Banking Basics 9781422296400, 1422296407

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All About Money: The History, Culture, and Meaning of Modern Finance Banking Basics Cost of Living Earning Money: Jobs Entrepreneurship A Guide to Teaching Young Adults About Money Investing Money Money and Relationships Planning for Your Education The Power to Do Good: Money and Charity Spending Money Sustainable Lifestyles in a Changing Economy Understanding Credit Understanding the Stock Market

Copyright © 2011 by Mason Crest Publishers. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, taping, or any information storage and retrieval system, without permission from the publisher. MASON CREST PUBLISHERS INC. 370 Reed Road Broomall, Pennsylvania 19008 (866)MCP-BOOK (toll free) www.masoncrest.com First Printing 987654321 Library of Congress Cataloging-in-Publication Data Fischer, James. Banking basics / by James Fischer. p. cm. -- (All about money: the history, culture, and meaning of modern finance) Includes bibliographical references and index. ISBN 978-1-4222-1761-0 (hardcover) ISBN 978-1-4222-1759-7 (series) ISBN 978-1-4222-1880-8 (pbk.) ISBN 978-1-4222-1878-5 (pbk. series) 1. Banks and banking—Juvenile literature. I. Title. HG1609.F57 2011 332.1—dc22 2010021814 Design by Wendy Arakawa. Produced by Harding House Publishing Service, Inc. www.hardinghousepages.com Cover design by Torque Advertising and Design. Printed by Bang Printing.

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Why Do You Need a Bank Account? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 What Is a Bank?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 What Is Money?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 How Do Banks Work? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 How Did Banks Begin? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Banking During the Middle Ages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 The History of Banking in the United States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Modern Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Checking Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 What Happens When You Write a Check?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 What Are ATM & Debit Cards? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 What Is Electronic Banking?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Balancing Your Checkbook. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 What Happens If You Overdraw Your Account?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Opening a Savings Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 What Happens to Your Money After You Deposit it?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 How Do You Apply for a Loan?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 What Is Interest?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Paying Off Your Loan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 What Is a Credit Rating & Why Does it Matter?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Is the Money in Your Bank Account Safe from Thieves?. . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 What Is the FDIC?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Do Banks Ever Fail?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 The Future of Banking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Here’s What You Need to Remember. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Words You Need to Know. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 Further Reading. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Find Out More on the Internet. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Picture Credits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 About the Author and Consultant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

Our lives interact with the global financial system on an almost daily basis: we take money out of an ATM machine, we use a credit card to go shopping at the mall, we write a check to pay the rent, we apply for a loan to buy a new car, we set something aside in a savings account, we hear on the evening news whether the stock market went up or down. These interactions are not just frequent, they are consequential. Deciding whether to attend college, buying a house, or saving enough for retirement, are decisions with large financial implications for almost every household. Even small decisions like using a debit or a credit card become large when made repeatedly over time. And yet, many people do not understand how to make good financial decisions. They do not understand how inflation works or why it matters. They do not understand the long-run costs of using consumer credit. They do not understand how to assess whether attending college makes sense, or whether or how much money they should borrow to do so. They do not understand the many different ways there are to save and invest their money and which investments make the most sense for them. And because they do not understand, they make mistakes. They run up balances they cannot afford to repay on their credit card. They drop out of high school and end up unemployed or trying to make ends meet on a minimum wage job, or they borrow so much to pay for college that they are drowning in debt when they graduate. They don’t save enough. They pay high interests rates and fees when lower cost options are available. They don’t buy insurance to protect themselves from financial risks. They find themselves declaring bankruptcy, with their homes in foreclosure.

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We can do better. We must do better. In an increasingly sophisticated financial world, everyone needs a basic knowledge of our financial system. The books in this series provide just such a foundation. The series has individual books devoted specifically to the financial decisions most relevant to children: work, school, and spending money. Other books in the series introduce students to the key institutions of our financial system: money, banks, the stock market, the Federal Reserve, the FDIC. Collectively they teach basic financial concepts: inflation, interest rates, compounding, risk vs. reward, credit ratings, stock ownership, capitalism. They explain how basic financial transactions work: how to write a check, how to balance a checking account, what it means to borrow money. And they provide a brief history of our financial system, tracing how we got where we are today. There are benefits to all of us of having today’s children more financially literate. First, if we can help the students of today start making wise financial choices when they are young, they can hopefully avoid the financial mishaps that have been so much in the news of late. Second, as the financial crisis of 2007–2010 has shown, poor individual financial choices can sometimes have implications for the health of the overall financial system, something that affects everyone. Finally, the financial system is an important part of our overall economy. The students of today are the business and political leaders of tomorrow. We need financially literate citizens to choose the leaders who will guide our economy through the inevitable changes that lie ahead. Brigitte Madrian, Ph.D. Aetna Professor of Public Policy and Corporate Management Harvard Kennedy School

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Why Do You Need a Bank Account? When you were little, you probably kept your money in a piggy bank. Maybe you still do. Or maybe these days you just stuff it in a back pocket—or throw it in a jar or a dresser drawer. But what do you do when the jar gets full?

