenied,thebankmustnotifyyouinwritingwithin30days,andthelettermuststatethereasonfordenyingyourloan.Ifyourloanisapproved,thebankwillgiveyouacheckmadeouttoyourautodealerortransferthefundstoyouraccount.Toprotectitselfincaseyoufailtorepaytheloan,yourbankwillholdthelegaltitle(ownershippapers)toyourpurchaseuntilyoupayofftheloan.

Beforeapplyingforaloan,youshouldrequestacopyofyourcreditreport.Ifthereareanyissuesorquestions,youmaybeabletoaddressthembeforeprocessingaloanapplication.Youareentitledtoafreecopyofyourcreditreport,atyourrequest,onceevery12months.Formoreinformationonhowtorequestacopy,visittheFederalTradeCommissionwebsiteathttp://www.ftc.gov

Before applying for a loan, you should request a copy of your credit report.

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What are checks, and how do they work?Youreachforyourwalletandit’snotthere.Panicgiveswaytodespairwhenyourealizethatyourwalletisgoneandsoisyourcash.Chancesareyou’llneverseethecashagain.

Theconsequencesarenotnearlyasseriousifyouloseyourcheckbook.Allyoudointhatcaseiscloseyourcheckingaccountandopenanewone.Afterthat,yourlostorstolenchecksareworthlesstoanyonewhomighttrytousethem.

Becausetheyaresafeandconvenient,checkshavebecomeapopularmethodofpaying forthingsortransferringmoney.Butwhatexactlyisacheck?

Insimpleterms,acheckisawrittensetofinstructionstoyourbank.Whenyouwriteacheck,you are instructing your bank to transfer a specific amount of money from your checkingaccounttoanotherpersonoranorganization.Youcanevenwriteachecktoconvertsomeofthemoneyondepositinyourcheckingaccountintocash.

Whenyoufillintheblankspacesononeofyourchecks,youaretellingyourbankthreethings:1)howmuchofyourmoneyyouwanttotransfer,2)whenyouwanttotransferit,and3)towhomyouwantittogo.Youauthorizethetransferbysigningthecheck.

So,ifyourfavoriteauntsendsyoua$50checkforyourbirthday,she’sactuallytellingherbanktotransfer$50fromheraccounttoyou.Butwhenyougotocashhercheckordeposititinyouraccount,howdoesyourbankknowifyourauntactuallyhasenoughmoneyinheraccounttocoverthecheck?

Theanswertothisquestionisn’twhatitusedtobe.

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Upuntil2004,thecheckhadtotravelallthewaybacktoyouraunt’sbankbytruckorbyplane.Iftherewasenoughmoneyinheraccounttocoverit,herbankwould“clear”thecheck.Iftherewasn’tenough,herbankwouldstampit“NSF”—NotSufficientFunds—and“bounce”itbacktoyourbank.Andontopofallthat,youraunt’sbankhadtosendhercancelledchecksbacktohereverymonth,alongwithheraccountstatement.

AllthatpaperworkmighthavebeenOKbackin1940,oreven1970,whenAmericanswrotefewer checks. But as checks becamemore popular, banks spentmore andmore time andmoneymovingbillionsofpiecesofpaperaroundthecountryeachyear—notthebestuseofresources,especiallywhennewtechnologyofferedamoreefficientwaytodothings.

In2004,Check21wentintoeffect.Thenewfederallawmadeitpossibleforbankstohandlemore checks electronically. Insteadof physicallymoving checks fromonebank to another,bankscannowelectronicallytransmitimagesofthecheckstheyprocess.It’salotfasterandlesscostly.

For more information on Check 21, see Frequently Asked Questions about Check 21, http://www.federalreserve.gov/paymentsystems/truncation/faqs2.htm

Instead of physically moving checks from one bank to another, banks can now elec-tronically transmit images of the checks they process.

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What is electronic banking?Thebankclosesintenminutes.Evenifyoumakeitthereintimetocashyourcheck,yournerveswillbefrazzled.Isn’tthereaneasierway?

