The Role of Banks
Learning Objectives
By the end of this section, you will be able to:
- Explain how banks act as intermediaries between savers and borrowers in the orthodox approach
- Explain how banks create liquidity through loans in the heterodox approach
- Evaluate the relationship between banks, savings and loans, and credit unions
- Analyze the causes of bankruptcy and recessions
Somebody once asked the bank robber Willie Sutton why he robbed banks. He answered: “That’s where the money is.” While this may have been true at one time, from the perspective of modern economists, Sutton is both right and wrong. He is wrong because the overwhelming majority of money in the economy is not in the form of currency sitting in vaults or drawers at banks, waiting for a robber to appear. Most money is in the form of bank accounts, which exist only as electronic records on computers. From a broader perspective, however, the bank robber was more right than he may have known. Banking is intimately interconnected with money and consequently, with the broader economy.
Banks make it far easier for a complex economy to carry out the extraordinary range of transactions that occur in goods, labor, and financial capital markets. Imagine for a moment what the economy would be like if everybody had to make all payments in cash. When shopping for a large purchase or going on vacation you might need to carry hundreds of dollars in a pocket or purse. Even small businesses would need stockpiles of cash to pay workers and to purchase supplies. A bank allows people and businesses to store this money in either a checking account or savings account, for example, and then withdraw this money as needed through the use of a direct withdrawal, writing a check, or using a debit card.
Banks are a critical intermediary in what we call the payment system, which helps an economy exchange goods and services for money or other financial assets. However, the role these institutions play in the broader economy is a subject of disagreement among economists. Whereas orthodox economists typically look at banks mainly in terms of facilitating the movement of money from savers to borrowers, many heterodox economists see their function as almost the complete opposite. In this section, we will look at these two perspectives on the role of banks.
Banks as Financial Intermediaries: The Orthodox Perspective
Banks allow people with extra money that they would like to save to store their money in a bank rather than look for an individual who is willing to borrow it from them and then repay them at a later date. Likewise, those who want to borrow money can go directly to a bank rather than trying to find someone to lend them cash. Transaction costs are the costs associated with finding a lender or a borrower for this money. Thus, from the orthodox economics perspective, banks lower transactions costs and act as financial intermediaries—they bring savers and borrowers together.
An “intermediary” is