Business Education: Basics of Banking and Financial Services

M1, M2, and M3 Measures of Money
The composition of the money supply in a country can change quite a bit over time. For instance, in the past, hard currency accounted for a much larger portion of money than it does now, while the proportion of checkable deposits has gone up in recent years. Governments have two official measures of money, known as M1 and M2.

M1 is the sum of all the currency held by businesses and individuals, all the traveler's checks, and all the checkable deposits held by businesses and individuals.

M2 contains all of the funds included in M1, as well as savings deposits, small-time deposits, money market funds, and some other deposits. Obviously, M2 is much larger than M1.

Finally, M3 is a classification of money that includes M2 as well as the long-term repurchase agreements held by banks and large-denomination time deposits.

Financial System
Finance consists of savings and investment. Money not immediately spent is either saved or invested. Savings refer all income and monetary holdings that are not spent. Investment, on the other hand, is money put to certain use in the hope of obtaining a future benefit.
Investments can be either economic or personal. Economic investments are loans to businesses, while personal investments are the purchase of financial assets like mutual funds, stocks, and bonds. The financial system consists of the set of institutions that enable saving and investing. As such, this system includes bond markets, insurance markets, stock markets, and banks.

Liabilities
A liability is a debt that has to be repaid.
Installment loans, credit card charges, mortgages on housing or other real estate result in liabilities. There are two types of liabilities, short-term
(current) and long-term. Short-term liability refers to a debt that requires repayment within a year of the date on the balance sheet. Short-term liabilities include taxes, medical bills, insurance premiums, utilities, and rent. Long-term liabilities refer to debt that needs to be paid one year or more from the date of the balance sheet. A good example of a long-term liability is a student loan or real estate mortgage.

Federal Open Market Committee (FOMC)
The Federal Open Market Committee (FOMC) is the primary maker of policy within the Fed. It has 12 members: the president of the Federal Reserve Bank of New York; four presidents of other regional Federal Reserve Banks; and the seven members of the Board of Governors. The regional Federal Reserve Bank presidents rotate out every year, so each region is represented equally and often. Every six weeks, the Federal Open Market
Committee gathers and discusses the economy. On occasion, the committee decides upon some strategic actions undertaken by the Federal Reserve Bank of New York.

Board of Governors of the Federal Reserve System
The seven-member Board of Governors is the highest authority in the Federal Reserve System. These members, usually renowned economists, receive appointment by the President, confirmation by the Senate, and serve terms of fourteen years. The board's main responsibility is creating and implementing monetary policy, although the board also must supervise the financial activity of banks, Reserve Banks, bank holding companies, and Federal Reserve System banks. The board decides how much money to loan these institutions and the rate of interest on these loans. Additionally, the board oversees any bank mergers and acquisitions for American banks, as well as those international member banks. The Board of Governors must report its activities to Congress.

Chairman of the Board of Governors
The Chairperson of the Board of Governors is the most important member of the Federal Reserve System. The chairperson controls the agenda of the Board of Governors, as well as the agenda of the Federal Open Market Committee. In Federal Open Market Committee meetings, the person has the most influence over the proceedings. The chairperson constantly receives reports from economists and other experts, so he or she usually has the best information on a given problem. The chairperson also serves as a spokesperson for the Federal Reserve in meetings with Congress and the President, as well as in meetings with economic representatives from foreign countries.

Great Depression
In 1929, the United States experienced the financial catastrophe known as the Great Depression. In large part, panic among depositors caused a massive run on the banks; many banks had insufficient funds and failed, hence causing the Great Depression. In 1933, Franklin Roosevelt led the passage of the Banking Act. This act established mandatory interest rates and prohibited risky bank transactions. Around the same time, the federal government created the Federal Deposit Insurance Corporation (FDIC), which guarantees bank deposits under a certain amount. These measures helped restore consumer confidence in the banks, although the United States did not rise fully from the economic doldrums initiated by the Great Depression until the Second World War.

Bank Mergers
In the 1980s, the federal government took many steps to deregulate banks. Perhaps most importantly, the federal government reduced restrictions on interstate banking, which enabled a number of small banks to merge. In particular, some large banks acquired small banks and used the existing infrastructure to enter new markets. In 1998, approximately 500 commercial banks were in existence, and in 2003, less than 200 commercial banks were in existence. Because of all these mergers, competition between the remaining banks has increased, thus creating more consumer services and low interest rates. Although fewer different commercial banks exist, more branches of each bank exist. Also, the remaining banks have larger funds with which to develop new technologies to aid consumers. However, some economists fear that the rise of enormous banks will diminish customer service in the long run.

