Principles of Banking Chapters 1-5

What were some of the causes of the Great Depression that began in 1929?

- People were buying on margin: people were borrowing money from banks to buy stocks - It was very easy for people to get credit. This led to speculative investing and an absence of deposit protections

What did the Banking Act of 1933 do?

- Prohibited banks from paying interest on demand deposits - Raised the minimum capital requirements of national banks - Prohibited banks that were members of the Fed from underwriting securities and affiliating with organizations dealing in securities - Allowed the Fed Board to forbid member banks to use reserve credit for speculative purposes - Created the FDIC to protect depositors at FDIC-insured banks

What did the Banking Act of 1935 do?

- Set standards for operations at FDIC member banks - Gave the FDIC authority to examine member banks to ensure that they comply with the standards - Empowered the FDIC to take action to reduce the possibility of trouble banks failing - Authorized the FDIC to pay depositors if an insured bank fails

What are some trends in banking today?

- Technological advances - More services offered in banks

What is a partnership agreement?

A legal agreement stating the contributions each partner has made to the business, the nature of the business, and the proportions in which each partner will share in profits or losses

What is power of attorney?

A legal document that authorizes a person named as an agent (attorney-in-fact) to act on behalf of another person (the principal)

What is a subprime loan?

A loan made to a borrower who does not qualify for prime market interest rates because of credit problems or other deficiencies. Charges a higher interest rate and/or greater fees

What is a reserve requirement?

A mandate that each bank set aside a portion of its cash assets against its outstanding deposits. These are managed by the Fed

Who are the parties to a check?

1. The person writing the check (the drawer) 2. The person to whom the check is written (the payee) 3. The bank that holds the checking account (the drawee)

What is a de novo bank?

A bank that has been in operation for less than five years

What is a correspondent bank?

A bank, often a larger bank, that maintains an account relationship or engages in an exchange of services with another, usually smaller, bank

What are share drafts?

A bill payment device offered by some credit unions

What is a corporation?

A business organization treated as a legal entity and owned by a group of shareholders. The shareholders elect the directors, who serve as the governing body managing the corporation's affairs

What is an on-us check?

A check deposited or otherwise negotiated at the bank on which it is drawn

What is a cashier's check?

A check written by a bank on its own funds. In this case, the bank is the drawer and the drawee

What is a bank holding company?

A company that has control over one or more banks or other BHCs. They may engage in financial activities through nonbank subsidiaries that banks themselves are not allowed to engage in (security brokerage, underwriting stocks and bonds, etc.)

What is an agreement corporation?

A corporate subsidiary of a bank engaged in international banking and finance

What is the Uniform Commercial Code?

A set of laws adopted by states to govern commercial and financial transactions between parties. Many states add their own amendments to the basic

What is lease financing?

A specialized area of finance dealing with renting property owned by a lender, financing the leases of a company engaged in rentals, or financing the purchase of an item to be leased out by the borrower

What is a statement of condition (balance sheet)?

A detailed list of a company's assets, liabilities, and capital (equity) on a specific date

What is a partnership resolution?

A document containing language certifying that the name of the partnership is exactly the same as the one provided to the bank and listing who is authorized to write checks and sign for loans on behalf of the partnership

What is a corporate resolution?

A document filed with a bank that defines the authority given to the corporation's officers and specifies who may sign checks, borrow on behalf of the corporation, and otherwise conduct business and issue instructions to the bank

What are some reasons a bank may put a hold on a deposit?

1. Bank has reason to doubt whether a check will be collectible 2. Check is over $5000 3. Customer has a history of repeatedly overdrawing the account

What makes a substitute check acceptable?

1. Contains an image of the front and back 2. Conforms to industry standards, including MICR ink 3. Is suitable for automated processing 4. Accurately represents all information on the original check 5. Bears the following legend: "This is a legal copy of your check. You can use it the same way you would use the original check." 6. Includes all endorsements 7. Includes identification of the party creating it

What are the four main components of an annual report?

1. Promotional information: promotes the company to investors using photographs of the bank at work, reports of employee contributions and achievements, and nonfinancial statistics 2. Analysis: discusses management's business strategies and how they played out in the previous year 3. Financial statement: sets out the numbers that reflect performance, such as the income statement 4. Audit report: a written statement by outside accountants attesting to the integrity of the financial reports provided

What is the profit and loss statement (income statement)?

A summary of revenue, expenses, and net income earned by a company during a stated period, such as a quarter or year

What is a ratio analysis?