Yes,thereis.Electronicsandcomputershaveturnedbankingintoaround-the-clockbusiness.Automatedtellermachines(ATMs)nowmakeitpossibleforyoutodomuchofyourbankingwheneveryouchoose.

ATMsarecomputersthataremuchlikelimited-servicebankbranches.Youcanusethemtomakeawithdrawal,makeadeposit,makealoanpayment,transfermoneyfromoneaccounttoanother,orcheckyouraccountbalance.Inmanycases,automatedtellermachinesofdifferentbanksarelinkedtogetherinnetworkssoyoucanusethemwhenyoutraveltoadifferentpartoftown,anotherstate,orevenanothercountry.Allyouneedisaplasticcardfromyourbankandyourownpassword.

Tiredofrushingtothebanktocashyourpaycheck?Askyouremployeraboutdirectdeposit,abankingservicethatmakesitpossibleforyoutohaveyourmoneyelectronicallyaddedtoyourcheckingaccounteverypayday.Insteadofreceivingapaycheck,youreceiveastatementthattellsyouyourmoneyhasbeendepositedinyouraccount.DirectdepositispopularamongpeoplewhoreceiveSocialSecuritychecksorpensionchecksbecauseitsavesthemthebotherofstandinginlineatthebank,battlingbadweather,orworryingaboutbeingrobbedonthewayhomefromthebank.

Anotherelectronicbankingserviceiscalledelectronicfundstransfer,orEFT.ByusingEFT,abankcantransferlargeamountsofmoneytoanotherbankbysendinganelectronicmessage.Electronictransferstakeonlyaninstant.Anelectronicmessageinstructsacomputertodeductacertainamountofmoneyfromonebankaccountandthenaddthesameamounttoanotherbankaccount.Themessage is sent, and theappropriateamount is transferred.Nocashorpaperchangeshands,butmoneyistransferredjustthesame.

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Technologyhasmade itpossibletobankfromthecomfortofyourownhome.Banksoffersoftwarepackagesthatallowcustomerstodebitorcredittheiraccounts,checktheiraccountbalances,orevenapplyforaloan.Consumerscanmakethesetransactionsonline.

There areeven “virtual banks” thathavenophysical bankoffice in a traditionalway.Theyprovidealloftheirservicestotheircustomersoverthe internet.Formore informationoninternetbanking,checkoutWhat You Should Know About Internet BankingontheFederalReserve Bank of Chicago web site: http://chicagofed.org/consumer_information/what_you_should_know_about_internet_banking.cfm

Technology has made it possible to bank from the comfort of your own home.

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Credit cards, debit cards, stored value cards: What’s the difference?Credit cardsarenotaformofmoney,eventhoughpeopleoftenrefertothemas“plasticmoney.”Whenyouuseacreditcardyouareactuallytakingoutaloan—buyingsomethingnowandagreeingtopayforitlater—andsoonerorlateryouwillhavetopaythebillforallthosethingsyou’vebought.

Manybanksissuecreditcards,eventopeoplewhoaren’tregularcustomers.Beforeissuingyouacreditcard,abankwillrequireyoutocompleteanapplicationformandwillexamineyourcreditrecordtoseeifyouhaveahistoryofpayingbackyourdebtsontime.

Sometimespeoplerunupcreditcardbillsthataretoobigtopayoffeverymonth.Whenthathappens,theymustpayamonthlyfinancechargethatcansometimestop20percentayear.In addition, banks (and other companies that issue credit cards) sometimes charge theircardholdersanannualfee.

Theyalsochargemerchantsafeeformakingthecreditcardserviceavailable.Financecharges,annualfees,andmerchantfeeshavebecomeanimportantsourceofincomeforbanks.

Debit cardslooklikecreditcards,buttheyareverydifferent.Whenyouuseadebitcardatthegaspumporatastore,theamountofthepurchaseiselectronicallydeductedfromyourbankbalance. Itwill showuponyourmonthlybankstatement,but there’snomonthlybillbecause the amount of each purchase is deducted almost immediately from your account.

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Somemerchantsofferyou theopportunity togetadditionalcashbackwhenyoupay forapurchasewithyourdebitcard.YoucanalsouseyourdebitcardatanATMifyouneedtowithdrawcashfromyouraccount,butiftheATMisnotpartofyourbank’snetwork,youmayhavetopayafee.

