The role of banks in an economy
One think one knows what a bank is and what it does. And not without reason: most people have had experience of at least one bank, even if it is only through having a salary account or withdrawing cash from an ATM.
A bank's activities in all its divisions can basically be simplified as follows: it transfers money and information, and in doing so transforms money, maturities and risks. Some of the example of four lines of a bank's business to examine how it does this, the value added it creates, the risks it encounters and the restrictions to which it is subject:
(1) Lending and deposit business,
(2) Securities issuing,
(3) Asset management
(4) Foreign exchange trading.
Lending and deposit business
A bank's role as an "intermediary" is clearest in the credit and deposit business. Clients "bring" to the bank their savings, i.e. the money they have chosen not to spend. The bank transfers this money to its credit clients in the form of loans. What is on the face of it extremely simple is nevertheless fraught with a great many risks. A bank's loans lack liquidity, either partially or totally. This means that the bank cannot sell them in return for demand deposits or central bank funds whenever it likes. On top of this, a borrower's credit rating may change during the life of a loan, thereby changing the value of the loan at that point in time, which reflects the interest and amortisation payments expected in the future.
A bank guarantees its creditors the nominal value of their deposits plus interest due, irrespective of the profit or otherwise made in lending transactions. Furthermore, the amounts a bank owes are generally more liquid than the amounts it is owed; in other words, creditors can call in the amounts the bank owes them more quickly than the bank can call in what is due to it from its borrowers. One of the banks' fundamental roles in the economy is to "transform" maturities in this way at its own risk.... [continues]
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