A technique for analyzing a financial statement that examines the relationships between certain values reported in the statement

What is a certificate of deposit?

A time deposit with a foxed maturity date and a fixed interest rate tied to the maturity and purchase amount

What are discount operations?

A tool of monetary policy in which banks borrow funds from the Fed. These loans, priced at the discount rate, help reduce liquidity problems for banks and maintain stability of financial markets

What types of deposit transactions are covered by Regulation E?

All electronic transactions

What is a certified public accountant?

An accountant licensed to practice public accounting. They are normally used to audit banks and other companies

What is a stop payment?

An order by a depositor to the bank (the drawee) to not pay a previously issued check or item

What is a negotiable instrument?

An unconditional written order or promise to pay a certain sum of money. The document must be easily transferable from one party to another by endorsement and delivery or delivery alone.

Some banks have experienced losses while others have remained profitable. Who ultimately is accountable for a bank's poor financial performance?

Banks are!

What is the difference between a blank endorsement and a special endorsement? When is each used?

Blank endorsement: the signature of the payee (used normally) Special endorsement: names another designated person, with the signature of the payee (used when the payee is mailing the check to another person)

What is the formula for capital ratio and what does it mean?

Capital ratio = Capital / assets x 100 Measures bank stability and strength; the capital account absorbs losses not covered by current earnings and loan loss reserves

What is the difference between a cashier's check, a teller's check, a certified check, and a traveler's check?

Cashier's check: issued by and drawn on a bank (the bank is the drawer and the drawee) Teller's check: is issued by one bank and drawn on another Certified check: accepted by the bank on which it is drawn Traveler's check: used when traveling, especially abroad

What is the M1 money supply?

Consists of funds that are readily accessible for spending, such as currency and coin, demand deposits, and traveler's checks

What is the chief risk banks face when making loans?

Credit risk: will the borrower repay the loan?

What are the basic differences and similarities between a checking account and a savings account?

Differences: - Checking accounts allow you to withdraw (no limit) - Savings accounts are limited to six withdrawals per month (if you pass this, you will be charged a fee or it will be prohibited) - Checking account normally has a debit card linked to it - Savings account does not have a card linked to it - Checking accounts do not earn interest - Savings accounts do earn interest Similarities: - Neither type of account is limited as to how many deposits may be made - Either individuals or businesses may open a checking or savings account

What is the formula for earnings per share and what does it mean?

Earnings per share = net income / average number of shares of stock outstanding Establishes income goals, such as $4 per share; earnings per share is compared with the market price of a stock to determine value in the market

Explain why easy credit, as exemplified by subprime lending, led to tighter credit, both of which helped trigger the Great Recession (2008).

Easy credit (subprime loans) led to home prices soaring because people had the money (credit) to purchase them. This caused even more relaxation with credit and led to a housing bubble. This eventually led to the Credit CARD act which imposed consumer protections.

How often is US currency changed?

Every 7 to 10 years

What are federal funds?

Excess reserves that banks deposit at Fed Banks and are made available for other banks to borrow, generally for a very short period of time such as overnight

What is wrongful dishonor?

Failure of the drawee to pay a properly payable check

What are securities?

Financial instruments such as stocks or bonds that have value and are easily bought and sold between parties

What did the Securities Exchange Act of 1934 do?

Gave the Fed authority to set margin requirements (all loans made by banks that accepted securities as collateral were subject to the margin requirements)

What kinds of government agencies issue mortgage-backed agency securities?

Ginnie Mae, Fannie Mae, and Freddie Mac

What would be the consequences if a bank overemphasized liquidity to the detriment of other factors in funds management?What would be the consequences of overemphasizing safety at the expense of liquidity and income?

Having excess reserves reduce the percentage of deposits available for lending, and this lowers income from loans. If a bank overemphasized safety, then they would avoid risk by giving out very few loans and invest in instruments that yield little income

What is a peer group?

In banking, a statistical grouping of similar characteristics, such as asset size. Each bank is compared to other banks in the group

What is the M2 money supply?

Includes M1 and near-monies like money market accounts, time deposits, and mutual funds

Why do banks invest in securities?

It diversifies risk, ensures assets are productive, and perhaps reduce taxes

How must a check be endorsed if there is an "and" relationship (John Doe and Jane Doe)?

It must be endorsed by both payees

How must a check be endorsed if there is an "or" relationship (John Doe or Jane Doe)?

It must be endorsed by either one of the payees

How must a check be endorsed if it's payable to an identifiable person (John Doe)?

