by Richard Sylla Currency note of one shilling, six pence, printed in the colony of New Jersey in 1776. (Gilder Lehrman Collection) Banks are among the oldest businesses in American history—the Bank of New York, for example, was founded in 1784, and as the recently renamed Bank of New York Mellon it had its 225th anniversary in 2009. The banking system is one of the oldest, largest, and most important of our industries. Most adult Americans deal with banks, often on a fairly regular basis. Nonetheless, banks and banking seem rather mysterious. What do banks do? Why have they for so long been an integral part of our economy? Why, as in the financial crisis that commenced in 2007, do banks every so often get into trouble and create serious problems for the country? Banks have two important economic functions. First, they operate a payments system, and a modern economy cannot function well without an efficient payments system. We make most of our payments by writing checks, swiping credit cards issued by banks or tied to them, and by paying bills via online banking. Most of the money stock of the country is in fact bank money; the rest of the currency is “legal tender” issued by the government, namely Federal Reserve Notes and coins. We have confidence in bank money because we can exchange it at the bank or an ATM for legal tender. Banks are obligated to hold reserves of legal tender to make these exchanges when we request them. The second key function of banks is financial intermediation, lending or investing the money we deposit with them or credit they themselves create to business enterprises, households, and governments. This is the business side of banking. Most banks are profit-seeking corporations with stockholders who provide the equity capital needed to start and maintain a banking business. Banks make their profits and cover their expenses by charging borrowers more for loans than they pay depositors for keeping money in the bank. The intermediation function of banks is extremely important because it helped to finance the many generations of entrepreneurs who built the American economy as well as the ordinary businesses that keep it going from year to year. But it is inherently a risky business. Will the borrower pay back the loan with interest? What if the borrower doesn’t repay the loan? What happens to the banking system and the economy if a large number of borrowers can’t or won’t repay their loans? And what happens if, in the pursuit of profit, banks do not maintain levels of reserves and capital consistent with their own stability? Show Full Essay Metadata Era: The New Nation, 1783-1815, The Great Depression and World War II, 1929-1945, Civil War and Reconstruction, 1861-1877, The Progressive Era to the New Era, 1900-1929, National Expansion and Reform, 1815-1860, The Rise of Industrial America, 1877-1900, 1945 to the Present Sub Era: Creating a New Government, The Great Depression, The American Civil War, The Early Republic, The New Deal, The Politics of Reform, The Age of Jackson, The Age of Jefferson and Madison, The Gilded Age, Facing the New Millennium Theme: Economics, Government and Civics, Reform Movements Curriculum Subject: Economics, Government and Civics Grade Level: 9, 10, 11, 12, 13+ Keywords: Banking, banking panics, corporations, depressions, deregulation, disintermediation, dual banking system, Federal Reserve notes, Finance, Great Depression, money, National Debt, Regulation, securities, stock Coverage People: Alexander Hamilton, Andrew Jackson, Robert Morris Coverage Events: Bank Holiday, Banking Act of 1935Banking Act of June 1933, Federal Reserve Act, Glass-Steagall Act, Great Depression, savings-and-loan crisis Coverage Organizations: Bank of New York, Bank of North America, Bank of the United States, Fed, Federal Reserve Board, Massachusetts Bank, Wall Street