Financial Services Modernization Act of 1999
In 1999, President Bill Clinton signed the Financial Services Modernization Act (also known as the Gramm-Leach-Bliley Act), which made it possible for investment companies, banks, and insurance companies to sell similar products in competition with one another. In other words, banks could now sell insurance, stocks, and bonds. Conversely, insurance companies and investment companies were now allowed to offer banking services. This act constituted a partial repealing of the Glass-Steagall Act of 1933. This legislation enabled consumers to complete all their financial transactions with one organization. However, each institution has suffered some growing pains while learning to perform the services of the other institutions.

Federal Funds Market
Commercial banks and other thrift institutions keep reserves at regional Federal Reserve banks in order to fulfill transactions and reserve requirements. These reserves, or federal funds, do not accumulate interest.
Money constantly flows from banks whose reserves exceed the requirement to banks whose funds are less than the requirement. These exchanges occur on the federal funds market. The federal funds market evens out disparities in reserves, but it does not change the overall level of reserves. Funds acquired in this manner are available immediately. Most of the transactions in the federal funds market take place overnight, although some transactions, known as Term Fed Funds, are made for longer periods.

Reserve Requirement Ratio
The reserve requirement ratio (also known as the fractional reserve requirement) is the percentage of total deposits a bank is required to keep in reserve. When raised, the reserve requirement mandates that banks retain more money, which means they can make fewer loans. Although the total amount of reserves stays the same, the overall money supply decreases because loaned money can be deposited elsewhere, thus multiplying its presence in the monetary system. The Fed usually raises the reserve requirement ratio in order to avoid inflation, which many economists believe is proportionate to expansion of the money supply. The Fed typically lowers the reserve requirement ratio in order to encourage lending and investment. Reducing the reserve requirement ratio has the effect of increasing the velocity of money and the money supply in general.

Defensive Open Market Operations
The Fed undertakes defensive open market operations in order to counteract the effects of uncontrollable influences on the level of reserves. Tax collection is a classic example of a force that defensive open market operations must offset. When individuals and businesses pay their taxes in April, they are more likely to withdraw funds from commercial banks. The Fed anticipates this trend and buys securities to bolster reserve levels. Temporary repurchase agreements and timed repurchase agreements are among the most common tools for dealing with cyclical reserve changes. In some cases, the Fed makes repurchase agreements with an option to renew. This option means that the original deal can extend indefinitely at the Fed's behest. Finally, these deals give the Fed the ability to micromanage the money supply.

Repurchase Agreements
In a repurchase agreement, the Fed temporarily purchases securities with the understanding that the dealer will buy them back in the near future. These repurchase agreements temporarily increase the money supply and bank reserves. Often, repurchase agreements take place overnight, and the securities are repurchased on the next business day. These transactions have become a popular way for the Fed to make small adjustments to the money supply. Before arranging a repurchase agreement, the Fed typically declares the duration. The Fed makes these transactions at the discount rate and credits these transactions with federal funds.

Reverse Repurchase Agreements
In a reverse repurchase agreement, the Fed temporarily sells securities with the understanding that the dealer will sell them back to the Fed later. Reverse repurchase agreements diminish bank reserves and money supply and can generate a small amount of short-term investment income. These transactions are secured because the government backs these securities. Additionally, securities dealers use reverse repurchase agreements in order to build up inventory and purchase other securities. In this case, temporarily owned securities serve as collateral to obtain longer-term securities.

Dynamic Open Market Operations
Dynamic open market operations are performed to tighten credit, ease credit, or increase or decrease reserves. Dynamic operations are not performed in advance of a predicted change, or in response to recent events. The Fed's ability to use dynamic operations has increased along with the rise of the monetarist philosophy among economists. Many economists believe that the Fed should concentrate on monitoring and adjusting the supply of money as a way of controlling inflation. Economists have paid more attention to regular, predictable changes in the money supply such as those changes that take place at the beginning of the week or month.