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What if you get a job—or your grandmother gives you $100—or you sell your old toys at a garage sale and make some serious cash? Do you really want wads of money stuck in your bedroom somewhere? What if the house burns down? There goes your cash! What if your little brother pokes around in your stuff and helps himself to some lunch money? Obviously, you need to keep your money safe. You could stick it under your mattress. You could put it in a treasure chest and bury it in the backyard. But if you keep earning money (which hopefully you will as get older), your mattress could get pretty lumpy. And a hole in the backyard isn’t terribly convenient for getting your money when you need it—or putting it in when you have more you want to stash.



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What Is a Bank? In the past, people used solutions very similar to these for keeping their money safe. They encountered the same drawbacks, that we’ve discussed though. They needed somewhere truly safe but also convenient. And that’s why banks were invented. In some ways, a modern bank isn’t so very different from your old piggy bank: it’s a place to keep your money safe. But in other ways, modern banks are far more complicated.

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A good way to help you understand how a bank works is to imagine starting your own bank. The first thing you will need to do is put some of your own money in the bank. Banks can’t get licensed unless their owners have their capital invested in the bank. Then you go to all your friends and ask them to contribute funds as well. With this money, you can get licensed. You rent a building, hire a staff, and open your doors for business. Now, more people will put money in your bank. Some will ask you for loans, and you will charge them interest, allowing your bank to earn more money. You also charge service fees for checking accounts and saving accounts. This income allows your bank to make more money. Your goal is to always have more money in your bank than is owed to it. So if you have $1 million in people’s bank accounts, you need to be sure you never make more than $1 million in loans!

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What Is Money? A “Rai” stone from the Pacific island of Yap. Such stones were used as currency until the 1960s. This Rai stone at the Currency Museum weighs about three tons—that’s 6,000 pounds or 2,722 kg!

Centuries ago—and even more recently in simpler cultures—people didn’t use money. They just traded one thing that had value for another. For instance, they might trade a cow for some wheat. Maybe you’ve never thought about what money really is. It’s what we use to buy things. It’s a symbol for what we value.

But cows die and wheat rots, so people wanted something more lasting that would allow them to accumulate wealth. Some cultures used clamshells for money.

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DID YOU KNOW? But money didn’t always look like it does today. Earlier cultures used very different things for buying and selling!

Clamshells come in many shapes and sizes, but coins could be standardized. In other words, one penny always equals the same as all other pennies.

Coins were first used by traders who sailed the Mediterranean Sea in the 7th century BCE. Coins were a convenient way for merchants to keep track of their wealth. Coins could represent both small and large amounts. (No one really wanted to accumulate a million cows—and they didn’t want one-tenth of a cow either!)

The first paper money was a promise to pay for something, like an I.O.U. China printed the first true paper money in the 6th century. When the Massachusetts Bay Colony printed its own paper money in the 1690s, paper bills were here to stay! Silver drachm from Trapezus on the Black Sea, 4th century BCE. The image on the coin shows a banker’s table piled up with coins.

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How Do Banks Work? Nowadays, we still use coins and bills—but money is no longer always something you can see and touch. Instead, money exists as numbers in bank accounts, saved in computer memories. This means that if you put a ten dollar bill in your bank, the bank isn’t going to put that same bill away in their safe—and when you go back to withdraw your money, you won’t get that same bill either! But you will get money that’s worth the same amount.

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That’s how banks work today. They keep track of your money using computers—they’re not big treasure houses filled with piles and pile of coins! But centuries ago, that’s what they were like.

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How Did Banks Banking in the Begin? Ancient World

The first banks were probably religious temples in ancient Greece. Temples were safe places for money to be stored. Temple officials could write “notes” for merchants, allowing them to turn in the notes for cash in other cities’ temples, rather than carting around piles of heavy coins.

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In ancient Egypt, the granaries— places like that shown here, where grain was stored—functioned like a network of banks. Merchants could transfer credit from one granary to another, without any actual money changing hands.

The Roman Empire established a form of banking much like the modern system. These banks were also often located in temples. They charged interest on loans, and they paid interest on deposits, just like today’s banks. But with the fall of the Roman Empire in the 5th century, banking disappeared.

The word “bank” comes from the ancient Latin word “bancu,” which meant a long bench.

DID YOU KNOW? When moneylenders in ancient Rome did business, they set up their bancus in enclosed courtyards within the temples.

