12E.2 How the Financial System Works: Savers and Borrowers

This lesson provides an introduction to how the US financial system works. Because this topic is complex and can be confusing for students, this lesson focuses on savers and borrowers but offers teachers the opportunity to address additional layers as they see fit.

In each source, students will be introduced to different financial institutions or financial products/services. For the institutions — financial intermediaries — students are asked to identify the institution, describe what financial products/services the institution offers, and determine if the institution provides for savers, borrowers, or both. For the financial products/services sources, students identify the product or service, describe its use, and determine if it provides for savers, borrowers, or both. Students are also asked to identify differences between financial products/services.

Students use the information from each source analysis to appropriately place the financial institutions and products/services in a chart that shows the relationship between savers, borrowers, and financial intermediaries and the flow of the financial system.

Teachers can then use the flowchart as a teaching tool for financial markets and can expand on the lesson to delve further into financial literacy with risks/rewards of financial institutions and products/services. Teachers should use the flowchart to address the following:

Banking Institutions (Financial Intermediaries)

1. Banks accept deposits (checking accounts) and savings (savings accounts and certificates of deposit) from savers.
2. Banks take deposits and savings and loan them out to businesses or individuals.
3. Banks offer loans to borrowers with an interest rate, a charge for borrowing.

Teachers may also address:

• The interest rates paid by the bank's borrowers need to be higher than the interest rates paid out to the depositors.
• The difference between those two interest rates is how the bank covers their costs and makes a profit.
• Banks and credit unions do not have all of their customers' money on hand at all times (they only have some of the money they keep as reserves; they use customers' money to lend to others).

Financial Markets

1. Savers (individuals/businesses) can purchase stocks from businesses and government bonds as an investment and can sometimes accrue more money than what they originally invested.
2. Businesses and banks sell stocks and bonds to help them pay for their business or public services (government).

Mutual Fund Companies/Banks (Financial Intermediaries)

1. Mutual fund companies / banks combine stocks, bonds, and other investments into a portfolio that is diversified, and they offer shares of the portfolio to savers.
2. Mutual fund companies / banks purchase stocks, bonds, and other investments from businesses and government entities using savers' money.

This lesson requires students to have prior knowledge of what interest is and how it is calculated.

Sources 1 and 2 introduce financial institutions for savers: banks (Source 1) and credit unions (Source 2). Sources 3, 4 and 5 represent the products/services banks and credit unions provide to savers: checking accounts (Source 3), savings accounts (Source 4), and certificates of deposit (Source 5). Sources 6 to 11 represent financial products/services offered to borrowers and those trying to obtain funds. Sources 6 and 7 introduce financial products/services that banks and credit unions offer household and business borrowers: loans (Source 6) and credit cards (Source 7). Sources 8 to 11 introduce financial products/services for government borrowers and businesses looking to obtain funds: stocks (Source 8), federal government bonds (Source 9), and municipal bonds (Source 10). The stocks and bonds source analysis also addresses the direct purchase by savers. Source 11 introduces mutual fund banks as a financial institution, the products/services they offer, and how they work with savers and borrowers.
Using the knowledge gained from the source analysis, students will complete a diagram of the flow of the financial system that answers the question of how banks and markets function. In reviewing the financial system flowchart, teachers should explain the lateral flow of banks taking in money from savers and using it to lend to borrowers as well as mutual funds buying stocks and bonds from borrowers and those looking to raise capital and selling them as an investment to savers.

Note: This set identifies how teachers can address personal finance by highlighting the risks and rewards of the financial institutions and products/services. Teachers could include an additional layer related to personal finance by covering other financial products/services for savers, such as retirement investments offered by banks and credit unions through IRAs and through companies' banks via 401Ks, or mortgage companies for borrowers. Savings and loans and/or insurance companies as financial intermediaries could also be discussed.

12E.2 Financial Systems Student Handout

12E.2 Financial Systems Teacher Key

• The Library of Congress. The Library of Congress’ Primary Source Analysis Tool supports an inquiry model of instruction by asking students to first observe, then reflect, then question. Their customizable tool includes specific prompts for student interrogation of books and other printed materials, maps, oral recordings, photographs and paintings, and many other types of primary sources.

• The National Archives and Records Administration (NARA). NARA has developed a vast collection of document analysis worksheets, ready for classroom use. Their website offers teachers a wide collection of customizable tools – appropriate for working with photographs, maps, written documents, and more. NARA has also customized their tools to meet the needs of young learners, and intermediate or secondary students.