BAF 307- Economic Banking

The General Context Banks have traditionally played a key role in the financial system by acting as financial intermediaries between ultimate savers and borrowers. As asset transformers, they have accepted deposits with one set of characteristics and created assets with a different set; in particular, they have engaged in maturity transformation with debt contracts on both sides of the balance sheet. They have also been the central mechanism within the payments system. For these and other reasons (notably a potential danger of deposit which may cause solvent banks to become insolvent, and the systemic consequences that could thereby accrue), banks have traditionally been regarded as ‘special’ within the financial system. For the same reasons they have also been subject to more intensive regulation than other types of financial institution. The nature of what a bank does has changed radically over the past few years, and it will change further in the years ahead. The type of institutions conducting banking business has also changed. With respect to the first issue, banks conduct a much wider range of business than simply taking in deposits and making loans (their traditional financial intermediation business). Banks have become financial services firms, and in many countries off-balance sheet income of banks exceeds income earned from traditional financial intermediation business. It is no longer clear precisely what a bank is, what business it conducts, or what should define appropriate business for a bank. What a bank is is no longer clearly-defined. At the same time as banks have been diversifying and re-defining their business, a wide range of new types of firms have begun to supply traditional banking services: transactions deposits, savings accounts and a range of loans. Such firms include supermarkets, utility companies, insurance companies, mutual funds and even a car manufacturer (BMW in Germany). There is little, if anything, that banks do that could not now equally be done by markets, non-bank financial institutions, and non-financial firms. In other words, banks have lost their traditional monopoly advantages. Banks are even losing their monopoly in the payments system. The idea of a bank as a middle-man in the payments process is being challenged by the removal of physical media and the development of electronic media: e-money. Some payments systems exclude banks altogether. This range of issues raises the question: who is a bank?