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The fall of the Roman Empire plunged Europe into centuries of financial and economic shambles. But in the Middle Ages, around the 11th century, bankers again began to do business in many of the Italian cities. These professionals, like the man and his wife portrayed to the left, were known as “moneychangers,” people who exchanged coins for legal contracts issued between merchants. This business usually took place in the city’s cathedral square. Some people also took out loans from the moneychangers, while others left their money with them in return for interest payments.

The Christian church in the Middle Ages did not approve of charging interest on a loan. This practice was a sin referred to as “usury.”

DID YOU KNOW? The church’s disapproval did not prevent ursury altogether, however. Often, merchants went to Jews for loans.

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When the United States was born in 1776, it had no commercial banks. At first, banking in the United States was not a unified system. Instead, private companies and even individuals started up many small banks that all functioned in different ways (and with differing degrees of safety). These small banks even issued their own money. Mostly, these banks used “notes” or “bills of exchange,” which meant that a person could present that particular piece of paper at the bank where it was issued and receive the amount of gold or silver specified in the note. Alexander Hamilton, America’s first Secretary of the Treasury, insisted that the United States needed a governmentrun bank. He helped establish the First Bank of the United States in 1791.

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At the same time, though, more than 50 different kinds of currency were in circulation in the United States. This made doing business very confusing! It also meant that dishonest people could take advantage of the situation. Finally, in the 1860s, the U.S. government created a truly national banking system. The dollar became the national currency. National banks issued bank notes that had the same value everywhere in the country. They were also backed by government bonds.

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Today, the Federal Reserve (also known as the “Fed”) is the gatekeeper of the U.S. economy. The Fed regulates all the banks in the country. It manages the nation’s money, and by raising and lowering interest, it influences the economy. And no currency is worth anything in the United States unless the Fed issued it. Just as banks serve individuals, the Fed serves banks. It helps process checks. It creates and enforces the rules all banks must follow.

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Before the Federal Reserve was established in 1913, banks could not always cover all their depositors’ accounts. Remember your pretend bank where you had $1 million? Imagine that you’ve decided to loan out $500,000—and then suddenly, everyone who put money in your bank wants to withdraw it. But you don’t have it! This is what happened sometimes in U.S. banks. It was called a “run on the bank,” and it meant financial ruin both for the bank and for the individuals who could not withdraw their funds. The Fed kept this from happening.

When the Fed was established in 1913, there were more than 30,000 different currencies floating around the country.

DID YOU KNOW? Currency could be issued by almost any business, including drug stores.

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Today, most banks allow their customers to write checks. These pieces of paper function a little like the “notes” that banks used to use, except that you don’t have to rely on the bank to write them. You can write them yourself, so long as you have an account at the bank and enough money in your account to cover the amount. The bank will then pay that amount out of your account to whoever receives the check. When you write a check, you need to fill in 6 blanks:

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1. The date. 2. The person or company that will receive the funds from your checking account. 3. The amount of money, written as numerals. 4. The amount of money, written out as words. 5. Your signature. 6. A memo, to remind yourself why you wrote this check.

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What Happens When You Write a Check? Every year, about 70 billion checks are written in the United States alone. That’s about 270 million checks that need to be processed every day! So if you pay for your groceries with a check, here’s what happens: 1. The grocery store deposits the check at its bank. 2. The grocery store’s bank passes it on to an intermediary bank for verification and settlement.

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3. The intermediary bank looks at the 9-digit routing number on the bottom left hand corner of your check and identifies your bank from that number. 4. The intermediary bank sends your bank a request for payment and credits the grocery store’s account for that amount. 5. Your bank debits your account and sends the money to the intermediary bank.

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When you were younger, did it ever seem to you that ATMs were wonderful, magical things that dispensed cash whenever your parents needed money? ATMs have indeed added a whole new level of convenience to banking, since they’re available 7 days a week, 24 hours a days. The catch, of course, is that you have to actually HAVE the money in your bank account in order to withdraw it from an ATM! Debit cards are what the ATM uses to match you with your bank account. These cards look like credit cards—but again, the catch with debit cards is that their use is limited by the amount of money you actually have in your bank account!

An ATM is simply a data teminal that connects to and communicates through a host processor that connects with an entire network.

DID YOU KNOW? The cash-dispensing part of an ATM has an electric eye that counts the money as it exits the dispenser.

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Most bank accounts today give you the option of having a debit card. Here are the elements you’ll find on the front of your card (shown here to the right): 1. The logo and name of your bank. 2. An EMV chip, electronic material that the ATM reads to identify your account. 3. A hologram. 4. Your account number. 5. The name and logo of the card brand (usually Master Card or Visa). 6. The card’s expiration date. (Your bank will send you a new card in the mail before this date.) 7. Your name. On the back of your debit card (shown above), you’ll find: 1. A magnetic strip. 2. A place where you will write your signature. 3. A security code. All these things help make your card more secure, so that it can’t be easily used by someone other than you.

If you lose your debit card, or if you think someone may have stolen it, you should call your bank immediately.

