Bank at School - Lesson 3         Previous Lesson        Next Lesson

What Do Financial Institutions Do and How Do They Work?                                                                                                       
Introduction
Financial institutions play an important role in our society. Many people think of a financial institution as a place people go when they need money. That's true, but as we shall see, financial institutions perform other services as well.

Objective
Introduce students to financial institutions and their services.
Provide a frame of reference for banking day.

Lesson Material
The principal role of most financial institutions is to attract money from customers, called depositors and to provide loans for people who need to borrow. Let's examine the flow of money more closely.

Most people do not like to carry around more money than they need for the next day or two. Financial institutions offer a safe place to keep money until you're ready to use it. People who put money in a financial institution are called depositors.
Not all depositors have the same needs. Financial institutions offer savings accounts for people whose primary need is to have a place to keep money they don't plan to use right away. A financial institution will offer a small payment to depositors who keep their money in a savings account. This payment is called interest. Interest rates for savings accounts may vary according to financial institutions, so it is wise to check around before opening an account.

Financial institutions must keep very strict records. To help the financial institution keep track of how much money each person deposits or withdraws, depositors fill out special forms. To deposit money into your account, you must fill out a deposit slip. The deposit slip lets the financial institution know how much money you put in your account. The deposit slip will also have your name and account number on it. A financial institution will not accept a deposit without a deposit slip, so make sure you always have one filled out when you make a deposit.

To help their customers keep accurate records, financial institutions issue receipts for every deposit or withdrawal made. The receipt is your proof that you deposited money into your account. Once a month, many financial institutions send customers a letter or statement summarizing all transactions that have occurred during that month. The statement will list the account balance and show how much interest your money earned. It's a good idea to check your statements to make sure there are no errors.

Why do financial institutions pay people to keep their money in the financial institution? Financial institutions need to have money, or capital, available in order to make loans. Financial institutions earn a profit by paying depositors less than they charge borrowers. So, a financial institution may pay depositors 3 for every dollar on deposit, but charge borrowers 7 for every dollar borrowed. The financial institution keeps the 4 difference.
When a financial institution lends money, the transaction is referred to as a loan. Loans are serious obligations. Remember, financial institutions use depositors' money to make loans. Financial institutions try to be very careful to make sure the people they lend money to will be able to pay the financial institution back.

How can a financial institution lend money that isn't theirs? Financial institutions do not lend out all the money they have on hand from depositors. They are required by law to reserve a certain amount for their depositors' needs. After all, the financial institution doesn't know when a customer might want to withdraw some money from their account. So financial institutions maintain a healthy supply of cash at the financial institution, to make sure their depositors' needs can be met.

Savings accounts aren't the only accounts financial institutions offer. Many times, a person might want to keep their money in a safe place, but also want to be able to put their hands on it in a moment's notice. Financial institutions offer checking accounts so people can have instant access to their money without having to carry around cash or go to the financial institution to get it from their account.

Here's an example: At the grocery store, the cashier tells you your groceries cost $20. You pull out your check book and write a check to the store for $20. What happens next? The store sends the check you wrote to your financial institution for payment. The financial institution will subtract $20 from your checking account and give it to the store.
Checking accounts offer people tremendous convenience. However, it's important to remember to only write a check if you are certain you have the same amount of money in your account. We will talk about checking accounts in more detail in a later lesson.

Suggested Activity

• Discuss who you've observed using a checking account/share drafts.
• Discuss why it is wise to keep money in a financial institution.

Suggested Homework 

• Pick something you would like to save for over the remainder of the school year. Ask how you can participate in your family's saving goals.
• Survey local financial institutions to compare their interest rates paid on passbook savings accounts.

Glossary
Bank - An institution which lends, receives, and keeps money.
Capital - money used for business or investment purposes.
Check - A written request to the financial institutions to subtract a specified amount of money from the check writer's account as payment for a received good or service.
Checking Account - A special account which allows a person to withdraw funds from their financial institution account without having to go to the financial institution personally.
Credit Union - A not-for-profit financial cooperative.
Deposit - The act of putting money in a financial institution.
Depositor - A person who makes a deposit in a financial institution.
Deposit Slip - A form used by a financial insittution to show who had made a deposit and for how much.
Dividends - The interest a credit union pays a member for keeping money in the credit union.
FDIC - Federal Deposit Insurance Corporation. Government Agency which insures bank deposits against loss up to $100,000 per account.
Interest - Interest is the fee a financial institution pays a depositor for keeping money in the financial institution; the fee a financial institution charges a borrower for borrowing money from the financial institution.
NCUSIF - National Credit Union Share Insurance Fund - Government Agency which insures credit union deposits against loss up to $100,000 per account.
Savings Account - An agreement between a financial institution and an individual, where the individual places his or her money with the financial institution in exchange for the financial institution's providing safekeeping and paying the individual interest.
Share Account - An agreement between the credit union and a member whereby the individual invests his or her money in the credit union thereby becoming an owner which entitles the member to dividends on that account.
Share Draft - A written request to the credit union to subtract a specified amount of money from the member's account as payment for received goods or services.
Share Draft Account - A special account which allows a member to withdraw funds from his or her credit union without having to go to the credit union personally.
Withdraw - The act of taking money out of an account.

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