Oneothermajordifferencebetweendebitcardsandcreditcards is thatyoudon’thaveasmuchlegalprotectionifyourdebitcardislostorstolen.Onalostorstolencreditcard,themostyou’reresponsibleforis$50.Butifsomeonestealsyourdebitcard,youcouldbere-sponsibleforupto$500infraudulentchargesortransfersunlessyoureportthelossortheftofyourcardwithintwobusinessdays.Youriskunlimited loss ifanunauthorizedchargeorwithdrawalappearsonyourstatement,andyoudon’treportitwithin60days.Soalwaysbesuretocheckyourmonthlybankstatements!

Thecardthatmaycomeclosesttobeing“plasticmoney”isthestored value card.Giftcardsandphonecardsarethetwotypesthatmostpeopleknowbest.Thecardsare“loaded”withacertaindollaramount—$10,$50,$100,oranyotheramount—andthatamountdecreaseswitheachuse.Forexample,ifsomeonegivesyoua$50giftcardtoBob’sBigBuy,andyoubuysomethingtherefor$30,youwillstillhave$20“stored”onthecard.Twothingstokeepinmindaboutstoredvaluecards:1)Youcan’tusetheminasmanyplacesascreditcardsordebitcards.IfyoureceiveagiftcardtoBob’sBigBuy,that’stheonlyplaceyoucanuseit,and2)Theyreallyare“justlikecash”inthatyou’reprettymuchoutofluckiftheyarelostorstolen.

When you use a credit card you are actually taking out a loan—buying something now, and agreeing to pay for it later.

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Do banks keep large amounts of gold and silver in their vaults?Today,banksrarelykeepgoldorsilverintheirvaults.That’sbecauseourpapermoneyisnolongerbackedbygoldorsilver,andourcoinsdon’tcontainpreciousmetal.

TheU.S.governmentstillholdsmillionsofouncesofgoldandsilver,butcitizensandforeigngovernmentscanno longerexchangetheirU.S.papermoney for it.Thegovernment’sgoldandsilverareconsideredvaluableassetsratherthanformsofmoney.Today’scoinsandpapermoneyarebackedbythe“fullfaithandcredit”oftheU.S.government.

Ifthatmakesyoualittleuneasy,trythefollowingexercise.Putaten-dollarbillandablankpieceofpaperonatabletop,andaskpeopletochoosebetweenthetwo.Chancesareeveryonewillchoosetheten-dollarbill.Why?Afterall,neithertheten-dollarbillnortheblankpieceofpaperisbackedbygoldorsilver.

ThedifferenceisthatpeopleallovertheUnitedStateswillaccepttheten-dollarbillaspaymentifyouwanttobuysomething.Butyouwouldhaveahardtimefindingsomeonewillingtoac-cepttheblankpieceofpaper.That’sbecausetheten-dollarbillisbackedbythepromiseoftheUnitedStatesgovernment,andtomostpeople,thatpromiseisasgoodasgold.

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Why do banks fail?Abankisabusiness,andlikeotherbusinesses,theycanfail.Sometimestheyfailbecausethepeoplewhorunthemmakepoorbusinessdecisionssuchasexpandingtooquicklyorputtingtoomuchmoneyintoonetypeofloan.

Sometimestheyfailbecauseoffraud.Maybethepresidentmakesquestionableloanstofriendsorhiresunqualifiedrelativesandpaysthemhugesalaries.Butbanksalsogooutofbusinessbecausechangingeconomicconditionsmakeitdifficultorimpossibleforborrowerstorepaytheirloans.Here’sanexample.

Gusher National Bank Slips on Falling Oil PricesFallingenergypricesmeancheapergasolineandlowerhomeheatingbills.So,fallingoilpricesmustbegood,right?

Not for everyone!Take the caseofGusherNational Bank.Gusherwas very aggressive inmakingloanstooilandnaturalgascompaniesthathadnoproblemrepayingtheirloanswhenenergypriceswerehigh.TheloansspelledbigprofitsforGusher,andeveryoneagreedthatGusher’sexecutivesweresmartbusinesspeoplewhoreallyknewhowtomakemoney.