DID YOU KNOW? Your bank will cancel the card so that someone doesn’t help herself to all the money in your bank account!

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Computers have changed the way we do many, many things—and banking is no exception. Electronic banking uses the Internet to add another level of convenience to banking. With electronic banking, you can look at your account online 24 hours a day. This means you can check to see how much money is in your account whenever you need. You can also pay bills on line, saving you time and postage.

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Electronic banking can be done at ATMs as well as your home computer, allowing you to deposit money into your account, make payments on a loan, or transfer money between accounts (from a savings account to your checking account, for instance), whenever you want to, night or day. Your debit card will also allow you to make online purchases. This means you can go shopping without ever leaving your house, using your card to make payments that will be automatically deducted from your checking account. Electronic banking also gives you the option to have paychecks deposited automatically into your account. And you can authorize direct withdrawals, so that your bank will automatically pay certain bills for you out of your account each month (such as your phone bill or a utility bill).

Your bank may charge you certain fees for various aspects of electronic banking.

DID YOU KNOW? For instance, you may pay a fee every time you use your debit card. Be sure you know what the fees are!

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Debit cards and electronic banking are incredibly convenient. Sometimes, they may be a little too convenient! When you’re using a piece of plastic instead of actual money, it’s easy to lose track of how much you’ve spent—and you may be unpleasantly surprised when the actual amount catches up with you!   That’s why it’s important to always write down in your checkbook ledger every purchase you make.

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A sample checkbook ledger is shown on the page to the right. You’ll see that there’s a column to record the check number, another column to record the date, another for the name of the person or company to whom you wrote the check, and another for the dollar and cent amount of the check. But don’t only use your checkbook ledger to record the checks you write! Be sure to also write down every time you use your debit card or make an electronic payment of any kind. If you’re using your debit card to make purchases at stores, be sure to keep your receipts. You can also write down deposits—any money you put into your account. Once a month, your bank will send you a statement that includes all the transactions that have taken place in your account during the past 30 days. You should always compare this with your checkbook ledger and make sure neither you nor the bank have made a mistake. Banks and stores are run by humans, and humans make mistakes, so make sure that the bank’s record agrees with yours. Check your receipts to make sure that the stories charged your account the same amounts that appear on the receipts. If find any mistakes, report them to your bank immediately!

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Unfortunately, it’s not just the humans in banks and stores who can make mistakes. So can all of us! Despite our best efforts, mistakes do happen. You’re out with friends and you use your debit card to write down the cost of the movie tickets you bought. Or you make an addition or subtraction error. Or you set up an automatic payment for a bill—and then forget one month to record it in your checkbook ledger. When any of those things happens, you can end up spending money you don’t really have. That’s called overdrawing your bank account. Writing a check for funds you don’t really have is against the law, so this isn’t something you should ever do on purpose. But when an honest mistake happens, the first thing to do is make sure you depost more money into your bank account. You should also contact the people or companies that received a “bad” check. Apologize and offer to either replace the check immediately with cash, or suggest that they resubmit the same check (so long you’re positive that there really ARE funds in your account now to cover the check). Most companies will expect you to pay a fee for giving them a bad check. And if you wrote the check to a person, their bank will charge them a fee as well if they tried to deposit the check, so you should offer to pay that fee for them. And then, to add insult to injury, your bank will charge YOU a fee also. These fees can be anyMost people where between $10 and $35. You’ll get a notice in the mail that understand that “bounced looks something like the one here, letting you know that your checks” happen once in a while to almost account has been overdrawn. everyone. Sometimes your bank may go ahead and pay the check But if it happens too often, for you, because bank employees know you’re a dependyou could lose your bank account—or even face able customer or because they know you have a direct deposcriminal charges! it coming in very soon. That will save you trouble and expense

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from the person or company who received the payment—but it will still cost you money, because your bank will charge you its fee, regardless of whether it makes the payment for you. The overdraft notice above indicates that the bank did make the payment—and then went ahead and charged the account $35.00. If you overdraw your account without realizing, the expenses can quickly snowball into nightmare proportions. Say you have $100 in your account, but you wrote a check for $105. The bank then deducts another $20 as an overdraft fee. That means you now have a negative $25.00 balance in your account. Not realizing yet that you’re in trouble, you go ahead and write 3 checks to cover several small purchases: a library fine for $3.00, $6.50 you owe the school cafeteria for lunches, and $4.75 for a bottle of ibuprophen you buy at the drugstore. Now your account is overdrawn by $114.25! This means you’re going to have to put that much into your account just to bring it up to zero. Moral of the story: Take the time to always balance your checkbook. It’s worth it!

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Savings accounts are the alternative to our old friend the piggy bank (or a box of money under your bed). They allow you to keep your money in a safe place, while it also earns interest. In other words, the bank pays you for keeping your money there. (The bank can then use this money for other people’s loans, which is why they want to encourage you to leave it in the bank for as long as possible.)