The Fed's Supervisory Functions
The Fed has numerous supervisory functions. Specifically, the Fed distributes currency and manages transfers of funds between member banks. The Fed also issues and redeems federal debt. The Federal Reserve ensures that banks maintain reserve requirements so the banks will have sufficient liquidity to meet their customers' withdrawal demands. The Fed is responsible for processing payments and checks. In this capacity, the Fed acquires a great deal of information regarding economic activity and trends.
The Fed is also responsible for researching the economy and staying abreast of changes that could influence the economy in general and the money supply in particular.

Announcement Effect
When federal regulatory agencies make an announcement or issue a report, the market reacts. This reaction is described as the announcement effect. For instance, the market rates typically move in the same direction that the Fed changes the discount rate. Also, the market responds to reports of a growth in the money supply, adjustment of other interest rates, and borrowing by the Treasury Department. The market perceives these announcements as heralding potential changes in credit and interest rates and seeks to adjust ahead of time. Sometimes, traders are aware that the Fed is about to make an announcement, but the traders have no advance knowledge of what the announcement's content. In such a situation, the market is especially volatile.

Credit Multiplier
The credit multiplier is a measure of the change in credit and in the money supply resulting from bank deposits. The credit multiplier is calculated as the change in credit divided by the monetary base.
In the banking system, a deposit can more than triple itself in the form of deposits and credit. As an example, imagine a $50,000 deposit in a bank with a reserve requirement of 20%. The bank is required to keep $10,000 in reserve, but it loans out the other $40,000. The recipient of the loan deposits it in his bank, and that bank can then loan out $32,000 of the deposit to some other customer. The original deposit now is several times its original value. This is an example of the credit multiplier.

Discount Rate
The discount rate is the rate of interest charged to banks that borrow funds from the Federal Reserve. Changes in the interest rates of banks and money markets follow changes in the discount rate. When the discount rate rises, in turn banks must charge a higher interest rate to customers. As a result, customers are less likely to seek loans, and the money supply is reduced. The money supply is reduced because money does not multiply itself in numerous deposits. On the other hand, a reduction of the discount rate encourages banks to borrow more money from the Fed and increase their lending by lowering their own interest rates. The net result is an expansion of the money supply.

Rates Affected by Discount Rate
The discount rate is the interest rate charged when member banks borrow money from the Fed through the discount window. The base rate is the benchmark against which adjustable rates are made. Sometimes, banks will give a base rate but indicate the possibility of a future adjustment within certain parameters. The repo rate, otherwise known as the official bank rate, is the discount rate the Bank of England uses in its loans to commercial banks in the United Kingdom and United States. The repo rate typically resembles the discount rate in the United States. The prime rate is the best rate of interest offered by a commercial bank; it directly ties to fluctuations in the discount rate.

Manipulation of the Discount Rate
One of the ways the Federal Reserve regulates the amount of money in the American economy is by manipulating the discount rate. The Federal
Reserve loans money to commercial banks that need funds to meet the required reserve ratio. The discount rate is the interest rate at which the Fed loans this money. In order to change the discount rate, one of the twelve regional Federal Reserve Banks to the Federal Open Market Committee initiates a proposal. If the Federal Open Market Committee approves the change, it passes the recommendation on to the Board of Governors. The Board of Governors makes the final decisions regarding changes in the discount rate.

Discount Window Programs
The Fed uses the discount window to extend seasonal credit, exceptional circumstances credit, and 14-day adjustment credit. When banks borrow at the discount window, they receive the discount rate. Banks typically borrow money at the discount window when they want to avoid problems with liquidity. In addition, the discount window is able to ensure financial market stability by offering a permanent venue for financial transactions. At one time, the discount window was only available when banks already had exhausted other sources of funds. Gradually, however, the Fed has relaxed the restrictions on transactions made at the discount window and has traded with banks at any time as long as the banks can prove financial stability.

Required Reserve Ratios
The Federal Reserve's primary responsibility is to control the amount of money in the American economy. One of the ways the Fed accomplishes this task is by establishing minimum amounts (expressed as a percentage of deposits) for bank reserves. In other words, every bank and thrift institution must keep a certain percentage of its deposits as reserves, in case there is a large withdrawal from the bank. Every type of deposit requires different required reserve ratios. The larger the deposit type, the larger the percentage each bank is required to keep in reserve.