It must be endorsed by the person

What is the Consumer Financial Protection Bureau (CFPB)?

It was established to protect consumers in the financial market and to ensure consumers had all the information they need.

What is a bank's largest asset? Its largest liability? Its largest income and expense items?

Largest assets: loans and investments Largest liability: Customer deposits Largest income item: Interest and fees earned on loans Largest expense items: Interest paid on deposits

What is the chief concern banks face when making investments?

Market risk: the risk that the market value of a security or other asset will decrease

What deposit account would you recommend to a customer who wants to earn interest and would like the option of writing a small number of checks (no more than six) every month?

Money-market account

What is the formula for net interest income and what does it mean?

Net interest income = interest earned - interest paid Defines the difference between interest earned on loans and interest paid on deposits; the higher the amount, the greater the profit if other expenses are constant

What is a holder in due course?

One who holds a negotiable instrument, such as a check, and who takes the instrument: 1. For value 2. In good faith 3. Without notice that it is overdue or dishonored 4. Without knowledge that it has unauthorized signature or is altered 5. Without knowledge of claims to the instrument 6. Without knowledge of defense against payment

What is the difference between paying a check and cashing a check?

Paying a check: giving cash in exchange for an on-use check Cashing a check: giving cash for a check drawn on another bank

What is the formula for return on assets (ROA) and what does it mean?

ROA = Net profit / total assets x 100 Return on assets measures how well a bank uses assets to produce income

What is the formula for return on equity (ROE) and what does it mean?

ROE = Net profit / total equity x 100 Return on equity measures the rate of return achieved relative to funds invested

What are reserve requirements?

Regulations on the minimum amount of reserves that banks must hold against deposits

Why is accurate financial data so important to bank shareholders and investors? To federal and state regulators? To customers?

Shareholders and investors: this information can have a direct impact on stock value (rising or falling) Federal and state regulators: this information helps reveal the true financial condition of a bank Customers: this information lets them know how safe their money is

How do banks contribute to their communities?

The CRA makes banks evaluate how they're helping meet credit needs of the community. They contribute by offering loans and other credit services

What is Regulation J?

The Collection of Checks and Fund Transfers: the purpose is to provide holders in due course with the rules for collecting and returning items and settling balances

What is a money market deposit account?

These accounts pay a higher interest rate than savings accounts because the rate of interest is tied to current money market rates. They also have a higher minimum monthly balance requirement and monthly transfers are limited to six

What is a demand deposit?

These are funds that a customer may withdraw from a bank with no advance notice, usually by writing a check or using an ATM

What is a financial holding company?

They are allowed to engage in the same activities as BHCs, but also can have affiliations with banks, insurance companies, brokerage firms, and securities dealers under a common ownership

What are banker's acceptances?

They are drafts or bills of exchange that banks accept as liabilities by pledging their credit on behalf of customers.

What does it mean when a bank is insolvent?

They are in a position where liabilities exceed assets, resulting in the party being unable to meet its debt obligations

What is commercial paper?

They are short-term, unsecured obligations of large, financially sound corporations, both foreign and domestic. There is no collateral except the firm's good reputation

What are negotiable certificates of deposit?

They can be sold before maturity and have a $100K minimum denomination. The rate may be negotiated with depositors.

How can customers make deposits into their accounts with going to the bank?

They can deposit cash or checks at ATMS and many banks now offer mobile services so that checks can be deposited via a picture. Also direct deposit

What are Treasury Inflation Protected Securities (TIPS)?

They have 5- 10- and 30-year maturities and protect investors against inflation because the principal increases with the CPI. When these mature, the investor is paid the inflation-adjusted principal or the original principal, whichever is greater.

What are credit unions?

They offer financial services to members who, by law, must share a common bond, such as being teachers or federal employees

What is a Section 529 College Savings Plan?

This account is only allowed to be used for higher education expenses. Also, contributions are not tax-deductible

What is a Coverdell Education Savings Account?

This account is to be used for K-12 school expenses and higher education expenses. Contributions are not tax-deductible

What is check kiting?

This begins with criminals opening several checking accounts at different banks. Then the criminal writes checks to transfer funds from one account to another. The transfers occur so frequently that actual funds don't exist in an account when a check is written

What is the statement of cash flows?

This illustrates a bank's sources and uses of cash over a period of times. Details the bank's financing, investing, and operating activities.

What is closed account fraud (paperhanging)?

This involves one or more checks being written against a closed account. Generally relies on the float time involved in interbank transactions

What is the Office of the Comptroller of the Currency (OCC)?

