Short Overview of the Banking System
The history of banking began with the first prototypes of banks around 2000 BC in Assyria, India and Sumeria. Here the principle of lending, while accepting deposits started to shape. Historians relate the essential historical development of a banking system to the period of Renaissance in Italy, particularly in Florence, Venice and Genoa. If you ever travel in Italy, you can still see the oldest bank in Siena, that has been operating since 1472. The development of banking advanced in Northern Europe in the beginning of the 15th century and, nowadays, we take by default the existence of these financial institutions. But why do we actually need banks, what makes them special and what are the current struggles that the banks face? This article gives a short summary about all that you should know about banks.
In the end, we all benefit from banks.
There are three reasons why we need banks. The first reason is that markets do not ensure efficient allocation of resources with the existence of frictions, such as transaction costs, asset indivisibility and agency costs. Furthermore, not all the investments lend themselves for markets, such as mortgages and small business lending. Lastly, there is a need for an accurate expertise when it comes to projects and money. In the end, we all benefit from banks through decreased transaction costs, reduced risk exposure assured by risk sharing and diversification and minimized agency problems, such as moral hazard and adverse selection.
Banks are special, because they have the authority and resources to obtain short-term funds (deposits) to invest in longer-term assets (loans). Also, they use liquidity transformation, meaning that cash-like liabilities are used to buy harder-to-sell assets. Another important feature of banks is that it can transfer the credit risk from safe deposit to risky loans. In other words, banks raise funds by attracting deposits, borrowing in the interbank market, or issuing financial instruments.
One of the requirements of Basel III is that the regulatory risk-based capital ratio should be 8%.
Above all the banks are the central banks, which have three essential goals. Firstly, they supervise and regulate all the other banks. For instance, banks have to adapt to Basel Capital Accord, promulgated by the Bank for International Settlements. One of the requirements of Basel III is that the regulatory risk-based capital ratio should be 8%. Secondly, the FED and the ECB act as lenders-of-last-resorts, by providing liquidity in times of stress. This becomes especially important when the interbank market “freezes”. Last but not least, central banks are in charge of monetary policy. Different policies can be used to stimulate or tighten economic growth. This can be done by increasing the money supply in case of a negative shock and, alternatively, by decreasing the money supply by raising interest rates when the economy is overheating.
The global economy suffers a loss of $2.1 trillion every year due to financial crime costs.
With the fast-changing world nowadays, banks also need to keep up with the speed of changes and overcome some serious challenges. Firstly, financial institutions started to have numerous problems with data breaches and system attacks. The number of firms that handle these situations increased by 480% from 2017 to 2018, reflecting the demand for cybercrime solutions. Global economy suffers a loss of $2.1 trillion every year due to financial crime costs - more than the GDP of Saudi Arabia, Pakistan, Switzerland, and Ireland, all combined. Every year approximately $2 trillion is laundered, while regulators are only able to catch 1%. Secondly, gid data use in finance provides both challenges and provides opportunities for the financial institutions. The possibility to tap into social media and research consumer databases can improve the services. However, it is extremely difficult to sort all this unstructured data and apply the learnt information. Last but not least, increasing efficiency, decreasing costs, and providing good services to customers are the areas where banks will always try to improve.
If nature were a bank, they would have already rescued it.
In conclusion, the banking industry has a fascinating history and it can be both a source of happiness and disappointment. The bottom line is that ultimately, the only person completely responsible for our own money is us, while, as Eduardo Galeano emphasizes, "if nature were a bank, they would have already rescued it".