Monetary Base
The Federal Reserve is responsible for maintaining a solid foundation of money for the American economy. The supply of money maintained by the Fed, called the monetary base, consists of all the coins, bank reserves, and Federal Reserve notes held by the Fed. If the monetary base is large, it can support a large amount of money in the economy. All of the Federal Reserve notes and bank reserves held by the Fed are liabilities, since they are owed to other institutions. The Fed's assets include loans made to banks, government securities, and gold and other deposits made with other central banks. While the United States economy still is based partly upon gold, American currency is not directly tied to the amount of gold held by the federal government. The Federal Reserve also makes deposits in other strong central banks around the world.

Open Market Operations
One of the ways that the Federal Reserve System adjusts the amount of money in the American economy is by buying and selling government securities, a process known as open market operations. The Fed sells government securities, including United States Treasury bills and bonds, to banks and private interests. When the Federal Reserve sells government securities, it reduces the amount of money in the American economy. When the Federal Reserve buys back government securities, it increases the amount of money in the American economy. The Federal Reserve does not sell government securities to other federal government organizations.
Open market operations are the primary policy tool used by the Federal Reserve to adjust the amount of money in circulation. The Federal
Reserve buys securities with money and with the creation of new bank reserves.
The purchase of securities by the Federal Reserve decreases the federal funds rate, because the presence of more reserves in the banking system increases the number of interbank loans and decreases along with demand for interbank loans.
The opposite occurs when the Federal Reserve sells securities. Banks and other institutions purchase securities with money and bank reserves. The sale of securities by the Fed diminishes the reserves in the banking system and decreases the supply of interbank loans. This in turn increases the demand for interbank loans and raises the federal funds rate. Typically, the Fed has a particular federal funds rate target in mind when it begins open market operations.

Effects of Open Market Operations on Lending
Open market operations (that is, the buying and selling of government securities by the Fed) directly influence the amount of lending by commercial banks and thrift institutions. When the Federal Reserve purchases securities from banks, it increases the reserves in those banks, thus enabling them to lend more. When banks lend money, they in effect create new money through the collection of interest. However, when the Federal Reserve sells government securities to commercial banks and thrift institutions, it diminishes the bank reserves and therefore diminishes the amount of lending done by banks. This means that less money will be created by interest payments from loans.

Multiplier Effect and Open Market Operations
When the Federal Reserve purchases securities from commercial banks and thrift institutions, it is in effect increasing the monetary base. This makes sense, since the money used to purchase the securities goes into the bank reserves, which then can be lent to individuals and businesses. Some of the loaned money will make purchases, buy new equipment, and continue business operations. However, some of the loaned money will be invested back in the bank. At this point, the money will exist in the banking system twice: both as an outstanding loan that the bank considers an asset, and as a bank deposit which the bank can use to make investments of its own. This phenomenon is known as the multiplier effect.

Check Clearing Service
The Federal Reserve offers check-clearing services to banks, in which it records all the receipts and expenditures of the bank clients. The high volume of checks in each Federal Reserve District makes this a substantial undertaking, but the Federal Reserve speeds financial transactions and guarantees payment for banks. Unlike commercial banks, the Fed never has to worry about being unable to cover transactions. Because the Fed is in charge of printing the money, it has no liquidity problems. This generates confidence in banking transactions. However, in recent years, private companies have begun to take over check clearing services, and the Federal Reserve's role in this task has diminished.

Regulation of Bank Holding Companies and Bank Exams
The Federal Reserve is responsible for supervising the activities of bank holding companies, institutions that own a controlling interest in more than one bank. As part of this supervision, the Federal Reserve administers bank exams that require the banks to supply detailed information on their accounts and practices. In particular, the Federal Reserve wants to assure banks are not involved in risky lending practices. Trained bank regulators review the institution's assets and liabilities and pay particular attention to the soundness of the bank's investments and the adherence to law.
The Federal Reserve also wants to maintain competition among banks and protect borrowers from predatory loans.

Creation of Currency
One of the main tasks of the Federal Reserve is to create the paper and metal currency used in economic transactions. Only one official currency circulates in the United States, the fiat money produced by the Federal Reserve. The Bureau of Engraving and Printing, a part of the Department of the Treasury, prints the Federal Reserve notes and sends the notes to the district banks. Then the district banks lend to commercial institutions. From there, currency makes its way to individuals and businesses. The currency produced by the United States Federal Reserve lasts approximately three years, although larger denomination bills tend to be exchanged less and thus have a longer lifespan. The US Mint produces the coins used in the United States.

