Because banking is key to the money supply, it is also heavily regulated by government, especially the federal government. The most important regulator is the Federal Reserve System, which regulates banks to achieve a given quantity of money in circulation. Another important bank regulator is the Federal Deposit Insurance Corporation, which seeks to ensure the stability of the banking industry.

Financial Intermediary: Matching Lenders and Borrowers

The intermediary function is simply the process of bringing together buyers and sellers. The economy is filled with assorted intermediaries, like retail stores that match up those producing goods with those consuming goods. The intermediary function is extremely important to a market-oriented economy. A market exists ONLY if buyers and sellers match up. Sometimes these two match up on their own. Sometimes they need assistance from an intermediary.

While many different types of intermediaries exist in the economy, banks match up those seeking to exchange legal claims or financial assets. By maintaining financial deposits and making financial loans, banks navigate the financial or paper side of the economy. They do not deal directly with physical production, but rather with legal claims on physical production.

What makes the financial intermediary function of banks different from other financial intermediaries (stock brokers or insurance agents) is that they work with transactions deposits (that is, checking accounts). Checking accounts are over half of the money supply. Banks are NOT just matching up buyers and sellers, but in so doing they maintain a significant portion of the nation's money supply.

Goals: Making Profit and Making Money

• Profitability: Banks pursue profit as a financial intermediary through revenue generated from interest on loans. Because banks are profit-seeking businesses, they must receive revenue to generate profit and to remain in business. They do this primary through interest charged for lending.


• Safekeeping: Banks pursue safety of deposits and money supply stability through reserves. As depository institutions, banks acquire the funds used for lending through deposits. Banks must keep customer deposits safe or they have no funds that can be used for interest-generating loans.

One of the most important consequence of this balancing is business-cycle instability. Banks that fall short of the either profitability or safekeeping are prone to bankruptcy. If banks go out of business, then a part of the economy's money supply could, quite literally, vanish into thin air, triggering a business-cycle contraction.

Fractional-Reserve Banking: Keeping Reserves

While reserves are essential to ensure the safety of deposits, they do not generate profit. The key is to keep enough reserves to back up deposits, but not so many that lending it not profitable.

• Keeping more reserves means more safety, but less profit. Focusing too much on the safekeeping of reserves is likely to prevent the profit needed for a bank to remain in business.


• Keeping fewer reserves means more profit, but less safety. Focusing too little on the profitability of making loans is likely to prevent sufficient reserves to ensure the safety of deposits.

Depository Institutions: Banks and Beyond

Four types of depository institutions are included under the general title of bank:

• Traditional Banks: These are the original banks which first issued checking accounts. These financial intermediaries invariably have "bank" in their names and have slogans like "Established in 1856."


• Savings and Loan Associations: An outgrowth of the exploding housing needs of the middle class in the mid-1900s, these financial intermediaries originally operated quite simply, taking in savings deposits and issuing home mortgage loans.


• Credit Unions: Created as nonprofit financial intermediaries to provide personal loans to labor union members, most have expanded in both customer base and services offered. They now provide full-service banking to a wider segment of the population.


• Mutual Savings Banks: Also created as nonprofit financial intermediaries, but with the goal of to provide home mortgage loans, they too operate now largely as full-service banks.

The Regulators

• Federal Reserve System: At the top of the list is the Federal Reserve System, or the Fed. The Fed has primary responsibility over the nation's money supply. And they exert this control by regulating banks and bank reserves. They also perform a lot of other regulatory functions that promoted the stability of the banking system.


• Federal Deposit Insurance Corporation: Another key federal bank regulator is the Federal Deposit Insurance Corporation, or FDIC. The mission of the FDIC is to insure bank deposits. If a bank cannot satisfy customer withdrawals because it has done something like go bankrupt, then the FDIC refunds deposits. Of course, because the FDIC is ultimately responsible for refunding the deposits of failed banks, they impose regulations designed to KEEP banks from failing.


• Comptroller of the Currency: This regulator is responsible for issuing charters for national banks. While the name is something of a misleading holdover from days gone by, the Comptroller of the Currency actually has nothing to do with currency. But it does make sure that any company seeking to start a national bank abides by accepted accounting practices and operates prudently.


• State Regulators: Each state also has a host of bank regulators. While the Comptroller of the Currency charters national banks, state banks are chartered by state regulators, including state corporation commissions.