Thentheeconomysloweddown,andthedemandforenergyfell.Factoriesburnedlessoilandnaturalgas.Truckdrivers,commuters,andvacationersdrovefewermilesandburnedlessfuel.Asaresult,energypricesdroppedsharply,andmanyenergycompaniesfellbehindontheirloanpayments.Someevenstoppedmakingpaymentsaltogether.

Monthspassed,oilpricesremainedlow,andmoreenergycompaniesfellbehindontheirpayments.Finally,Gusherlostsomuchmoneytobadloansthatgovernmentregulatorshadtostepinandclosethebank.Gusherhadfallenvictimtochangingeconomicconditions— fallingenergypricesandahighconcentrationofloanstoenergycompanies.

A bank is a business, and like other businesses, they can fail.

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OrtakethecaseofBedrockBank...

Bedrock Bank Gets Too Big Too FastBedrock Bank’s new president was determined to turn his bank into the region’s biggestlender.Bedrock’sloanofficersgotthemessageandstartedmakingasmanyloansastheycouldforcondominiumdevelopments,shoppingcenters,officebuildings,andhigh-pricedsuburbanhousingdevelopments.Loanapplicationswerenotalwayscheckedascloselyastheyhadbeeninthepast,andsomeoftheloanswereapprovedmorequicklythantheyhadbeenintheolddays.Butnobodyseemedconcernedbecausethelocaleconomywasstrongandrealestatevalueswererisingrapidly.

Everythingseemedfine;everyonewasmakingmoney.Butthentheeconomysloweddown,andthingstookaturnfortheworse.Theweakeconomyforcedmanybusinessestoclose,leavinglotsofvacantofficespace.Realestatevaluesplummeted,andmanydevelopersfellbehindontheirloanpayments.

Intheend,BedrockBankwaslosingsomuchmoneyonbadrealestateloansthatgovernmentregulatorswereforcedtostepinandcloseit.TheregulatorstriedtofindabuyerforBed-rock,butnootherbankwantedtogetstuckwithalltheloansthathadgonebad.Eventually,anotherbankagreedtobuyBedrockifthefederalgovernmentwouldagreetokeepmanyoftheproblemloans.

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Do you lose money if your bank fails?TheFederalDepositInsuranceCorporation(FDIC)hasprotectedbankdepositssince1934.Inallthattime,noonehaslostmoneythatwasFDIC-insured.Federaldepositinsurancecoversmosttypesofdeposits,includingsavingsdeposits,checkingdeposits,andcertificatesofdeposit.Thebasicinsuredamountis$100,000.

In thedays before federal deposit insurance, theU.S. banking systemwasplaguedbybank“runs”or“panics.”Attheslightesthintoftrouble,depositorswouldruntothebankandlineuptowithdrawtheirmoney.Alltoooften,onlythefirstfewpeopleinlinehadanyhopeofeverseeingtheirmoneyagain;otherslosteverything.Evenhealthybankssometimesfailedafterrumorscauseddepositorstopanicandwithdrawtheirmoney.

For many years, the public seemed willing to accept the losses. But then came the GreatDepression of the 1930s, and financial pressures forced thousands of banks to close theirdoorsforever.Lossesranintothehundredsofmillionsofdollars,andmanypeoplelosttheirlifesavings.

Thewaveofbankfailuresshatteredpublicconfidenceinthebankingsystem,andAmericanslooked to the federal government for help. Congress responded by establishing the FDIC,whichprovideddepositinsurancecoverageofupto$2,500perdepositor.Publicconfidencerebounded,andbankfailuresdeclinedfromapproximately4,000in1933to62in1934.

Overtheyears,thefederaldepositinsurancelimithasincreased,andfederaldepositinsurancehashelpedtomaintainpublicconfidenceintheU.S.bankingsystem.Bankfailureshavenotbeeneliminated,butlonglinesofpanic-strickendepositorshavebecomeanuncommonsight.

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Do you lose money if your bank is robbed?No.Nearlyallbankshaveprivateinsurancethatcoversthemiftheyarerobbed.(Itisnotthesameasfederaldepositinsurance.)