Monetary Transmission Process
The monetary transmission process is the response of the product, financial, and labor markets to actions of monetary policy. For example, when the Fed sells securities, bank reserves and thus the money supply decrease, interest rates rise, and investors buy securities. These actions deplete the money supply further and decrease aggregate demand. On the other hand, when the Fed buys securities the money supply and bank reserves increase, so interest rates decline. When interest rates decline, investors are less likely to purchase securities of their own, so the money supply will remain high. This abundance of cash in the system is likely to increase aggregate demand. An increase in aggregate demand is good news for retailers and other vendors.

Recognition Lags
The goals of the Fed are to limit inflation, minimize unemployment, maintain a strong real GDP, and maintain stable prices in the financial and international markets. However, the Fed's ability to make accurate and timely adjustments to the monetary supply is hampered by recognition, response, and implementation lags. A recognition lag is the delay between an economic shock and the government and economic experts' observation of the shock. The duration of a recognition lag depends on the severity of the event. Events that may have a recognition lag include recessions and depressions, because these problems require assembly of economic data prior to their diagnosis.

Response Lags
The actions taken by the Fed rely on imperfect information and uncertain predictions regarding future economic events. The response lag, the delay between a policy's implementation effect, is one of the problems associated with action by the Fed. Most of the Fed's actions do not yield immediate results. For instance, if the Fed sells securities, the diminution of the money supply does not instantaneously lower interest rates. Economists estimate that the economy can take six months to respond to changes in the federal funds rate. To an extent, the Fed can consider the response lag when implementing policies. However, the duration of the lag is unpredictable.

Implementation Lags
Unfortunately, the Federal Reserve does not have the luxury of perfect information and immediate implementation. When a large macroeconomic event occurs, a significant gap, known as the implementation lag, emerges between the event and the implementation of a response policy. The implementation lag is longer than the recognition lag but shorter than the response lag. The Fed attempts to minimize the implementation lag by meeting regularly and giving the Board of Governors authority to call meetings at a moment's notice. Nevertheless, important decisions take time, and the delay between recognition and implementation invariably affects the utility of the Fed's policies.

Operating Targets vs. Intermediate Targets
Operating targets are short-term goals. For instance, in 1994, the Fed began setting a daily target for the federal funds rate. On the other hand, the Fed intends intermediate targets, as steps toward a larger goal. For instance, the Fed set intermediate targets for monetary aggregates, nominal GDP, exchange rates, and interest rates. The Fed does not set intermediate targets for the federal funds rate; rather, it seeks to control this rate through managing the money supply. In setting intermediate targets, the Fed monitors debt level, net borrowed reserves, total reserves, total federal funds trading, and other economic indicators.

Advantages and Disadvantages of Saving in a Bank
One of the advantages of saving money in the bank is the low level of risk involved. The bank provides a stable interest rate, so there is very little market risk. Also, all deposits up to a certain amount are insured by the FDIC, so there is little risk of default. Conversely, investments in stocks and bonds are much riskier. On the other hand, savings placed in a bank do not have any protection from inflation. If the money's value decreases, the depositor has no way to recoup the loss. Also, the relatively low interest rate means that the investor will receive a lower long-term return on his or her investment.

Commercial Banks
Commercial banks are institutions with the authority to accept deposits and make loans. Commercial banks receive this authority either from the Comptroller of the Currency in the United States Treasury or from a state agency. At present, approximately 10,000 commercial banks exist in the United States. There are actually fewer commercial banks today than there were 10 years ago, because a trend of mergers has combined many formerly independent banks. Commercial banks accept checkable deposits, time deposits, and savings deposits. The highest interest rates are paid on time deposits, while the lowest interest rates are paid on checkable deposits. The interest rate on checkable deposits is often zero.

Operations
Ultimately, a commercial bank wants to increase its stockholders' long-term wealth as much as possible. A bank makes money by charging a higher interest rate for loans than it pays out for deposits.
However, this policy presents some risk, because the chance that loans will not be repaid always exists. If unable to pay depositors who wish to withdraw their money, the bank will fail. While it is very uncommon for a bank to be unable to pay its depositors, in some situations depositors become very concerned and a large number of them seek to withdraw their money. This is called a run on the bank. In order to avoid runs, a bank must be especially prudent regarding the manner in which it makes loans.