This is a bureau of the Treasury Department that is responsible for chartering, examining, and supervising national banks and federal savings associations

What is an automated clearing house?

This is a clearing facility operated for the convenience of banks in a particular region, generally through the regional Fed Bank. An ACH electronically processes interbank credits and debits.

What is the Community Reinvestment Act (CRA)?

This is a federal law mandating that federal bank regulators regularly evaluate how financial institutions help meet the credit needs of their communities, including low- and moderate-income sections of the community, and publicly rate the bank's performance

What is the Securities Investor Protection Corporation (SIPC)?

This is a non-profit membership organization created by the Securities Investor Protection Act of 1970 to provide financial protection to customers of failing brokers or dealers who are members

What is the annual percentage yield (APY)?

This is a rate reflecting the total amount of interest paid on a deposit account, based on the interest rate and the frequency of compounding for a 365-day period

What is a disbursement account?

This is also designed for businesses and is usually a zero-balance account funded by a concentration account when payments must be made

What is a concentration account?

This is designed for businesses and is a central account for all deposits that aren't invested.

When a deposit account is opened, why is it important for a bank to establish the authority of the customer to use the account? What three steps does the bank take to accomplish this?

This is important the bank needs to be sure that the person in front of them is who they say they are so that they are not given incorrect access to the funds. 1. Collect identifying information about the individuals(s) 2. Verify customer identification 3. Determine if a customer appears on any gov't agency lists of known or suspected terrorists

What is a teller's check?

This is like a cashier's check, but is issued by one bank and drawn on another

What is an annual report?

This is management's summation of the bank's achievements over the course of the year. Includes information about the bank's financial position and business performance.

What is Regulation E?

This is the Electronic Fund Transfer Act. This establishes the rights, liabilities, and responsibilities of parties to EFT. Also requires disclosures related to EFTs, including recurring credits to deposit accounts. Lastly, it outlines the consumer's and bank's responsibilities respectively for reporting and resolving disputed or erroneous EFTs and for servicing payroll cards

What is Reg CC?

This is the Expedited Funds Availability Act. Banks must alert customers to their funds availability policies and the policies must be displayed where customers making deposits can see them.

What is Reg DD?

This is the Truth in Savings Act. This requires banks to give customers the information they need to compare deposit account features. This only applies to consumers opening deposit accounts, not to businesses

What is the Daily Balance Method?

This is the application of a daily periodic rate to the full amount of principal in the account each day.

What is the Average Daily Balance Method?

This is the application of a periodic rate to the average daily balance in the account for the period. The average daily balance is determined by adding the full amount of principal in the account for each day of the period and dividing that figure by the number of days in the period.

What is Check 21?

This law allows banks to process checks electronically provided that, in the process of collecting checks, if a bank insists on receiving a paper check, that bank is provided with a substitute check from the electronic image file

What is a special endorsement?

This names another designated person. For example, in the "endorse here" section, it may say "Pay to the order of _____" with a name in the blank.

What is the Edge Act Corporation?

This was established under the Federal Reserve Act. It is a corporation that is a bank subsidiary for either foreign trade-related banking or foreign investment

Where is currency that is suspected of being counterfeit sent?

To the US Secret Service

What are treasury notes and bonds?

Treasury notes have maturities of between 2 and 10 years. Treasury bonds have maturities of 30 years. Both are marketable, but bear more risk than treasury bills.

What is buying on margin?

Using borrowed fund to purchase assets such as stocks

How do account transactions differ for joint accounts held in joint tenancy versus those held as tenants-in-common?

With joint tenancy: only one signature is required on checks. Either account holder may make deposits, wire checks, make withdrawals, transfer funds, access the account electronically, stop payment on checks, or close the account Tenants-in-Common: account holders normally must act together. Both signatures are required for a withdrawal and on checks

What is a treasury bill?

With maturities of less than one year, these securities are readily marketable and have limited market risk.

Why are deposits important to banks?

Without deposits, banks would not have any money to lend and therefore they would not be able to pay interest on deposits

What kinds of government agencies issue nonmortgage-back agency securities?

The Export-Import Bank

Why does the Federal Reserve manage the money supply?

The Fed needs to make sure that the money supply does not outpace the needs of the economy.

How does the Federal Reserve manage the money supply?

The Fed utilizes monetary policy to manage money. The Fed must ensure that the money supply does not outpace the needs of the economy. It utilizes three tools: discount operations, reserve requirements, and open-market operations

What is the most important organization involved in developing the Generally Accepted Accounting Principles (GAAP)?

