chapter  6
15 Pages

Financial intermediaries

Banking is a precarious business. Under certain conditions, banks could lend out more than they should, and shift the risk of their own lending practices onto the depositors which use banks to ironically reduce risk. Imagine a situation where a depository institution (commercial banks, savings banks, savings and loan associations, and credit unions) lent out all its depositor’s funds. If any of these loans defaulted, some depositors would lose money. Banks make money from depositors remaining confident that the bank understands its own risk, is diversified against major shocks affecting its ability to provide liquidity, and has a borrower pool that supports the bank’s strategic goals concerning profit.