Cash Assets
The assets of a commercial bank are divided into four parts: securities, loans, interbank loans, and cash assets. A commercial bank's cash assets consist of the combination of reserves and all the funds to be received from other banks as payments for checks. The reserves of a commercial bank include all of the currency in the vaults and the bank's balance on its reserve account at a Federal Reserve Bank. Commercial banks make deposits in a Federal Reserve Bank much the same way an individual or business makes a deposit at a commercial bank. In order to maintain operations, commercial banks are required to keep a minimum percentage of deposits as reserves. This safety precaution is intended to protect the bank from 'coming up short' during large withdrawal periods. The percentage of deposits that must be held in reserve is called the required reserve ratio.

Using Interbank Loans, Securities, and Loans
Sometimes commercial banks have reserves in excess of the required reserve ratio. When this occurs, these banks are allowed to lend their excess reserves to other banks with a shortage of reserves. These interbank loans take place in the federal funds market. The Federal Reserve Bank sets the interest rate, also known as the federal funds rate, for these loans. Indeed, establishing the federal funds rate is considered the most important monetary policy enacted by the Fed. After cash assets and interbank loans, a bank's remaining assets are composed of securities and loans. Securities are bonds created either by the United States government or by another large, stable institution. Banks buy and sell these bonds depending on the interest rate. Finally, banks make money by loaning funds to businesses and individuals and assessing a high interest rate.

Comptroller of Currency
The Comptroller of the Currency (sometimes known as the OCC, or Office of the Comptroller of the Currency) is an agency of the United States Treasury responsible for chartering new banks as national banks. As national banks, these banks may be given surprise annual inspections, and they become subject to all federal regulations. Besides chartering national banks, the Comptroller of Currency also regulates services offered by banks, with the goal of promoting competition. The OCC also monitors the banking system in order to ensure that all citizens have access to services. The OCC investigates and enforces money laundering and financing of terrorist organizations involving commercial banks. Finally, the OCC oversees the conduct of national bank agents and affiliates, thus ensuring that these employees maintain the highest ethical standards.

National Banks
The United States government charters certain private banks as national banks. Specifically, these banks receive their charter from the Comptroller of Currency, a part of the United States Treasury Department. Law requires national banks to become members of the Federal Reserve System. Also, they are required to join the FDIC. Thus, national banks must maintain a certain amount of reserves with the central bank in their region in order to guarantee stability. National banks buy and sell government bonds, which helps to regulate the supply of money. Only about 30% of the commercial banks in the United States are national banks, although national banks are the most powerful banks in the country.
The federal government places certain restrictions on national banks in exchange for those banks' rights to buy and sell government securities and the banks' respective memberships in the FDIC. National banks cannot lend more than 15% of their equity to one agent. Also, limitations exist regarding loans that national banks can make to their own directors and officers. As of 1999, national banks are allowed to engage in all financial activities with the explicit exceptions of real estate development, merchant banking, and insurance underwriting. It should be noted that designation as a national bank does not mean that the institution does business in all fifty states.

Savings and Loan Associations
Savings and loan associations are thrift institutions that make personal, commercial, and home loans and accept checkable and savings deposits. Savings and loan associations have reserves, and like commercial banks, they are required to meet the minimum reserve ratios established by the Federal Reserve Bank. Most of the assets of savings and loans are held as home mortgage loans; for this reason, they sometimes are called building and loan associations. Savings and loan associations must register with the Federal
Deposit Insurance Company (FDIC), which means that individual deposits up to $250,000 are guaranteed. In the 1980s, lax regulation led to a number of defaults by savings and loan associations, costing many depositors their entire savings. Since this debacle, the federal government has taken a much more aggressive stance towards savings and loan regulation.

Savings Banks
Savings banks are thrift institutions that primarily make consumer and home loans and accept savings deposits. In essence, the savings bank redistributes money from those persons who wish to spend less money than they make to those persons who wish to spend more money than they make. This arrangement enables borrowers to pursue the business projects that help fuel the economy. Sometimes the depositors actually own the savings banks, in which case the banks pay dividends rather than interest. Such institutions are called mutual savings banks. A savings bank holds reserves and must meet the minimum reserve ratio established by the Federal Reserve Bank. Savings banks do not accept demand deposits, thus differentiating them from commercial banks. The general category of savings banks includes mutual savings banks, municipal savings banks, postal savings systems, credit unions, and savings and loan associations.