Inaddition,mostbankstakeelaboratemeasurestosafeguardthecashandothervaluableitemsleftintheircare.Bankvaultshavelongbeenprotectedbyreinforcedconcretewalls,timelocks,andmetalalloydoorsthatresistdrillingandexplosions.

Atonetime,armedsecurityguardsstoodwatchoverbanks,buttodaymostbanksseemtohavedecided(wisely)thattheywouldrathernotexposetheircustomersandemployeestogunplay.Shotgunsandrevolvershavebeenreplacedbyclosed-circuittelevisioncamerasthatmaintainaconstantwatchovereveryonewhoentersorexitsthebank.

Another innovation is theexplodingdyepack. Incertaincases,bankemployeesareabletoplaceapackageofreddyeinwiththerobber’sstashofstolencash.Later,whenthecrookopens the stash, the concealed dye pack explodes, covering the robber and the ill-gottenmoneywithdyethatwon’twashoff.

Most banks take elaborate measures to safeguard valuables. Shotguns and revolvers have been replaced by closed-circuit television cameras that maintain a constant watch over everyone who enters or exits a bank.

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How does the Federal Reserve fit into the U.S. banking system?AlthoughtheFederalReserveisofteninthenews,noteveryoneunderstandswhatitisandwhatitdoes.PerhapsthebestwaytoclearthingsupistohaveaFederalReserve“Q&A”tocoversomeofthemostcommonquestionsthatpeopleask.

What is the Federal Reserve?ItisthecentralbankingsystemoftheUnitedStates.

What does it do?TheshortansweristhattheFederalReserveis:

•abankforotherbanks,•abankfortheU.S.government,and•responsibleforU.S.monetarypolicy,whichinfluences

howmuchmoneyandcreditwillbeavailabletotheU.S.economy.

Italsohelpsto:•superviseandregulatebankinginstitutionstoensurethesafety

andsoundnessofthenation’sbankingandfinancialsystem•protectthecreditrightsofconsumers,and•maintainthestabilityofthefinancialsystembyhelpingto

containrisksthatmayariseinfinancialmarkets.

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When was the Federal Reserve established?CongresscreatedtheFederalReserveSystemin1913tohelpmaketheU.S.bankingsystemsaferandmoreefficient.

How many Federal Reserve Banks are there?Thereare twelveFederalReserveBanks.Eachof the twelveReserveBanksserves itsownFederalReserveDistrict.

Where is the headquarters for the Federal Reserve?TheSystem’sheadquartersisinWashington,D.C.ItiscalledtheBoardofGovernorsoftheFederalReserveSystem.

Does the Federal Reserve lend money to businesses and consumers?No.TheFederalReservedoesnotlendmoneytoprivateborrowers,butitsometimeslendsmoneytobankswhentheneedarises.Does the Federal Reserve print U.S. paper money?No.AlthoughFederalReserveNotesaccountforalmost100percentoftheU.S.papermoneyincirculation, thenotesareactuallyprintedbytheBureauofEngravingandPrinting,whichis partof theU.S.TreasuryDepartment.Thepapermoney is then shipped to the FederalReserveBanksandtheirbranches.Whenbanksneedcash fortheircustomers’needs, theyorderitfromtheFederalReserveBankintheirDistrict.Also,sincemoneygraduallywearsout,theFederalReserveBanksprocesscashinordertodetermineitsfitness.Wornoutbillsareshredded;newbillsareintroducedintothesystemtoreplacetheoldones.

Do all Federal Reserve Banks store gold bars in their vaults?OnlytheFederalReserveBankofNewYorkhasaworkinggoldvault,andalmostallofthegoldinitsvaultisforeign-owned.TheU.S.government’sgoldisheldatFortKnox,Kentucky,theU.S.Mints inDenverandPhiladelphia, theSanFranciscoAssayOfficeof theU.S.Mint,andtheU.S.BullionDepositoryinWestPoint,NewYork.

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Does the Federal Reserve process all the checks Americans write?No.TheFederalReserveBankshandlelessthanone-thirdofallU.S.checks.Privateentitiesprocesstherest.