The Financial Accounting Standards Board (FASB)

What is the LIBOR rate?

The London Interbank Offered Rate is an international money market rate that represents the average rate offered by banks for placement of Eurodollars

What law governs the requirements that make a check negotiable? What are those requirements?

The Uniform Commercial Code, Article 3 Requirements - a check must be: - Payable to bearer or to order - An unconditional order or promise to pay - For a fixed amount of money - Payable on demand or at a definite time - Written and signed

Why is the National Bank Act of 1863 important in relation to dual banking? Does dual banking still exist today?

The act created charters which led to dual banking (state v. federal)

What is a depositary bank?

The bank in which a check is first deposited

Who is the 'drawee' regarding checks?

The bank that holds the checking account

How must a check be endorsed if it is payable to "bearer" or "cash"?

The check does not need to be endorsed. Thus, any person who holds the check may use it

What is a beneficiary?

The party legally entitled to receive the proceeds of an annuity, insurance policy, letter of credit, trust fund, retirement account, or will, either from an appointment, assignment, disposition, instrument, or contract

What is a restrictive endorsement?

The payee or other holder restricts the purpose of the check. For example, "For deposit only"

What is the principal?

The person or company that appoints another (an agent) to act on his or her behalf

Who is the 'payee' regarding checks?

The person to whom the check is written

Who is the 'drawer' regarding checks?

The person writing the check

What are open-market operations?

The purchase and sale of US Treasury and federal agency securities by the Fed to influence the growth of the nation's money supply. They are the principal means by which the Fed implements monetary policy.

What is the Federal funds rate?

The rate banks charge one another for overnight loans of reserve funds held at Fed Banks

What is the Fed funds rate?

The rate one bank charges another for overnight use of reserve funds o bring reserves up to requirements

What are pyramided reserves?

The reserve patterns of banks before the Fed system was authorized. Smaller banks would place their reserves in larger banks, which would then place their reserves and those of the smaller banks in money center banks such as those in NYC

What is the right of survivorship?

The right of surviving tenants to take full possession of specific assets, such as account funds, upon the death of other tenants, without establishing an estate but subject to state laws

What is a blank endorsement?

The signature of the payee

What is equity?

The investment interest of all shareholders in a corporation, equaling the excess of assets over liabilities and including common and preferred stock, retained earnings, surplus, and reserves

What is monetary policy?

The management of a nation's money supply by a central bank, such as the Fed, to ensure availability of credit in quantities and at interest rates consistent with specific economic objectives.

To satisfy the requirements of negotiability, checks must be what five things?

1. Payable to bearer or to order 2. An unconditional order or promise to pay 3. For a fixed amount of money 4. Payable on demand or at a definite time 5. Written and signed

What is a financial intermediary?

An institution that accepts funds from customers who want to save or invest and lends funds to customers who want to borrow

What is a substitute check?

A paper reproduction of the original check drawn from an electronic file that contains an image of the front and back. It bears the full MICR line as allowed by industry standards for such checks, conforms in paper stock and dimensions to the standards and can be processed through automated check systems

Define recession.

A period of significant economic slowdown, often defined as a decline in the GDP over two or more consecutive quarters

What is a cash letter?

An interbank electronic or paper transmittal form, resembling a deposit slip, used to accompany cash items sent from one bank to another

What is matched funding?

An asset and liability management technique in which assets are financed with liabilities of the same maturity or duration

How do automatic transfer services benefit a customer?

An example would be connecting one's saving and checking accounts. If you overdraw your checking account, then it can be set up so that funds automatically transfer from your savings to your checking to cover the overdraft

What is a fiduciary?

An individual, bank, or other party to whom specific property is turned over under the terms of a contract and who acts for the benefit of another party on a basis of trust and confidence

What is a NOW account?

An interest-earning transaction account against which check-like instruments may be drawn

What five government agencies regulate bank activities?

FDIC, OCC, Federal Reserve, CFPB, State Banking Departments

What is net interest income?

The difference between interest paid (on deposits) and interest received (on loans)

What is the difference between the discount rate and the prime rate?

The discount rate is what the Fed charges banks for short-term use of its funds. The prime rate is the base rate that a bank will charge customers

Why are shareholders and investors interested in a bank's financial data?

The information can have an immediate effect on stock value

What is the prime rate?

The interest rate a bank offers its most creditworthy customers and the base rate used to set interest rates for other loans

What is the discount rate?

The interest rate the Fed charges banks for short-term use of its funds