Credit Unions
A credit union is a thrift institution that mainly makes consumer loans and accepts savings deposits. Credit unions are owned either by an economic group, like the employees of a particular firm, or by some other social group, such as the employees of a particular state government. In essence, the members of a credit union loan money to one another. The interest rates are very low, in part because the loans usually are for small amounts. Most often, credit union loans are for medical emergencies, car payments, and household appliances. Credit unions hold reserves, and like commercial banks, credit unions are required to meet the minimum reserve ratios established by the Federal Reserve Bank.

Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000. The deposits insured by the FDIC include retirement and savings accounts, among others. National banks are required to join the FDIC, but state banks are not required to join. The purpose of the FDIC is to promote depositor confidence and to prevent runs on banks. The FDIC occasionally buys or sells assets in order to enable a proposed bank merger.
The organization was developed in 1933 as a response to the Great Depression.
Member banks and thrift institutions pay for the operations of the FDIC. There are five members of the FDIC Board of Directors. The President of the United States selects the five members of the FDIC Board of Directors, and these appointments are confirmed by the Senate.

Federal Regulation of Depositary Institutions
The purpose of federal regulation of depositary institutions is to maintain efficiency, solvency, liquidity, and most of all to reduce risks for consumers. Unfortunately, federal regulation does not always meet this goal. Accordingly, the financial crisis of 2008 illustrated the failures of the regulatory system. In the wake of these problems, the federal government has instituted a series of stress tests for major depositary institutions. A stress test is a computer model that measures a bank's performance after some cataclysmic event. In order to remain in business (that is, to avoid being closed or forced into merger by the federal government), banks must prove their durability and stability. At the same time, the government is said to be developing a systemic risk regulator that would measure the stability of the economy as a whole.

Holding Companies
Most commercial banks are run by holding companies, classified as corporations that own controlling shares of stock in a number of different businesses. A holding company can run many businesses without going to the trouble of merging or consolidating them. In addition, the holding company only has liability for the business to the extent of its ownership; since the holding company does not own the entire business, it is not solely liable.
Holding companies enable banks to provide services not explicitly allowed by the Fed. These services include tax planning, investment advice, and data processing. Holding companies that administer a number of related businesses sometimes are referred to as parent companies.

Brokerage Companies and Insurance Companies
Brokerage companies are the primary depositories of investment accounts for the purpose of trading stocks and bonds. Formerly, brokerage firms appeared more distinct from banks than they are now. The main difference at present is outlined by the Glass-Steagall Act of 1933, which forbids banks from underwriting corporate securities. The Securities Investor Protection Corporation (SIPC) insures brokerage firms. Insurance companies are the primary vendors of life, health, property, and disability insurance.
According to the McCarran-Ferguson Act, the federal government can regulate insurance if the state governments are not doing a good job. The National Association of Insurance Commissioners is composed of the commissioners of insurance from each state; this group has no power over insurance regulation but is charged with administering the law and recommending new laws.

Mutual Fund Companies
Mutual fund companies typically start open-end and closed-end mutual funds. The mutual fund companies then sell these funds to investors. The Federal Deposit Insurance Corporation insures these groups. The FDIC will reimburse a depositor for any losses up to the amount of $100,000, even if the depositor is not a U.S. citizen or resident of the United States.
The FDIC insures all types of deposits regularly received by a financial institution except for Treasury securities. Deposits made in different institutions are insured separately, as are deposits maintained in different categories of legal ownership. IRA and Keogh funds are insured separately from any nonretirement funds the individual may have at that same institution.

Regulation of Savings and Loans
In the 1970s and 1980s, the federal government limited the deposit interest rates that savings and loan associations could offer. This limitation created a problem when the interest rates rose dramatically, because customers rapidly withdrew their funds in order to invest in securities. This run caught many savings and loans by surprise, and in some cases institutional failure caused depositors to lose their investments. In the wake of this crisis, the federal government expanded the rights of commercial banks and insurance companies to include the services previously offered exclusively by savings and loans. At this point, the tarnished brand name made it better business for savings and loans to operate as components of other financial institutions. This arrangement remains to the present day; namely, to the extent that savings and loans still exist, they are called banks.