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The interest that banks pay on saving accounts changes, depending on what’s going on in the rest of the economy.

DID YOU KNOW? You can get your money out whenever you want it, but you may lose out on an interest payment you would otherwise have received. Some kinds of savings accounts also charge penalties for early withdrawals.

Several factors affect interest rates, including inflation and supply and demand.

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When you open a savings account, you will get a register that looks like a checkbook register. You won’t have checks to record in it, but you should use it to keep track of your deposits and any withdrawals. Every month, your bank will send you a statement, showing what money has been deposited into your account, what has been withdrawn, and interest payments. Check it over when it comes, and let your bank know right away if you spot any errors.

Interest payments are low these days, so you’re not likely to get rich from

the interest payments. Banks need to pay an interest rate that’s lower than the amount they are charging on loans (so that they can make a profit). This means that during times when loans are “cheap” because of low interest rates, savings accounts don’t earn as much money.

Say your bank will pay you 1% interest on your savings account. This means

that if you put $1000 into a savings account and leave it there for a year, at the end of that year the bank will pay $10 into your savings account. The next year, assuming you’ve made no deposits or withdrawals and interest rates remained the same, you would get 1% of $1010, which would be $10.10 . . . and so on, each year.

In reality, however, most savings accounts pay interest that is com-

pounded daily and paid monthly. This means that every day, the bank deter-

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mines what 1/365th of 1 percent equals—and then at the end of the month, that amount is added to your account. Each day, the principal (the amount you started out with) is increased by the interest payment for that day, so you end up getting interest on the interest! The more money you have in a savings account, the more money you will earn in interest.

Most banks require that you keep a certain amount of money in your sav-

ings account in order to avoid paying fees on the account. A special kind of savings account called a Money Market account pays more interest but also requires that you keep a larger balance in the account. Money Market accounts also charge a fee if you make more than a certain number of withdrawals each month.

Saving takes discipline but it’s worth the effort. It helps if you have a goal

in mind. The goal could be big or small; you could save up for the money you’ll need to cover the cost of senior prom—or you could save for your college education. Either way, figure out how much you’re going to need. Then determine how much you can set aside each month. For instance, if you know you’re going to need $720 for the prom a year from now, you might want to set aside $60 each month. College is a lot more expensive than the prom, of course, but you can still set yourself realistic goals.

It helps if you deposit the money in your savings account at the same time

you make a deposit into your checking account. That way you don’t think of that money as funds that are available to you now.

Saving is a habit that pays off throughout your entire life. Begin small now,

so that you create good habits that will one day allow you to purchase a car . . . go on a nice vacation . . . or buy a house!

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Banks offer other services besides checking and savings accounts. They also give out loans. Loans come in different shapes and sizes, but to apply for any loan, you will have to fill out an application that includes the following information: 1. Your name. 2. Your address. 3. The name, address, and phone number of your employer. 4. Your employment history (a list of any jobs    you’ve had and the dates you had them). 5. Your current income. (how much money you make). 6. Any debts you already owe. 7. The monthly amount of your rent or mortgage payment. 8. Some form of identification (like a driver’s license, birth certificate, or passport). 9. Your social security number.

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Once your bank receives the application, they will go over it carefully to decide whether or not they feel you are capable of repaying the loan. Smaller, “home-town” banks may be more likely to take a risk on someone than larger banking institutions. If the bank decides that you are unlikely to repay a loan, your application will be marked “declined.” If, however, your application is approved, the bank will “close” the loan. During this process, the bank determines what your monthly payment plan will be over the term of the loan. Loan terms can be anywhere from a year to thirty years, depending on the purpose and amount of the loan. The monthly payments will cover the principal, plus the interest the bank is charging you. You will need to sign a paper, promising to repay the entire amount of the loan, plus the interest. The bank will then either issue you a check for the amount of the loan or put it directly into your bank account.

Your bank can sell your loan to another bank. This is one way banks can get their money back more quickly.

DID YOU KNOW? If your bank sells your loan, you will get something in the mail, telling where your payments should go now.

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The interest you pay on a loan is similar to the interest you receive on a savings account— except now the payments go the other way, from you to the bank, instead of from the bank to you! This is one way banks make money—and the reason they can afford to pay interest on savings. Most loans have compounding interest, which means that you will be paying interest on both the original principal (the amount you borrowed to start with), plus the interest that has accrued throughout the life of the loan.

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Here’s how compounding interest would work if you had borrowed $10,000 at a 6% interest rate, compounded annually (every year), over a three-year term. Year 1 $10,000 x .06 = $600 Year 2 The total amount of your loan with the interest added is now $10,600. So the compounded amount this year will be: $10,600 x .06 = $636 Year 3 Now the total amount you owe is $11,236. So this year, you will add on: $11,236 x .06 = $674.20 At the end of the third year, when you finally pay off the entire loan, you will have paid the bank a total of $11,910.20. In other words, in this case, you’ll have paid the bank $1,910.20 for the convenience and privilege of having that $10,000 at the beginning of the three years.

