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HOMOGENEOUS PRODUCT: Goods that are either physically identical or at least viewed as identical by buyers. In particular, the producer of a product can not be identified from the product itself. This is a key assumption underlying the perfect competition market structure, and like other assumptions is only approximated in the real world. Agricultural products, metals, and energy goods come as close as any in the real world.

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BANKING:

An industry containing depository institutions that provide financial intermediary services and safekeeping of checkable deposits that make up an important portion of the economy's money supply. These depository institutions--including traditional commercial banks, credit unions, savings and loan associations, and mutual savings banks--pursue financial intermediation and deposit safekeeping through fractional-reserve banking. Banking is regulated by the Federal Reserve System, Federal Deposit Insurance Corporation, and the Comptroller of the Currency, among a host of other federal and state regulators.
Banking plays a key role in providing safety for a portion of the economy's M1 money supply, as well as other near money assets. In addition, banking is also an critical financial intermediary, bringing together borrowers and lenders, those willing to lend a portion of their unspent income and those needing to borrow extra income.

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

Banking is among many industries that provide a financial intermediary function for the economy. A financial intermediary is an entity that matches up buyers seeking to borrow funds and issue legal claims with sellers seeking to lend funds and acquire legal claims. Other financial intermediaries are stock brokers, insurance agents, mutual funds, and bond traders. Financial intermediaries do their duty through financial markets by assisting the exchange of such legal claims as stocks, bonds, insurance, and bank deposits.

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

As financial intermediaries that deal in transactions deposits, banks must balance two competing goals:
  • 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.
Banks must balance these two goals. Focusing too much on profitability is likely to limit the ability to keep deposits safe. Focusing too much on safekeeping is likely to limit the ability to generate profit.

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

The simultaneous pursuit of profitability and safekeeping are achieved through fractional-reserve banking. Reserves are customer deposits that are not used for loans and kept available to process day-to-day transactions, that is, to back up deposits. Banks keep a fraction of deposits in reserves, but only a fraction, hence the term fractional-reserve banking.

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.
Banking is the business of keeping enough reserves to ensure deposit safety, but not too many to limit profitable lending. Most banks perform this task admirably. But some stumble along the way, often edging too far in the direction of profit and failing to adequate ensure the safety of deposits.

Depository Institutions: Banks and Beyond

The banking business is comprised of traditional commercial banks and other assorted depository institutions. These depository institutions are financial intermediaries that accept deposits, make loans, and directly control a significant portion of the nation's money supply.

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.
While each type has a unique history, was established for different reasons, and once played distinct roles in the economy, they all effectively operate as banks. In particular, they all issue checkable deposits and contribute to the economy's money supply.

The Regulators

Because banks play a critical role in maintaining a sizeable portion of the economy's money supply, banking is among the one of the more heavily regulated industries in the economy. Here are a few of the key banking 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.

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Recommended Citation:

BANKING, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: October 17, 2017].


Check Out These Related Terms...

     | banks | fractional-reserve banking | reserve | traditional banks | savings and loan associations | credit unions | mutual savings banks | thrift institutions |


Or For A Little Background...

     | money | M1 | profit | industry | monetary economics | government functions | financial markets | liquidity |


And For Further Study...

     | money creation | Federal Reserve System | Federal Deposit Insurance Corporation | Comptroller of the Currency | central bank | monetary policy | bank panic | monetary aggregates | barter |


Related Websites (Will Open in New Window)...

     | Federal Reserve System | Federal Deposit Insurance Corporation | Comptroller of the Currency |


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