When a bank grants a loan, it creates brand-new money
A bank does not simply pass along savers' cash to borrowers. When it makes a loan, it credits the borrower with a fresh deposit, and new money comes into existence. Regulators require banks to hold only a fraction of those deposits in reserve, a setup called fractional-reserve banking.
At its core, a bank takes deposits from the public, holds them as balances customers can withdraw on demand, and lends. It raises money through current accounts, fixed-term deposits and by issuing bonds and, historically, banknotes; it lends through overdrafts, instalment loans and purchases of tradable debt. Reserves backing its deposits can come from new deposits, from selling assets or from borrowing from other banks, including the central bank.
Because banks sit at the heart of an economy's stability, most countries regulate them closely. Beyond reserve rules, they must keep minimum capital under the international Basel Accords. For most people and businesses a bank account is essential: banks clear cheques and handle card payments, wire transfers, automated clearing and cash machines, and money transfer firms are not regarded as a full substitute. Services reach customers through branches, the post, telephone, the internet, mobile phones, video links and relationship managers who visit wealthy or business clients.
The classic profit engine is the spread, the gap between the interest a bank pays for its funds and what it charges borrowers. Lending income rises and falls with the economic cycle, so banks have pushed fees and advice as steadier earners. In the United States they have also merged with investment and insurance firms under the Gramm-Leach-Bliley Act to sell everything in one place, priced consumer loans by credit risk, and spread debit, credit, prepaid and smart cards. In countries with weaker financial systems, some people still buy houses with suitcases of cash.
Modern banking took shape in the prosperous cities of fourteenth-century Renaissance Italy, building on credit practices from the ancient world. Families such as the Medici, the Fuggers and the Rothschilds dominated for centuries. The oldest retail bank still operating, Banca Monte dei Paschi di Siena, dates from 1472, and the oldest surviving merchant bank, Berenberg, from 1590.
Source: Bank