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Loan payments can be made in a few different ways. You can write a check and send it the old-fashioned way, via “snail mail,” to your bank. Do not, however, send cash through the mail! You can also make a payment in person at your bank. (But you’ll probably want to use a check for this as well, so that you have a record of the transaction.)

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Payments can also be made electronically, online. This is an option that usually needs to be set up first with your bank. When your bank issued you the loan, they will have given you a date each month that the payment is due. Some banks will mail or e-mail you monthly reminders, but others do not. Either way, be sure to remember to make your payment on time each month. If you don’t, you will end up paying extra late fees.

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When you apply for a loan, one of the things the bank does is use your Social Security number to find out your credit rating. Your credit score is a number between 300 and 850. A score of 720 or higher is considered excellent, and it will mean you can get the best interest rates available when you apply for a loan. If your score is under 500, it’s unlikely the bank will agree to grant you a loan at all. The score is based on several factors, including: 1. Have you paid your bills on time in the past? (35% of your score) 2. How much money do you already owe? (30% of your score) 3. How long is your credit history? (15% of your score). As a young person, you won’t have had time to establish a long credit history, since you won’t have been paying bills for very long. It’s a good idea to get a credit card as soon as you can, even if you share it with your parents, so that you can begin establishing your credit history. (But make sure to always make payments on time. You don’t want to start out with a bad credit history!) 4. Do you have a mixture of different kinds of credit? (10 percent of your score). Banks like it if you have several different kinds of loans, including credit cards, mortgages, and car loans.

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5. How many credit applications have you made recently? (10% of your score) Banks worry about people who are constantly applying for another credit card as a way to juggle their expenses. All this information is reported by credit cards and banks to the three credit reporting companies: Experian, Equifax, and TransUnion. Here’s what DOESN’T count in your score: 1. Your age. 2. Your sex. 3. Your race. 4. Your job or the length of time you’ve been employed. 5. Your income level. 6. Your education. 7. Your marital status. 8. Whether you’ve been turned down for credit in the past. 9. Length of time you’ve lived at your current address. 10. Whether you own your home or rent. Your bank may consider some of these factors when deciding whether to approve your loan— but none of these have any bearing on your credit rating.

You can get your credit score for free once a year by going to Annual CreditReport.com

DID YOU KNOW? You will have access there to credit scores from the 3 different companies.

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In the old days, when robbers broke into a bank, people whose money was in the bank vault could be out of luck. Their hard-earned cash could be on its way to South America or the French Riviera. Today, however, that’s not the case. Your money is an electronic record stored in the memory of your banks’ computer system, so it’s not actually sitting inside

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the bank somewhere. And your bank is also protected by the FDIC, which is part of the U.S. federal government. A far greater danger these days is identity theft. Thieves who get access to personal account numbers and passwords can then electronically move money from your bank account. That’s why it’s very important to protect your identification, Social Security number, and all passwords. Don’t give this information out to anyone, either over the phone or on the Internet. Keep track of your cards—and if they turn up missing, immediately notify your bank, even if you’re not sure they’ve been stolen. Don’t let anyone help himself to YOUR hardearned cash!

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The Federal Deposit Insurance Corporation (FDIC) is a part of the U.S. government that insures all bank deposits up to at least $250,000 (through December 31, 2013). It was created in 1933 after thousands of banks failed during the Great Depression of the 1920s and early 1930s. Since the start of FDIC insurance on January 1, 1934, no depositor has lost a single cent of insured funds as a result of a bank failure.

The FDIC gets its fund from payments made to it by member banks, as well as from earnings on investments in U.S. Treasury securities. The FDIC insures more than $7 trillion of deposits in U.S. banks, deposits in virtually every bank in the country.

The FDIC also examines and supervises U.S. banks that belong to the FDIC. This means that it makes sure that banks are following government guidelines. Inspectors regularly visit the banks. If a bank is not meeting the guidelines, the FDIC issues a warning.

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You can tell if your bank is a member of FDIC.

DID YOU KNOW? All member banks are required to post a sign in their buildings that states, “MEMBER FDIC.”

If the problem continues, the FDIC can change the bank management, putting someone else in charge of the company. The FDIC can also force the bank to take action to get themselves back in shape. If necessary, the FDIC can even close the bank. But if that happens, the depositors’ money is still insured by the FDIC. (In other words, you wouldn’t lose your money!)

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Yes, sometimes, even today, banks do fail. There are three reasons why this can happen. First, depositors can panic and withdraw all their money. Banks don’t have everybody’s money on hand, but they’re required to keep a reasonable percentage on hand. Not everyone goes to the bank on the same day, but if people start to lose confidence in their bank and enough depositors make withdrawals, the banks may run out of money.

