Banks are an integral part of the capital markets and help keep the economy fluid.

Investors help keep the capital markets healthy by investing in securities, often for the long term. But what about capital that they may need for more immediate use?

While there are a number of short-term investment alternatives, people may prefer to deposit their extra cash in a bank. It’s safer than keeping money in a drawer or carrying it around, and it’s easily accessible. The money that people and organizations deposit in bank accounts is the capital that banks put to work.

By lending money to businesses to meet short-term financing needs, banks help keep the economy fluid, or liquid. And by providing long-term mortgages, banks provide individuals with the capital they seek to purchase homes. In fact, banks are such an important source of community funding for both businesses and individuals that their lending practices have sometimes been credited — or blamed — for the economic health of the country.

What’s a bank?

Between the 1930s and 1999, different types of banks had different functions and operated separately. Commercial banks accepted deposits for transaction, demand, and time accounts from their individual and business clients and made loans. Investment banks underwrote corporate debt and initial public offerings of stock, and advised business clients on mergers, acquisitions, and other financial issues. Merchant banks served business clients, often with a focus on raising capital and managing international transactions.

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Since the passage of the Financial Services Modernization Act of 1999, which deregulated the banking and financial industries, some of the traditional differences among commercial banks, investment banks, brokerage firms, and insurance companies have been blurred, although not totally eliminated, especially from a regulatory perspective. Similarly, savings banks, thrift institutions (also known as savings and loan associations), and credit unions once were restricted to accepting deposits and lending money. Today they offer many of the same services as commercial banks.

The Banking System

A double system

Most developed nations have a centralized banking system and a single authority that charters, regulates, and supervises all of the country’s banks. The United States is unusual in having a dual system.

Some banks are chartered by the state in which they operate and are regulated by either the Federal Reserve System (the Fed) or the Federal Deposit Insurance Corporation (FDIC). Other banks, known as national banks, are federally chartered and regulated by The Office of the Comptroller of the Currency (OCC). Federally chartered credit unions are regulated by the National Credit Union Administration (NCUA).

In fact, while there are sometimes differences about which regulations take precedence — laws governing lending practices are one example—federal and state laws tend to be compatible. If they’re not, federal rules take precedence.

So why maintain two systems? To most bank customers, the differences are imperceptible. But the dual banking system is credited with adding competition that promotes innovation. For example, state banks have pioneered many of the industry’s best ideas, including the checking account.

Controlling the currency

The OCC charters, regulates, and supervises the activities of national banks, their international branches, and US branches of non-US banks. Among its primary tasks are oversight of lending and investment practices — the ways in which banks put capital to work — and the directors and officers who work for the banks. The goal is to keep the banking system secure and honest and to ensure that banking services are widely available.

Much of a bank’s capital comes from the money in its deposit accounts. But because customers can draw on demand deposits whenever they like, the bank has to have money on hand to meet those demands. So banks don’t actually lend out all the money they take in from deposits.

The money a bank doesn’t lend is known as its reserves. The amount a bank must hold in reserve is set by the Federal Reserve, which uses reserve requirements as one way to control the economy’s money flow. Increasing reserves is also a way to help ensure that banks will be able to weather a financial crisis.

In conclusion

Public confidence in the banking system, is built, at least in part, on the FDIC, which insures bank deposits up to $250,000 per depositor. NCUA provides similar insurance for the credit unions it regulates. Accounts registered in different ways, such as trust accounts or IRAs, are insured as separate accounts. However, securities are not insured even when you purchase them through a bank or they carry the bank’s name.

The Role Of Banking System In Capital Markets by Inna Rosputnia

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