A bank is an institution that accepts deposits from savers, extends loans to borrowers, and provides a range of other financial services to its customers. Banks are a central part of the modern financial system. Banks play a key role in organizing the flows of funds between savers and borrowers, including households, companies, and the government. In recent decades advances in information technology have delivered major changes in the quality and range of banking services, and have generated cost savings for banks. Customers in many countries use electronic distribution channels, such as automated teller machines, telephone and mobile banking, and internet banking, to gain access to banking services, in preference to visiting traditional high-street branches. Innovations in payments have led to a shift away from cash and cheques to faster and more convenient electronic payment systems, such as credit and debit cards, and contactless payment technologies, in some cases linked directly to customer bank accounts. Those parts of society unable to access the new distribution channels, however, have been denied many of the benefits of technological progress. Less visible to the banking public has been the rise of the ‘shadow banking’ system, comprising financial institutions that offer similar services to banks, but operate without banking licenses and largely beyond the scope of regulation.
The recent history of banking has witnessed the inexorable growth of large banking organizations, the biggest of which now span the globe. Much of the growth of the largest banks has been fuelled by the acquisition of competitors, sometimes at the height of banking or financial crises when banks in financial difficulty have been bailed out or rescued. Even the largest banks are inherently fragile and vulnerable to the possibility of collapse. A bank’s depositors expect the bank will always be willing and able to cash their deposits quickly; but when a bank grants a loan to a borrower, the funds tied up in the loan may not be accessible to the bank for many years, until the loan is due for repayment. Provided all of the bank’s depositors do not demand to withdraw their deposits simultaneously, the bank should be able to meet its commitments to depositors, and remain solvent. However, banks are vulnerable to a possible loss of depositor confidence. If all depositors seek to withdraw their funds simultaneously, the bank may soon run out of the cash it needs to repay them.
Until 2007, many commentators would have agreed that modern, technologically sophisticated banks, operating within a system of light-touch regulation, would always be able to provide plentiful finance for borrowers seeking to invest. The global financial crisis of 2007–9 was a rude awakening, and has led to a fundamental reappraisal of this view. During the crisis many banks suffered huge losses, some went out of business, and others required large taxpayer-funded bailouts to avoid collapse. As many economies entered recession, governments encountered large public spending deficits and mounting public debt. The global financial crisis was followed by a sovereign debt crisis, affecting countries such as Greece, Ireland, Portugal, and Spain. Central banks around the world have implemented unconventional monetary policies in an attempt to boost economic activity. New laws have been passed, and new rules imposed, to constrain the freedom of banks to undertake risky lending. New supervisory frameworks have been developed to monitor not only the risk of individual banks, but also the stability of the entire financial system.
Society benefits when the banking system operates efficiently and borrowers and depositors are able to realize their aims. Economic growth and development are hindered if promising investment opportunities remain unexploited because entrepreneurs are unable to borrow the funds they need to exploit these opportunities. A poorly performing or underdeveloped financial system can present an obstacle to growth and prosperity, if loans are granted for unproductive purposes dictated by family connections, political influence, or cronyism.
The key role of banks in the financial system and the vulnerability of banks to sudden collapse, owing to a loss of confidence on the part of depositors or other providers of funding, are recurring themes throughout this Very Short Introduction. This book highlights the financial services banks provide, the risks they face, and the role of the central bank. The book describes the main events of the global financial crisis and the sovereign debt crisis, and investigates the ways in which the banks themselves, industry supervisors and regulators, central banks, governments, and international agencies have adapted to the harsh lessons learned from the upheavals of the past decade.
Source: Banking: A Very Short Introduction (Very Short Introductions) 1st Edition by John O. S. Wilson
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