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Second, a bank may not be able to borrow money from other banks. Normally, banks are always swapping money back and forth overnight; it’s a normal part of how banks do business. But if you’re a bank owner, and the other banks don’t trust you anymore, you’re out of business. Just as individuals have credit ratings, so do banks. A big cut in a bank’s credit rating can scare other banks badly enough that no one wants to deal with it. Third, FDIC regulators can become worried that a bank’s reserve levels are too low. These reserves need to equal the ratio of a bank’s core capital compared with the total of its risk-weighted loans and other assets like cash. The minimum acceptable ratio is 6 percent, and the most solid banks have ratios of 13 percent to 20 percent. When banks fail, it’s not good for the economy. But you don’t have to worry about your own money. If your bank was bought by another company, your money will be available the next day. And if your bank was shut down by the FDIC, you’ll have access to your money within a few days.

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One day, we may no longer need currency. The familiar greenbacks and shiny coins may be a thing of the past. Instead, all money may exist electronically. Companies could issue credits that would take the place of today’s dollars. (Frequent flyer points, issued by most airlines, is an example of a system where credits rather than dollars can be used to purchase a company’s service.) Some economists even wonder if the Internet might allow us to go back to a barter economy, where we exchange items and services, rather than using the old services provided by banks, including checks, debit cards, and credit cards.

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Without a doubt, the future holds many changes. Computers and the Internet will continue to revolutionize our world. New inventions will come along as well. Who knows what could happen! What’s important for you is to keep up with the changes—so that you can keep YOUR money safe.

If our banking system changes, there will still be criminals who will take advantage of that.

DID YOU KNOW?

In the old days, bank robbers wore black masks. In the 21st century, they will be cyber experts who slink through the Internet.

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• Banks keep your money safe and offer an alternative to carrying piles of money around with you all the time. • The first banks were religious temples in Greece that let merchants store their money and cash in notes at other temples, instead of carrying around coins. • In the United States, the first bank was started by Alexander Hamilton in 1791, but it wasn’t until the 1860s that a standardized, national banking system was developed. • Today, the Federal Reserve (Fed) monitors and regulates all the banks in the country. • Checks act like bill notes that allow you to transfer money from one bank account to another. • Electronic banking lets you access your account 24 hours a day—not just when the banks are open during business hours. • Balancing your checkbook is important to make sure you don’t spend money you don’t have. • While checking accounts give you easy access to money you want to spend almost every day, saving accounts let you save money while earning interest.

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accrued: Increased, grew, added to. authorize: Give permission to do something. bonds: Certificates that show that the holder of the bond is owed a debt by the group that issued the bond, and guarantees repayment of the debt plus interest after a certain period of time. capital: The amount of money, whether in cash or material goods, that is available to use. circulation: In use; passing from place to place. compounded: Added to (as in interest being added to the principal), so that the piece that is added becomes part of the whole. credits: Additions that are made in an account or on a bookkeeping ledger. currency: Money; the thing that is used as a medium of exchange. debits: Subtractions that are made from an account or on a bookkeeping ledger. discipline: Behaving according to a set of rules or expectations; self-control. economists: People who study how money is made, distributed, and spent. hologram: A three-dimensional image, created using lasers and other special equipment. interest: Money paid as a percentage of a larger amount, for the privilege of using or borrowing that amount.

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intermediary: Someone or something that acts as a go-between, a mediator between two other parties. ledger: A book in which business transactions are recorded, such as money being paid into and out of an account. logo: A distinctive symbol or image, representing a company or product and designed to be quickly recognized. principal: The amount of money you originally borrowed, separate from the interest. reserve: For a financial institution such as a bank, cash, or goods that can be quickly turned into cash, that is kept on hand to meet any needs customers may have. revolutionize: Change something drastically; make extreme changes. securities: Certificates or other evidences that you are owed a debt or have part or total ownership of property; similar to bonds. settlement: The payment of a debt. standardized: Held to a standard that has been established; made equal according to an agreed upon measurement. term: The length of time of an investment, or the amount of time you have to pay off your loan. transaction: A business exchange or dealing. vault: A secure room, often lined with steel, where money and valuables can be safely stored. verification: Making sure that something is true.