Is the Federal Reserve responsible for regulating and supervising the entire U.S. banking system?No.Itsharesthisresponsibilitywithotherfederalandstateregulatoryagencies.

Does the Federal Reserve set interest rates?TheFederalReserveisresponsibleforU.S.monetarypolicy.Thismeansitmakespoliciesthatinfluencehowmuchmoneyandcreditwillbeavailable to theU.S.economy. InterestratesoftengoupordowninresponsetotheFederalReserve’smonetarypolicydecisions,butonlythediscountrateissetdirectlybytheFederalReserve.ThediscountrateistheratebankspaywhentheyborrowfromtheFederalReserve.

The Federal Reserve does not print money. U.S. paper money is printed by the Bureau of Engraving and Printing, which is part of the U.S. Treasury Department.

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Resources for everyoneYoucanrequesthardcopiesofmanyofthesepublicationsthroughtheFederalReserve’sonlinepublicationscatalog:http://www.newyorkfed.org—Click“PublicationsCatalog.”

A Guide to Your First Bank Account, FederalReserveBankofAtlantahttp://www.frbatlanta.org—Click“Publications”and“BooksandBrochures.”

A Penny Saved,FederalReserveBankofNewYorkhttp://www.newyorkfed.org—Click“PublicationsCatalog”and“Comics.”

Building Wealth,FederalReserveBankofDallashttp://www.dallasfed.org—Click“Publications&Resources.”

Choosing a Credit Card,BoardofGovernorshttp://www.federalreserve.gov—Click“PublicationsandEducationResources”and“ConsumerInformationBrochures.”

Consumer Guide to Check 21 and Substitute Checks,BoardofGovernorshttp://www.federalreserve.gov—Click“PublicationsandEducationResources”and“ConsumerInformationBrochures.”

How to Establish, Use, and Protect Your Credit,FederalReserveBankofPhiladelphiahttp://www.philadelphiafed.org—Click“Publications”and“ConsumerBooklets.”

In Plain English: Making Sense of the Federal Reserve,FederalReserveBankofSt.Louishttp://www.stlouisfed.org/publications—Click“InPlainEnglish.”

Paying for It: Checks, Cash, and Electronic Payments,FederalReserveBankofAtlantahttp://www.frbatlanta.org—Click“Publications”and“BooksandBrochures.”

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The Story of Banks,FederalReserveBankofNewYorkhttp://www.newyorkfed.org—Click“PublicationsCatalog”and“Comics.”

The Story of Checks and Electronic Payments,FederalReserveBankofNewYorkhttp://www.newyorkfed.org—Click“PublicationsCatalog”and“Comics.”

The Story of Money,FederalReserveBankofNewYorkhttp://www.newyorkfed.org—Click“PublicationsCatalog”and“Comics.”

What You Need to Know About Payment Cards,FederalReserveBankofPhiladelphiahttp://philadelphiafed.org—Clickon“Publications”and“ConsumerBooklets.”

What You Should Know About Internet Banking,FederalReserveBankofChicagohttp://www.chicagofed.org—Clickon“EducationResources”and“PersonalFinanceInformation.”What You Should Know About Your Checks,BoardofGovernorshttp://www.federalreserve.gov/pubs/check21/shouldknow.htm

What Your Credit Report Says About You,FederalReserveBankofPhiladelphiahttp://www.philadelphiafed.org/consumers/creditreport.html

When is Your Check Not a Check?,BoardofGovernorshttp://www.federalreserve.gov/pubs/checkconv/default.htm

Your Credit Rating,FederalReserveBankofPhiladelphiahttp://www.philadelphiafed.org/consumers/creditrating.html

Your Credit Report,FederalReserveBankofSanFranciscohttp://www.frbsf.org/publications/consumer/creditreport.html

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For additional copies, contact:

Public and Community Affairs DepartmentFederal Reserve Bank of BostonP.O. Box ����2Boston, MA 0220�

1-�00-�0�-1333www.bos.frb.orgbostonfed.publications@bos.frb.org

Revised 1/200�

federal reserve bank of boston TM