What Makes Banks Special? A Study of Banking, Finance, and Economic Development
60 Pages Posted: 20 Apr 2016
Date Written: November 30, 1999
How do interactions between banks and nonbank financial intermediaries affect economic development, stability, and efficiency? Will banks continue to be relevant in a financial system in which nonbanks take business away from banks, in which the financing of production is less and less important to banking business, and in which e-money is spreading fast? How will the electronic age change banks' role in financial intermediation?
Over the past two decades, finance theory has contributed significantly to understanding banks and identifying what qualifies them to be special financial intermediaries.
Historically, banks have had a comparative advantage in certain functions - such as providing liquidity and payment services and supplying credit and information - which competition, technological change, and institutional development have increasingly eroded. And the spread of e-money could deal a blow to conventional banking, generating entirely new ways of doing finance.
After integrating his examination of money, production, and investment, Bossone argues that banks remain special in that they lend claims on their own debt and the public accepts the debt claims as money. His study shows that banks and nonbank financial intermediaries perform complementary functions essential to the economy. Risk reduction policies in payment systems, banking asset allocation, and the deposit market affect the economy's tradeoff between risk and efficiency and the cost of generating resources to finance production.
As possibilities for global communications expand, trust will matter more than ever, and banks and other financial intermediaries will be in a good position to bridge gaps in trust when it comes to creating money and intermediating funds.
This paper - a product of the Financial Sector Strategy and Policy Department - is part of a larger effort in the department to study the links between financial sector and economic development and improve financial sector policy reforms. The author may be contacted at firstname.lastname@example.org.
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