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Allman, Barbara. Banking. Minneapolis, Minn.: Lerner, 2006. Casu, Barbara, Claudia Girardone, and Philip Molyneux. Introduction to Banking. Upper Saddle River, N.J.: Prentice Hall, 2006. Eagleton, Catherine, and Jonathan Williams. Money: A History. Buffalo, N.Y.: Firefly Books, 2007. Giesecke, Ernestine. Everyday Banking: Consumer Banking. Portsmouth, N.H.: Heinemann, 2002. Giesecke, Ernestine. Money Business: Banks and Banking. Portsmouth, N.H.: Heinemann, 2002. Grossman, Richard S. Unsettled Account: The Evolution of Banking in the Industrialized World since 1800. Princeton, N.J.: Princeton University Press, 2010. Hammonds, Heather. Banking. Mankato, Minn.: Smart Apple Media, 2006. Hudak, Heather C. Banking. New York: Weigl, 2009. Larson, Jennifer S. Where Do We Keep Money? How Banks Work. Minneapolis, Minn.: Lerner Classroom, 2010. Macht, Norman L. Money and Banking. New York: Chelsea House, 2001. Rothbard, Murray N. A History of Money and Banking in the United States: The Colonial Era to World War II. Auburn, Ala.: Ludwig von Mises Institute, 2002.

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Banking Kids www.bankingkids.com Banking, Money Instructor www.moneyinstructor.com/banking.asp Federal Reserve Kids Page www.federalreserve.gov/kids Kids Bank.com www.kidsbank.com SmartStart for Kids www.cibc.com/ca/youth The websites listed on this page were active at the time of publication. The publisher is not responsible for websites that have changed their address or discontinued operation since the date of publication. The publisher will review and update the websites upon each reprint.

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Hamilton, Alexander 20 identity theft 49 ATM 28–29, 31

interest 11, 17, 19, 22, 36–39, 41–43, 46, 58–59

bill of exchange 20

Internet 30, 49, 54–55

bond 21, 58–59 loan 11, 17, 19, 23, 31, 36, 38, 40–47, checkbook ledger 32–34, 58

53, 59

checking account 11, 31, 39 credit card 28, 46–47, 54

moneychanger 19

credit rating 46–47, 53

Money Market account 39

currency 12, 21–23, 54, 58 overdraft fee 35 debit card 28–29, 31–34, 54

overdraw 34–35

deposit 17, 26, 31, 33–34, 38–39, 50–52

piggy bank 8, 10, 36 principal 39, 41–42, 58

Egypt 16 electronic banking 30–32

Roman Empire 17, 19

Federal Deposit Insurance Corpora-

savings account 11, 17, 31, 36–40, 42

tion (FDIC) 49–51, 53

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Federal Reserve (FED) 22–23

U.S. Treasury 50

Greece 16

withdrawal 31, 37–39, 52

Alexander, Billy pp. 38–39, 44–45 Algiamil pp. 44–45 BB&T Bank, Dennis Brown; Creative Commons pp. 10–11 Bichara, Sergio Roberto pp. 42–43, 44–45 Borchet, A.F.; Creative Commons pp. 26–27 Bowie15; Dreamstime pp. 48–49 Connors, Michael pp. 8–9, 36–37 Davenport, Bill pp. 36–37 Dratwa, Kamil pp. 14–15 Dreamstime pp. 52–53 Griffindor; Creative Commons pp. 10–11 Haitham Alfalah, Creative Commons pp. 10–11 Hatsdakis, Renaude pp. 8–9 Jason7825; Creative Commons pp. 10–11 Jochimczyk, Marcin pp. 12–13 Jones, Alexander pp. 28–29 Kartha, Arjun pp. 24–25 Krechowicz, Jakub pp. 44–45

Leavell, Laura pp. 36–37 Michailidis, Constantine; Creative Commons pp. 12–13 Mizerak, Robert; Dreamstime pp. 48–49 Moses, Sunira pp. 12–13 Nawaz, Sufi pp. 8–9 Pierre-André, Vullioud pp. 44–45 Relajp pp. 20–21 Romersa, Max 54–55 Rosseel, Kevin pp. 30–31 Takemoto, Flavio pp. 26–27 Trumbull, John; New Historical Society pp. 20–21 Sawyer, Jane M. pp. 36–37 Simmonds, Dani pp. 8–9, 10–11, Solis, Jenny pp. 26–27 Stastny, Jan pp. 40–41 Stitt, Jason; Dreamstime pp. 32–33 Ugalde, Miguel pp. 30–31 U.S. Government pp. 50–51 Van Leen, Adrian pp. 14–15 Widling, P. pp. 44–45 Yaroslav B. pp. 54–55

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James Fischer received his master’s in education from the State University of New York, and went on to teach life skills to middle school students with learning disabilities. Money management and financial skills were a major part of his emphasis in the classroom. He has applied these skills to his writing for this series. Brigitte Madrian is Professor of Public Policy and Corporate Management in the Aetna Chair at Harvard University’s Kennedy School of Government. She has also been on the faculty at the Wharton School and the University of Chicago. She is also a Research Associate at the National Bureau of Economic Research and coeditor of the Journal of Human Resources. She is the first-place recipient of the National Academy of Social Insurance Dissertation Prize and the TIAA-CREF Paul A. Samuelson Award for Scholarly Research on Lifelong Financial Security.

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